Mon­ster Deals, Big Ques­tions

A surge in M&A can be a sign the econ­omy is sput­ter­ing “I’m not sure the same lessons ap­ply this time around”

Bloomberg Businessweek (Asia) - - Global Economics - −Matthew Philips

On Nov. 23, when drug­mak­ing gi­ants Pfizer and Al­ler­gan agreed to com­bine, na deal worth $183.7 bil­lion, 2015 gained the dis­tinc­tion of be­com­ing a record year for merg­ers and ac­qui­si­tions. The Big harma deal, by far the year’s largest, pushed 2015 past the $3.4 tril­lion mark in global M&A value set in 2007, just be­fore the fi­nan­cial cri­sis. That beat the pre­vi­ous record, set in 2000, which also came right be­fore the econ­omy fell into re­ces­sion, pulled down by the dot-com col­lapse.

A flurry of cor­po­rate deal­mak­ing is “a clas­sic late-cy­cle de­vel­op­ment,” says David Rosen­berg, chief econ­o­mist at Gluskin Sh­eff, a Toronto money man­ager. “When com­pa­nies em­bark on peak &A ac­tiv­ity, it is more of­ten than no co­in­cid­ing h a peak n the stock mar­ket and, dare I say, a peak in the busi­ness cy­cle. Com­pa­nies are telling us they can no longer grow or­gan­i­cally.” The dol­lar value of deals in 2015 through Dec. 21 was $3. tril­lion.

Dur­ing six and a half years of ex­pan­sion, the U.S. con­omy has av­er­aged only 2.2 per­cent an­nual wth. With in­ter­est rates near zero and cor­po­rate bal­ance sheets flus with cash, the eas­i­est way for ex utives to boost share prices has of­ten been to in­crease div­i­dends and buy back stock.

That strat­egy worked toa de­gree. Even with lack­lus­ter eco­nomic growth, the stock mar­ket has al­most tripled since its March 2009 low. Yet cor­po­rate prof­its peaked in the sum­mer of 2014. With con­sumer de­mand still weak around the world, sales growth re­mains elu­sive. Rather than try­ing to gen­er­ate rev­enue them­selves, com­pa­nies have been uy­ing growth inst d, ac­quir­ing ri­vals at an un­prece­dented pace.

The near-term im­pact of a merger boom tends to be neg­a­tive for the econ­omy, Rosen­berg says. The watch­words of cor­po­rate M&A—cos and syn­er­gies—usu­ally trans­late

into peo­ple los­ing jobs. ''The idea is to take ca­pac­ity of the sys­tem and gen­er­ate bet­ter re­turns for share­hold­ers,” he says. ''I don"t think I’ve ever seen a merger that didn’t in­volve job losses.”

Judg­ing the longer-term im­pact of all th­ese deals is trick­ier. Some will in­vari­ably­turn out to be mis­takes. “In a world where bor­row­ing money is vir­tu­ally free, you’re prob­a­bly do­ing more of th­ese deals than you should,” says Jim Paulsen, hief in­vest­ment strate­gist at Wells Cap­i­tal Man­age­ment. But a surp us of deals doesn’t mean a eces­sion is lurk­ing nearby. Given how bizarre this re­cov­ery has been—al­most seven years of weak growth de­spite record-low in­ter­est rates—“I’m not sure the same lessons ap­ply this time around,” aulsen says.

For one, the cur­rent flood of deal is more U.S.cen­tric than pre­vi­ous ones. So far this year, merg­ers and ac­qui­si­tions made by U.S. com­pa­nies have ac­counted for al­most $2 tril­lion in deals, more than half the global to­tal. Euro­pean tar­gets made up the small­est share of global ac­qui­si­tions in 17 years, 21 per­cent, or only $785 bil­lion. That gives many cor­po­rate watch­ers con­fi­dence that M&A isn’t over­heat­ing, be­cause it’s mostly fo­cused on the world’s strong­est econ­omy.

This year’s rush is also note­wor­thy for the num­ber of trans­ac­tions val­ued at more than $10 bil­lion, says Rus­sell Tho son, who leads Deloitte& Touche’s U.S. M&A prac­tice. By his cal­cu­la­tion, it’s about dou­ble the num­ber of high-priced merg­ers dur­ing the pre­vi­ous peaks of the past 15 years. “That is quite stag­ger­ing,” says Thom­son, who point out that this year’s crop is more evenly spread across the var­i­ous parts of the econ­omy, “in­stead of be­ing con­cen­trated in one or two in­dus­tries.”

Ear­lier re­ces­sions were pre­ceded by ever-riskier deal­mak­ing in sin­gle in­dus­tries. Such fo­cus led to fi­nan­cial im­bal­ances as too much money poured into one part of the econ­omy. Think the dot-com bub­ble that burst in 2000 or the 2008 r sis that dev­as­tated house holds, home­builders, and banks. This time the lack of eal­mak­ing fo­cused on one in­dus­try low­ers the chance of a re­ces­sion. The av­er­age ex­pan­sion

since World War II has lasted less than five years. Joseph LaVorgna, chief U.S. econ­o­mist at Deutsche Bank Se­cu­ri­ties, re­jects the idea that re­cov­er­ies “die of old age. They die of im­bal­ances, and right now I’m not see­ing a lot of im­bal­ances.”

Ev­ery re­ces­sion is dif­fer­ent, but they all tend to have the same main in­gre­di­ent: in­fla­tion. De­spite an ab­nor­mally long re­cov­ery and rates near zero, in­fla­tion is very low. So is growth. The av­er­age forecast among econ­o­mists sur­veyed by Bloomberg is for the U.S. econ­omy to ex­pand 2.5 per­cent in 2016. That makes LaVorgna ner­vous: “I’m more wor­ried over the in­abil­ity to gen­er­ate de­cent eco­nomic growth than I am over what this M&A boom is sig­nal­ing.”

From a cor­po­rate stand­point, with so much cash flood­ing the sys­tem, ac­qui­si­tions have be­come less risky given most com­pa­nies’ lower cost of cap­i­tal, says Stephen Mor­ris­sette, who teaches M&A strat­egy at the Univer­sity of Chicago Booth School of Busi­ness. “You really have to over­pay for some­thing, for a deal not to end up adding value.”

Rather than a warn­ing of weaker growth, some econ­o­mists see the record M&A ac­tiv­ity as the op­po­site. “I think it’s a sign of strength in the U.S.,” says Torsten Slok, chief in­ter­na­tional econ­o­mist at Deutsche Bank. “Cor­po­rate Amer­ica’s ap­petite for risk is fi­nally be­gin­ning to thaw. Even if ac­tiv­ity slows down next year, I think we are still two or three years away from a re­ces­sion,” he says. Allen Si­nai, chief global econ­o­mist of De­ci­sion Eco­nomics, agrees. “If any­thing, this is a sign of mat­u­ra­tion. It’s as if this re­cov­ery is just reach­ing pu­berty. Chrono­log­i­cally, it’s old, but func­tion­ally, it’s still very young.”

The bot­tom line An M&A wave can sig­nal an eco­nomic down­turn, but this record-break­ing cy­cle may not fol­low the script.


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