M&A misunderstanding

M&A misunderstanding​
Posted on 25 April 2014

"But it’s alright Ma, it’s life and life only”” - Bob Dylan
Like London buses, you wait ages for a blockbuster deal then several come along at once. Merger and acquisition (M&A) activity has picked up markedly in the last year: a 6-month rolling average of deals reported by Bloomberg is at a post-crisis high, and in April there have been two announced $20bn-plus deals, with unconfirmed reports of another two pending.

The upturn is not unexpected. M&A has a cyclical component. If anything, the surprise is that it took so long coming. The financial crisis clearly cast a long shadow: CEO and CFO confidence has taken a while to recover. But the objective drivers of M&A have long been in place, and it has been a recurrent investment theme for us these last few years.

Targets are attractive: corporate profitability and cashflow is respectable. Funds are available: balance sheets are cash rich, investor appetite for corporate bonds remains high, and banks are more able, and willing, to lend if asked. Post-crisis restructuring, new technology and the ongoing search for consolidation provide plenty of bottom-up business cases. PEs are no longer depressed, but low interest rates mean that when viewed through the lens of discounted cashflow, valuations can still look cheap to would-be acquirers. Confidence has been the missing ingredient, but surveys suggest that it is again gathering some momentum after the weather-affected first quarter.

What does more M&A mean for investors? It is not easy to second-guess the deals themselves – some sectors, such as pharmaceuticals, are more active than others, but in the aftermath of the crisis opportunities will be plentiful and spread across most sectors and regions (including, unusually, Japan, if Abenomics is going to work…). Instead, we’d view a wave of M&A as another reason for tactically and strategically favouring developed equity markets ahead of most other assets.

This contrasts with the popular view that M&A destroys value, and that the shareholders of acquiring companies in particular lose out as ego-driven, reckless CEOs overpay for unfamiliar assets. We’ll certainly know what to do the next time a French sewage company buys a US entertainment group. However, the debate about M&A is (yet) another economic issue in which received wisdom may diverge from reality. Don’t take my word for it: despite its title, Robert Bruner’s “Deals From Hell: M&A Lessons That Rise Above the Ashes” suggests that with some obvious high-profile exceptions, M&A is more often than not positive for shareholders. And the studies he reports mostly focus on relatively short-term movements in share prices: if we were able to consider the effects of industry consolidation on value added, and on the long-term returns from investing, my guess is that the likelihood of positive outcomes would be higher still.

This may have to remain an article of faith, however. For many big, old companies the acquiring of suppliers and smaller competitors, and the divesting of restructured or sidelined assets, is part and parcel of business life, often with its own departmental structure. M&A can’t easily be disentangled from BAU, and a convincing assessment of its worth may be elusive.

Kevin Gardiner, Chief Investment Officer, Europe

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