It has been a long wait, but animal spirits are finally stirring again. Not just in financial markets, where the bull market has been underway for more than five years now, but in the real world of corporate activity.
After half a decade of caution, rebuilding balance sheets and keeping their heads below the parapet, business leaders are finally on the look-out for opportunities. With interest rates at rock bottom, market volatility low and growth hard to come by in a sluggish global recovery, there has never been a better time to think about getting the corporate chequebook out.
A global phenomenon
According to a recent report in the Financial Times, takeover deals worth $1.7trn were completed in the first six months of this year. That’s a 75% increase on last year and the highest since the pre-crisis mergers and acquisitions (M&A) boom in 2007.
It’s proving to be a global phenomenon – big rises in activity were recorded in the US, Europe and Asia. A lot of the activity has been in the healthcare field, with more than $300bn of the total in this sector alone. It would have been even higher had Pfizer managed to persuade AstraZeneca’s shareholders to sell out.
Positive economic backdrop
M&A is typically a late cycle activity. That’s because launching a bid for another business requires a high degree of confidence from an acquiring company that the favourable environment is likely to continue. That positive sentiment is only widespread after the recovery has been underway for a while.
So takeovers are both a sign of a positive economic backdrop but also an indication that the cycle is maturing. They can be a warning sign as well as a piece of positive reassurance. So should we be worried that M&A is picking up so fast?
Dot.com bubble
The first point is that the deals that have recently been announced seem to make sense from a business point of view. That’s important because later in the M&A cycle, companies that are afraid they might miss the boat are talked into deals that make more sense to the investment bankers dreaming them up than to the shareholders of the acquiring company.
The classic example of this was the merger of Time Warner and AOL at the top of the dot.com bubble. This deal, which effectively marked the top of the market, was at the time the biggest ever corporate combination but, despite the apparently good idea of trying to capitalise on a convergence of mass media and the Internet, it failed on many fronts.
Huge goodwill
The bursting of the dot.com bubble sharply reduced the value of AOL, leading to a huge goodwill write-off and a massively embarrassing $99bn loss for the combined group in 2002. It quickly became evident that a market-leading Internet company did not necessarily have the right skills to manage a massive entertainment business employing 90,000 people.
Finally, turf wars between the two sides ensured that the planned synergies from putting the companies together never materialised. Soon AOL was dropped from the company name and a chastened Time Warner put its piece of top-of-the-market folly behind it.
Financial firepower
Takeovers like this one have cemented the view that takeovers are a good way to squander shareholders’ money, but this is not always the case. Good reasons to pursue deals might include expanding market share; diversifying into new, fast-growing market areas; pushing more volume through an existing fixed cost base; and increasing capacity.
So, the uptick in M&A is, for now, a good thing. It suggests that company managements have the financial firepower and, more importantly, the confidence to seek ways to grow their businesses.
There will be a time to worry about M&A, but it isn’t just yet.
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