Increased Potential for Mergers & Acquistions this Year
Merger and acquisition (M&A) activity of publicly traded companies has increased significantly in the last year, hitting an eight-year high, according to Bloomberg. The increase is encouraging, and we anticipate that the trend will continue throughout 2015.
In 2014, we saw a 27% increase in volume of M&A activity to $3.5 trillion. Another increase of that magnitude would top the historical peak of $4.3 trillion in 2007. At the half way point of 2015, $2.15 trillion in deals or announcements have been made according to Dealogic. If that same trajectory continues, it would put us within striking distance of the record.
The catalyst for this growth is the improved health of the banking system and corporate America. Those reaping the greatest benefit are the shareholders of these companies.
Bank lending is critical to any recovery and, as of late, it has been a key source of funding for M&A activity. It took the banking system a few years to right itself to start making meaningful loans again after the housing bubble. Heavily funded by the banking system, the housing bubble burst caused a huge liquidity crisis. Fortunately, the Fed flooded the system with liquidity and provided much needed capital to banks allowing them to recover.
Corporate America Shapes Up
In addition to bank recovery, Corporate America’s actions to trim companies back to more profitable status has facilitated an environment for M&A. Surviving the worst recession since the Great Depression has forced companies to be more competitive and focused. Over the previous 10 expansions since 1949, the average annualized real GDP had been 4.56% and the current expansion to date that began in 2009 has only been 2.2%.
Corporate America looked inward for ways of improving margins by laying off employees, discarding nonproductive lines of businesses, cutting debt and looking for other ways to increase efficiency. With cash accumulating to record levels, more companies have initiated stock buyback programs to increase stock prices.
Overall there has been vast improvement in the financial condition of the market, as evidenced by the total leverage (ratio of total debt to total equity). For companies in the S&P 500, total leverage has been reduced from 200% to 103% as of March 2015, levels not seen since the late 1980’s. However, companies remain hesitant to take on any additional risk with uncertainty internationally and in Washington.
Improved Conditions Positive for Increased M&A
With the improved health of corporate balance sheets and the increase in the number of willing lenders, the stage is set for M&A. These factors have incrementally strengthened over the last 3½ years, but only in the last eighteen months have they really taken hold. In a study conducted by JP Morgan, they argue that we are $2 trillion behind in terms of volume based on historical statistical relationships between economic indicators. So if they are right, we have a ways to go. (need this to refer to in the last sentence)
On April 9, 2013, the S&P 500 reached its previous high of 1,565 that occurred on October 9, 2007. Until reaching this milestone, most companies wouldn’t consider selling unless their stock had recovered.
Margin expansion has been stretched; further efforts to widen them would be counterproductive and could cause them to contract. At the same time, organic, top-line growth is becoming tougher to achieve. CEOs and their boards are feeling the heat from institutional shareholders to increase the value of their stock. Shareholders are looking to M&A as a means of meeting these market expectations. Companies have several tools to finance M&A activities: the cash on their balance sheet, the rising price of their stock as a means of exchange for the target company’s stock, and the ability to borrow money at today’s extremely low rates to fund the purchase.
Darwin at Work
Further driving the M&A trend are CEOs’ fear of lacking the strategic resources necessary to meet their long term needs. Worse yet, they fear their competition acquiring those resources and positioning to purchase.
Many transactions can be accretive almost immediately or within a short period of time. In some cases the market recognizes this and the acquiring company’s stock also rises in value after the announcement is made, further building CEOs’ confidence to make acquisitions.
Some companies recognize that options for growth are limited and it is better to be acquired. We saw this recently when Humana made it known that they were for sale. Aetna agreed to buy Humana, and UnitedHealth Group quickly targeted Aetna. Aetna went from hunter to hunted. Cigna was also targeting Humana when it received a proposal to be bought from Anthem. The catalyst for this M&A activity is the drive to consolidate and grow to stay competitive under the new healthcare law.
There are other areas of the market, like Media, Oil & Gas and Technology that are experiencing the same type of activity based on their own unique catalysts.
Though M&A has picked up significantly over the last eighteen months, based on JP Morgan’s study, we are still behind in volume-based historical measures. All of which is good news for investors.