Your name does not have to be Nouriel Roubini, Paul Krugman or Ben Bernanke to understand that the United States economy is not faring so well these days. Still recovering from the most severe financial crisis since The Great Depression, the economy is plagued with uncertainty related to costs associated with regulatory reform, a consumer that prefers to save rather than spend, and potentially higher income, dividend, and capital gains taxes.
The “headwinds” for the market and ultimately, a CEO are blistering. These executives are struggling to enhance shareholder value as costs have been slashed and final consumer demand remains weak. With historically high cash balances and a limited appetite to pursue new ventures, some CEO’s are turning to mergers and acquisitions (M&A) as a means to acquire new technologies and services that will enhance their footprint in the market, yet at the same time provide the opportunity to realize further cost synergies and enhanced distribution opportunities.
Most recently we have seen M&A activity increase with BHP Billiton’s hostile bid for Potash, Intel’s acquisition of McAfee, First Niagara merging with NewAlliance Bancshares (biggest US bank takeover since 2008), HP and Dell’s bidding war for 3PAR, and HSBC’s stake in South-Africa based Nedbank. According to Bloomberg data, deals in August will total $285 billion, close to the $297 billion of deals in August of 2007.
There seems plausible four main reasons for the recent M&A flurry:
- Anemic economic growth in developing countries, limiting revenue expansion and potentially bottom line growth after expenses have been aggressively cut. The limited growth is attributed to an apprehensive consumer and unforeseeable regulatory future created by policy leaders.
- Excessive cash on corporate balance sheets are due to lack of demand or confidence, leading to hesitancy to hire additional workers or increase capital expenditures. Shareholders demand that cash be invested in current or future businesses, not remain as reserves.
- Low borrowing costs coupled with low earnings rates on corporate cash lead to low cost of capital and inefficient interest gains on cash.
- Executives are not expecting a double-dip recession, but instead a slow growing economy that forces them to diversify or grow revenues and margins through M&A efficiencies.
Underlying these deals, there seems to be a consistent pattern developing. BHP Billiton, the world’s largest mining company is attempting to buy Potash to enhance its emerging market presence with Potash’s investments in China, Chile, and India. Intel’s acquisition reflects a chip maker acquiring a security company to supposedly enhance its top and bottom line while growing margins through synergies. HSBCs acquisition of Nedbank is just another attempt of an established company searching for growth in emerging markets.
While M&A activity is normally bullish for stocks and the economy in general, many experts believe as though these deals are not for the right reasons. Most of the acquisitions reflect an attempt to grow in other countries. This reiterates executives’ view of the weak US economy and the need to diversify away from a sluggish revenue stream. In August of 2007, an extraordinary amount of deals were done correlating closely with a stock market and economic high or top.
Many market commentators will use the M&A flurry to describe a negative catalyst where CEOs and executives tend to be late in timing markets and can invest capital at the height of the market rather than prior to a boom. I take a slightly different view and see the deals completed as a mixed revelation of confidence in the strong emerging market growth versus tepid growth for developed economies. While companies are admitting that domestic growth is fragile, they are confident enough to finally deploy capital with confidence that they will receive a higher yield on their investment than current interest rates on cash balances.
Corporations are also in disagreement with the market regarding the battle of bonds versus stocks. Companies believe stocks are too cheap and this is reflected in their hesitance to use stock to finance deals. Normally, businesses issuing equity for financing usually relates to a management’s belief that their stock is either overvalued or at fair value. Debt and cash are inexpensive avenues to raise capital and this phenomenon was most recently exacerbated in IBM’s ability to sell 3 year paper for just 1%.
I believe that the “headwinds” for the market and the economy that caused the near 20% decline in equities and recent soft economic data are suddenly becoming “tailwinds” that can rejuvenate stronger and more sustainable growth. Since the equity market decline and fixed income rally that started in late April, many economic and market variables have changed. The 10-year treasury yield that was pressing above 4% currently yields close to a record low of 2.40%, The Fed that was previously readying to withdraw liquidity in the market, is now on the cusp of further Quantitative Easing. Also, the dollar strength that was experienced months ago has started to fade as the greenback has erased half of its gains against the Euro, and finally, Crude Oil that traded around $85-$90 per barrel, currently rests around $73 lowering gasoline prices and allowing more disposable income for consumers. The variables are stimulating in nature for the consumer and businesses and it possible that CEO’s are taking note of that and investing in M&A.
Ultimately there is no debating that US economic data has been soft but I feel as though the scale has tipped far enough where the variables that drove economic growth in 2009 have corrected themselves to a currently favorable position. CEO’s are starting to invest in future business rather than continue to hoard cash. This allows me presume that the recent M&A buzz reflects that companies believe in a recovery rather than a recession and therefore to be cautiously optimistic with regards to previous impediments now becoming catalysts for growth.