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Second-degree merger

22 December 2014 By Rob Cox

Success begets imitation, especially in Wall Street’s M&A factories. More than $3.2 trillion of deals were proposed around the world in 2014. More will be encouraged by the uproarious response given by investors to shares of acquiring companies. As the easy pickings evaporate, though, the laws of corporate finance will prevail. Buyers can expect greater skepticism.

There’s no obvious reason for the pace of mergers to slow. Companies are flush with cash and stock prices are robust. The total value of deals still lags its historical correlation to global market value.

Most importantly, companies are being generously rewarded by their owners for shopping. Of the 136 acquisitions over $1 billion unveiled by U.S. companies through Dec. 2 this year, two-thirds of buyers experienced a rise in their shares upon announcement, according to Thomson Reuters data. That defies the 50 percent average over the past seven years.

Such incentives will motivate boards, not to mention chief executives larded with stock options, to sanction more deals. Indeed, it’s what happened in the second quarter, as the number of big acquisitions nearly doubled after four out of five U.S. buyers got stock-market bumps for ones unveiled in the first three months of the year.

With each successive quarter, however, investor ardor waned. After the roaring start, 70 percent of buyers secured a deal-related stock lift in the second quarter; 63 percent in the third; and 56 percent in the fourth. A return to the long-term average is only natural. Investors are bound to cool on M&A as the more obvious transactions, where overlapping businesses slash costs, get done.

Pairings like Signet Jewelers and Zale, or cement-makers Holcim and Lafarge, were prime examples, where the net present value of synergies met or exceeded any premium paid. There is a limited supply of such deals, however. Similarly, inversions, where switching tax domiciles promised an instant increase on the bottom line, provided a sugar rush that has since crashed.

Following a post-crisis dearth of deals, the M&A business is rapidly fulfilling pent-up demand. Animal spirits are still high in corner suites, but less so among investors. In 2015, one will catch up with the other.

This view is a Breakingviews prediction for 2015. Click here to see more predictions.

 

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