2015_12_16 Fortis Musings


Global M&A breaks the record and everyone gets nervous...

Well M&A did it! The all time record for a single year has been broken and we are at more than $4.3T worth of deals in 2015. Why do we even bother paying attention to this? Because M&A peaks tend to correspond with peaks in the stock market, which of course makes sense in that the more M&A there is the more companies will be bid up, etc. From a corporate stand-point that makes little sense as why would you be buying companies at record high prices. 2009 would have made for some nice purchases but M&A was less than half that year what it will be this year. 

The reason is fairly simple. When things get really bad (2009) most companies are simply trying to survive...very few have the cash to make transformative moves. So they hunker down for a few years and once things have stabilized (and their own stock gone up) they get back in the market because they need to "grow" and acquisitions are an easy way to grow. 

So let's look at global M&A vs. the S&P 500. Certainly it isn't perfect because this is global vs. US but the general points will still be valid:

Source: Dealogic 

This chart has the ability to give people the willies because 2004-2007 look eerily similar to 2012-2015...and we all know what 2008 brought. We think this is overdone for the following reasons:

  1. This is simply a chart with an overlay. Things look similar all the time...until they don't. 
  2. No one knows where M&A (or the market) is going in 2016. I can promise you almost no one was predicting a record in 2015. We could see some pretty major oil and gas mergers in 2016.
  3. People tend to mentally anchor on their most recent experiences to predict the future. The last downturn was the Great Recession which was very very bad for both the economy and for the stock market. There is no reason the next recession and stock market downturn need to be on the same level as the worst financial crisis in 70 years. 

But not to worry...the government will slow down this M&A party

In addition as the Economist showed this weekend, the government is helping to slow the M&A boom slow as well. As they explain, there are two agencies in the United States responsible for reviewing and approving M&A (i) the  Federal Trade Commission (FTC) and (ii) the Department of Justice (DOJ). These agencies have gotten a lot tougher recently. To quote the article:

But regulators are changing their approach, too... Rather than emphasising traditional yardsticks such as market shares in specific places, or barriers to entry, they are using a broader sense of whether a deal hurts competition—for example whether margins or prices will rise.

And ironically make the speculators a whole lot of money

In other words the regulators are broadening what causes could lead to their blocking of a deal. This has led to the following in the markets:

How far will the antitrust backlash go? One measure is the number of pending deals where the shares of the target are trading at a big discount to the proposed offer price, suggesting that arbitragers and investors do not expect the transaction to go through. Of the 20 largest pending transactions nine are trading at a discount of over 10%, including the merger of Baker Hughes and Halliburton, two oil-services firms.

This creates many opportunities for firms/individuals in the merger arbitrage game (speculation on whether or not deals will close). We don't play that game but there are likely to be some significant returns made by these spreads for those who choose wisely.