M&A Hangover

Beware the Market Bust

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The ultimate trigger for mergers: Cheap money.
  • Why it matters

    Why it matters

    The value of takeovers this year could surpass the record year 2007, possibly signaling a decline in market values.

  • Facts

    Facts

    • In May alone, companies agreed to M&A transactions worth $243 billion, the largest monthly value ever reached.
    • The fundamental fuel for the fusion fever are the trillions in cheap money printed by central banks of the West, the writer says.
    • Companies aren’t spending much of their mountains of cash on investments because few believe the current economic upsurge has long-term sustainability, he argues.
  • Audio

    Audio

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This time everything will be different! As so often in an era of rising stock prices, flourishing business in the capital markets and a boom in mergers and acquisitions, the augurs of the financial markets are ready to give good arguments on why everything can only move in one direction: Upward.

A market in which the ascent is currently especially steep is the business of mergers and acquisitions, or M&A in short. In May alone, according to figures from data provider Dealogic, companies agreed to transactions worth a breathtaking $243 billion, or €217 billion – the largest monthly value ever reached.

In the first five months of the year, the figure was $1.85 trillion. The entire year could very well end up surpassing the peak value achieved in 2007.

Once again, the chief executives of large companies are eager to expand their empires through a wave of mergers. And once again, investment bankers are standing alongside to whisper advice in their ears.

They never tire of emphasizing that this time, everything is different, that CEOs learned their lessons from the many unsuccessful takeovers at the turn of the millennium and in the years before 2007. The claim is that this time, companies will be bought only when the purchase makes strategic sense and can be proven to increase value.

Soothing words, but the reality is unfortunately different.

In many of the transactions, the top managers are, just as in the past, also driven by their shareholders, their advisers and their own megalomania. On top of that come the seductions of the credit markets, where money for M&A can be had more cheaply than ever before.

And so the current trend for mergers rampant through all industries is not a sign of healthy economies, but the exact opposite. It is a symbol for what is currently going wrong – on the financial markets and in the entrepreneurial world.

The fundamental problem: Firms are investing too little because, even eight years after the beginning of the financial crisis, there is scarcely trust in a long-term upsurge.

In the United States, for example, investments by large companies in relation to the influx of funds have declined over the past five years from 29 percent to 23 percent. This means top managers are sitting on mountains of cash that they either reduce by repurchasing stock shares or put into M&A deals, which are often risky.

A further warning signal is the fact that the mergers and acquisitions are being paid for with increasingly hazardous loans. In corporate bond markets prices are at record highs.

The excesses of earlier boom years are back again. The loans are being issued more and more frequently with only very lax creditor obligations. The so-called covenant lite structures – loans with fewer restrictions on collateral, payment terms and cash flows – are again moving to the state they were in before the beginning of the 2007 financial crisis.

Banks have again become more willing to take on risks when making capital available for takeovers. Loans whose interest can be paid with further indebtedness are once more in fashion.

There are more signs of an overheating M&A market. The share of deals financed with a company’s own stock has doubled within two years to almost 30 percent. Activists who force CEOs into often senseless deals or split-ups are on the march.

The number of hostile takeovers is rising dramatically. And so-called quick flips, when investment funds buy and then sell companies in a short period of time, seem to be slowly becoming popular once more.

What is ultimately fueling the fusion fever are the trillions in cheap money printed by Western central banks. For that reason, a regulation currently in place in the United States with regard to debt markets – that banks are not allowed to issue more than six times a company’s operating income as a takeover credit – is a fruitless undertaking.

Instead of the banks, credit funds or even investment funds themselves provide the capital necessary for financing highly risky takeovers.

Thus the surge in takeovers is an alarming outgrowth of the debt-driven world in which we live. But even the omnipotence of the central banks will reach a natural end sometime, and with it, the third large M&A bubble of the 21st century will come to an inglorious end.

In the last 20 years, boom phases in the market for M&A deals have always gone hand in hand with bubbles on the stock and bond markets. Is everything different this time? Not in the least.

 

To contact the author: schaefer@handelsblatt.com

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