Confidence drives mergers
Faster US growth may pull merger activity higher, floating all economic boats, writes Sikonathi Mantshantsha
That the US Federal Reserve is now talking about the possibility of raising interest rates from the middle of 2015, in the face of almost full employment in an economy that no longer needs the artificial support of quantitative easing, must shift the focus to how much more growth the world’s biggest economy will achieve next year.
Alongside the GDP growth spurt, mergers and acquisitions have topped seven-year highs in value, with the acquirers of companies paying premiums of about 25% to gain control of their target firms. Those deals, and buoyant share markets, are reflected in the US economy’s annual 3.5% growth in the third quarter of 2014.
That helped lower unemployment to 5.8% in October, bringing the US economy to what officials call “near full employment”.
Investors are pinning their hopes on the prospect that the markets will maintain the momentum into 2015, and that some of the mooted megadeals will indeed finally emerge.
There has been an increase in major general merger activity this year, with transactions of $30bn and above fitting the category of megadeals. Among the biggest deals this year were General Electric’s $17bn takeover of Alstom’s energy assets and Oracle’s $5bn acquisition of Micros Systems. But a few other proposed large mergers never materialised, and there is promise of more yet to come.
This year’s merger spree was driven by companies rich in cash and that have strong balance sheets, which is unlike conditions in the heyday of deal-making back in 2007, says Reuters in a June 2014 article.
That was when private equity
investors used cheap money to saddle companies with debt in the hope that it would be serviced from the rapidly increasing sales fuelled by almost free money coming from the mortgage sub-prime crisis and the petroleum economies of Asia and the Middle East.
China held a promise of super growth, which had been sustained for at least three decades.
The Reuters story came just months before even bigger deals became apparent.
Locally, SABMiller’s market capitalisation was inflated by about R100bn on the JSE, to more than R1-trillion, after its failed takeover attempt of Heineken was speculated to leave the brewer vulnerable to its own takeover by Anheuser-Busch InBev. The family that controls the Dutch brewer Heineken rejected SABMiller’s unsolicited approach in September, opting instead to remain independent.
While it has gone slightly quiet again, the rumour mill continues, and there is speculation that AB-InBev is engaged in consulting funding institutions about a possible takeover of the London-based brewer with South African roots.
With the major equity indices hovering at around record valuations, the buzzword is confidence, and that is exactly what the markets want, says Sasha Naryshkine, a portfolio manager at Vestact in Johannesburg.
The S&P 500 is leading the pack, hitting a record 2,000 points late in November. “It’s a good thing for equity markets; more and more people are confident of the future,” says Naryshkine.
While it is positive to have the confidence that is fuelling the merger waves, Naryshkine also cautions that the worst possible mergers can be consummated during times of such heightened expectations. “It was during the resources boom before 2007 that the worst mergers were done.”
But things have since changed for the worse in resources.
The oil price has declined 30% from the $111/barrel high in August last year, to the current $78/barrel, while the prices of both platinum and gold have declined by 23% and 17% respectively over the same period. The drop in the prices of these major commodities may help
The JSE all share index has stayed just above the 50,000 mark since October … This record-breaking performance comes in the face of seemingly insurmountable problems in the domestic economy
drive consolidation in their fields, says Naryshkine. “Commodity prices have moved significantly lower now, and [therefore] you’d expect some merger activity in that space,” says Naryshkine.
Unlike the pre-global recession resources mergers, which was for growth, a new wave of transactions would be fuelled by the need to survive, Naryshkine says. Survival-driven mergers come about when the cost of production surpasses the selling price and revenue. Producers then merge to exploit scale and gain control over volumes supplied to the markets.
“A lower-price environment is when the best merger deals are done,” says Naryshkine, pointing out that at the height of the resources boom before 2007, “people didn’t think prices could fall; they were too confident”.
This low point in the commodities cycle, together with the depressed global economic outlook, does not bode well for expansion opportunities, says Wayne McCurrie, a portfolio manager at Momentum Asset Management.
“There is an oversupply of resources, and generally oversupply situations take time to work themselves out of the system,” he says. It is not good for either expansionary mergers or new projects.
In the face of depressed resources markets, companies will have to think about ways in which they can cut costs in order to cope with lower commodity prices, says McCurrie.
At $80 a barrel of oil, certain
producers in the Middle East and the US are not profitable.
Some of the ways they could arrest the situation is to merge with rivals in order to exploit economies of scale, or to arrest the production glut that is threatening to put a sustained downward pressure on prices.
In contrast with the depressed resources prices, markets in other industries are doing rather well, courtesy of these same lower oil prices.
The JSE all share index has been staying just above the 50,000 mark since October. That’s due to the combination of a weakening local currency, reduced domestic output and higher global economic output.
This record-breaking performance comes even in the face of seemingly insurmountable problems in the domestic economy. SA’s annual GDP growth has stuttered to about 1% a year from 3% three years ago, and the rand has weakened significantly to R11 against the dollar now, from R7/$ in 2011.
It is therefore clear that most of this performance is not anchored on the local economic reality, but rather on a generally warmer global sentiment.
It’s not about to get better any time soon.
SA’s significant structural problems, the biggest of which is the dire shortage of energy to power up economic activity, will not be solved in the short term, says McCurrie.
“And that environment does not bode well for expansion. It doesn’t help the investment climate,” he says.
It is in the US that things have improved significantly, says Naryshkine. Earnings growth of about 9%/year, while they seem pedestrian in the emerging markets context, have lit a fire under share prices in the world’s number one economy.
“This rising tide of mergers does float all boats, but there are risks that have to be carefully weighed up,” says Naryshkine.