Get your coat – An M&A party may be in progress but what stage of the night have we reached?
Here on The Value Perspective we like to keep a close eye on global merger and acquisition (M&A) levels. Rather than viewing any increase in M&A activity as an indication the party is really about to begin for investors, however, we view it as more of a sign the die-hard revellers are eying up that last bottle of liqueur at the back of the cupboard and a neighbour is two nines into dialling the police.
This attitude, often mistaken for mean-spiritedness, is actually based on the simple observation that human beings – including company directors – are more inclined to invest when sentiment is good than when valuations are cheap. As such, there has typically been a strong correlation between M&A activity and stockmarket levels – and a long history of deals that destroy value rather than create it.
Musing, in Mind the gap, on factors with the potential to “drive markets to new and crazy highs”, we picked out the so-called ‘M&A gap’, adding: “The global stockmarket has only ever been at the level it is now on two previous occasions – and both times there was some $4tn (£2.56tn) of M&A activity going on in the world. Today the equivalent figure is nearer $2.8tn so maybe this gap will be filled.”
Well, some four months later, it appears there may have been no “maybe” about it. According to Thomson Reuters data, quoted in the Financial Times, global mergers and acquisitions reached a total value of $2.18tn in the first half of 2015. This is 38% up on the first six months of 2014 and is in fact the highest figure since 2007 – the year, of course, before the start of the global financial crisis.
Driving this rise has been a surge in US-focused deals, with the Financial Times noting in the unambiguously titled article Record valuations drive 2015 M&A boom: “A heady cocktail of ultra-low financing costs and a search for growth across sectors propelled US M&A activity up 60% to $987.7bn, the strongest first half since records began in 1980.”
The same piece points out the average deal valuation – “a key measure of how much buyers are willing to pay” – stands at 16x earnings before interest, taxes, depreciation and amortisation (EBITDA), compared with the previous high of 14.3x seen in, yes, 2007. A further suggestion of, if not a bubble, then bubbliness, comes from anecdotal evidence that hostile takeover activity is on the increase.
And speaking of bubbles, sorry, bubbliness, technology companies are well to the fore in all this. The Financial Times article says: “Valuations have been highest in the tech sector, led by Avago’s $36.4bn acquisition of rival Broadcom, which was the largest tech deal since the dotcom bubble and valued the target at 20x EBITDA.”
Among all these record and recent highs, one curiosity noted in another FT article, Maths, not history, drives mergers and acquisitions, is that the number of deals announced in the first half of 2015 – “a metric often used to gauge the robustness of an M&A cycle” – is flat compared with the same period last year. What has served to boost the numbers is the fact that deal sizes have continued to expand.
“Transactions valued at more than $5bn have increased in number by 42%, as large companies suffering slower growth have turned to deal-making to boost revenues and market share,” the article observes. We will leave it you to draw your own conclusions as to what degree it is a coincidence those latter metrics are often the ones on which boardroom remuneration is based.
Two quotes stand out here – the first from an academic arguing we are in a different cycle from the one ahead of the financial crisis, who adds: “The higher [valuation] multiple, by itself, is not an indicator of a bubble since Treasury bond rates have dropped since 2007.” Well, yes – just so long as one ignores how QE has, as we suggested in ‘Wriggly’ believe it or not, completed changed the rules of the game.
The second quote is from a banker who prefers a fierier analogy than bubbles, opining how 2015 “feels like the last days of Pompeii – everyone is wondering when a volcano will erupt.” Except of course the inhabitants of Pompeii had no idea they were living a few miles away from an active volcano – or else they would presumably have moved somewhere they were less likely to be buried alive by molten ash.
Make what you will of our extension of the banker’s analogy but we will be sticking to the party-based one with which we started this article. And all those M&A numbers would certainly have us calling a minicab – if it was not for the fact that, metaphorically speaking, we grabbed our coat some hours ago and have been snugly tucked up in bed ever since.
Investment Specialist, Equity Value
I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm.
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