“Of course, you might think people would prefer to do M&A in an environment of low prices but it never works like that. People very rarely buy cheap – in reality, most make acquisitions when they are able to, which is normally when their profits and their cash buffers are high and people are willing to lend them money.
“That all means confidence is high but, of course, it also means the target share price is likely to be high. Very few companies do deals at the optimal time – buying low and selling high, which is the entire ethos of our own approach. Indeed, if you look at the correlation between M&A and the stockmarket, companies tend to do it the other way round.”
So wrote The Value Perspective in Confidence Trick, back in early 2011, when M&A activity involving UK companies had just dropped to a 16-year low. Markets having ground their way steadily upwards over the last three years or so, things have come full circle, confidence is high and, as we predicted, corporate deal-making is very much back in fashion.
Upping the ante considerably, however, is a ‘summer essay’ by Jeremy Grantham in which the co-founder of GMO raises the prospect of “a large increase in financial deals”, clarifying what he means by that by adding: “Don’t tell me there are already a lot of deals. I am talking about a veritable explosion, to levels never seen before.”
Some of the supportive factors to which Grantham points tend to feature in every upswing in M&A activity – for example, profit levels staying at high margins and, of course, a general improvement in sentiment. After all, M&A is all about having the conviction to ‘press the button’ so whether the environment is actually supportive can almost matter less than whether people think it is.
Bur there are other helpful factors that are quite beyond the norm – first and foremost among which is that deals can be financed at extraordinarily low rates and, it would seem, for extraordinarily long periods. This will not have escaped the notice of the big businesses that are of course the ones that swing the needle in M&A and a number of ‘mega-mergers’ are already appearing on the radar.
Here on The Value Perspective, we have often observed that investors cannot know the future – only the price they pay for an asset. Some people reckon they can take this a step further, however, believing they can also know the cost of any debt involved in a transaction – although there has to be a question mark over whether you can actually lock in very cheap rates for the necessary length of time.
That said, The Value Perspective has a great deal of respect for Grantham and we will not be dismissing his views lightly. And, should he prove to be right about that unprecedented level of M&A deals in prospect, how well-placed are we to profit? Well, while value investing does not specifically target potential M&A candidates, there is an associated benefit to owning cheap businesses.
That is, even if the wider stockmarket fails to recognise the value of a company we own, there is still the possibility we can be the beneficiary of a competitor, management team, private equity investor or whomever deciding to make a bid. In the event of Grantham’s anticipated frenzy of deal-making, therefore, we would be confident of seeing our fair share of the action.