Understanding The Rise In Mergers And Acquisitions Activity

Includes: DIA, IWM, QQQ, SPY
by: John M. Mason


This year there has been a substantial pickup in mergers and acquisitions.

No one seems to have a firm grasp on what this increase means...whether it is a good sign or not.

Investors need to be careful how they choose investments at this time and not get caught up in all the publicity surrounding the deals being announced.

More attention is being paid to an increase in merger and acquisition activity. For example, the New York Times plays up the pitch "Stampede of Mergers Could Mean Growth, or Irrationality, Ahead."

The news, released by Thomson Reuters, is that $2.2 trillion in M&A deals have been announced globally this year. According to the Times, "it is setting up 2014 to be a robust year for deal makers."

A lot of analysts, myself included, have been looking for a "boom" in corporate M&A to pick up for several years now. For one, many healthy corporations have had a lot of cash hanging around and this has, in the past, always been an indicator of an increasing level of deals to follow…especially in the early stages of an economic recovery.

Second, longer-term interest rates have been at phenomenally low levels, making it cheap to obtain the amounts of money needed to do transactions at an extremely low cost.

The only thing that seemed to be holding back the corporations that had the cash or the borrowing power was uncertainty. In this case the uncertainty seemed to be connected with Washington, D. C. and the direction economic policy was going to take with respect to the business sector.

As a consequence, the better-off corporations used their cash…or used their borrowing power…to repurchase their stock or to increase their dividends.

Corporate managements did not show any inclination to use these funds to invest in productive physical investment like plant and equipment…again due to the uncertainty about government policymaking…and, also, because of the very anemic economy.

This was all well-and-good, but it signaled that these corporations didn't have anything better to do with their money than to "buy-off" shareholders…showing the shareholders that they were concerned about their well-being even if they didn't have anything else better to do with the company funds.

Capital investment in plant and equipment still lag historical experience, although investment in intellectual property has shown exceptional strength through this recovery. But, this has not led to strong demand for putting labor back to work in the jobs they had worked in historically.

But, now it seems that merger and acquisition business is picking up.

The question that has not been answered is whether or not the rapid increase in actual deals taking place is good for the economy. Just look at the headlines for the New York Times article:

Does the pickup in deals indicate that the economy is expected to grow more rapidly…or, is the pickup a sign of irrationality?

If the pickup is a sign that managements are expecting the economy to grow more rapidly, this is certainly not occurring because of a decrease in uncertainty with respect to government policy. The only discussion about the government's economic policy pertaining to corporations is the discussion coming out of the US Treasury Department about reducing the amount of "inversions" that are taking place. Inversions are corporate acquisitions where an American company purchases a foreign company and then moves its headquarters to the country of the foreign country so as to avoid being taxed at United States tax rates which are the highest in the developed world.

And, the focus on the "inversion" issue does not seem to be solely for economic reasons.

Otherwise, President Obama seems to be in his "lame duck" phase and is putting out little or nothing in the way of economic policies that can reduce uncertainty or spur on the economy.

In terms of economic irrationality the Times article cites David Einhorn, who heads up the hedge fund Greenlight Capital. Mr. Einhorn is selling short some companies that are targets for takeovers because they are have relevant weaknesses and hence are more willing to sell "at any sort of premium."

The other argument that can be made is that many of the acquisitions are being made because this is the only way, in such a weak economy, for the acquiring company to show investors an increase in corporate revenues.

We, of course, will not know whether the pick up is due to faster economic growth or irrationality for a few more years. In the meantime, I believe that it is important to reflect on a couple of other issues.

First, historically we have seen that most acquisitions don't really work out and have to be unwound in some way after a few years. The record is that a good deal more than 50 percent fail. This raises, in general, some concern over the rush of managements to acquire other organizations at all.

Second, in most cases, for acquisitions to succeed, there has to be a substantial re-structuring of resources so as to combine most effectively the two organizations. This usually requires substantial reductions in employment and the selling off of duplicate or unneeded assets. Such consolidations do not…in the short-run…add to productive output or reduced unemployment.

Benefits to economic growth and rising employment usually are achieved only after several years…not initially.

Third, corporate acquisitions are often just the result of executive egos. That is, corporate acquisitions are often made for the wrong reasons although a "reasonable" justification is given for the transactions. This, of course, is not a good rationale for making such a substantial economic decision.

Bottom line, merger and acquisition activity is increasing, something that many of us have been expecting for three or four years. And, this is taking place at a time when economic growth is still not that strong, either in the United States, but especially in Europe, which is experiencing disinflation and where Italy has just been diagnosed as being in its third recession since 2007.

My concern is that the rise in activity is due to the low interest rates at a time when many corporations have too much money "hanging around" and when corporate leaders are a little more afraid that others are going to get the "jump" on them. In terms of this latter point, these corporate leaders have been waiting around for several years, poised to make an acquisition…or two…or three. They have not really wanted to be the first to make the move. Now that some companies have moved, others are jumping into the game…not to be left behind.

Yes, there will be some "good" acquisitions made during this time but I am not really sure that the rapid increase in M&A activity taking place at this time are in the best interests of the companies involved or are going to contribute in a major way to increasing economic growth and reducing underemployment. Like I just said, there will be some "good" acquisitions…just be careful in your investment decisions and don't get caught up in all the "hype" surrounding the headlines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.