Equity investors used to punish the shares of companies that launched bids. Their eagerness to see firms spend cash means they are now more likely to applaud such moves. Quantitative easing and low returns explain how it started. A worrying deterioration in credit quality could be how it ends.
Asset managers have been running down their cash piles and are keen for companies to follow suit. Morgan Stanley has analysed data going back to 1997 and found that this year more European acquirers saw their shares rise than not after bid announcements – for the first time ever. Take, for example, British medical technology company Smith & Nephew after it agreed in February to buy U.S. sports medicine firm ArthroCare. A similar phenomenon is being observed in the United States. Roughly two of every three U.S. bidders have seen their stock rise so far this year, according to Thomson Reuters data – just look at Zimmer, which said in April it would buy rival orthopedic products maker Biomet, or generic drugmaker Actavis, whose purchase of Forest Laboratories was announced in February.
This is unusual, as the traditional justification for bidders’ shares falling is still as valid as ever. Buying companies typically involves paying a large control premium and then getting bogged down in an integration which is costly to implement and can even lead to lower revenue for the combined entities. The whole endeavour is often a recipe for value destruction.
But right now, equity investors are willing to see firms worldwide do almost anything rather than continue to sit unproductively on roughly $7.5 trillion in cash. Not only that, activist investors are switching sides and helping companies launch takeovers. Just look at Bill Ackman’s support of Valeant’s hostile offer for rival pharma group Allergan. Activist investors used to be the thorn in the side of acquirers.
The situation can be explained by a combination of desperation with the low returns available on cash, twinned with a growing confidence that economic recovery is taking hold, reducing the need for big liquidity cushions. The danger is complacency. For the most part, companies still aren’t hugely leveraged. And in some cases, the best route to growth might well be mergers or acquisitions. But as equity investors cheer on bidders, the likely outcome is more companies doing risky cash deals that weaken their balance sheets. Rising share prices on M&A could herald a worse future for bondholders.