The critics of ultra-accommodative monetary policy are fond of saying that it has done a better job since the global financial crisis of reviving financial markets than of helping the real economy.
|Richard Fisher, president |
of the Dallas Fed
By the spring of this year the price earnings ratio of US stocks had reached the highest decile of reported values since 1881 and stocks have risen further since. Junk bond yields stand at record lows, as do spreads between junk and investment grade debt. Covenant-lite lending has enjoyed a revival that, until very recently, would have been unthinkable.
Yet even as financial markets enjoy their omni-bubble, some $2.5 trillion of the liquidity the Fed had injected into the financial system by buying Treasuries and MBS has been put back by lenders as excess reserves deposited at the Federal reserve banks in the absence of loan demand from creditworthy borrowers.
Suddenly the M&A market is thriving. A string of multi-billion dollar corporate deals has been announced this year and even though some have also been withdrawn and others remain contested and unagreed, volumes were up across the board by some 40% in the first half of 2014 compared to last.
Why this sudden splurge? Tax inversions have added to the deal frenzy but do not explain its full ferocity. The furore over inversions looks like a distraction from two more fundamental drivers.
First M&A volume always follows a rise in stock prices. Companies never buy each other on the dips. Private equity sponsors are meant to do that and they have been mainly selling not buying this year.
Companies buy each other when they are expensive because both acquirers and sellers crave the comfort of transacting at high equity prices: selling executives and boards so as not to look like fools for getting out at the bottom; buyers because big deals, even with a large component of cash consideration, are often substantially share-financed. They need their currency to be strong.
So far, so familiar from previous M&A booms.
But another force is now at work. Economic growth may have just reached escape velocity after six years of monetary accommodation in the US, but it is stalling in Europe where disinflation is evident. Companies can’t grow their earnings. But they can buy earnings and any cash-financed purchase, whether funded from internal resources or extraordinarily low-cost debt, will be earnings accretive from day one.
M&A is now a pre-emptive strike. Companies want to buy earnings before equity investors panic, realize valuations have got stretched and ditch their stocks. Dirt cheap and ubiquitous debt just makes this easier to do.
Equity investors themselves are eager players in this game of illusions. Having pushed companies with strong balance sheets to raise dividends and buy back shares in recent years, they now want M&A to be the next driver to keep the stock market motoring ahead. It’s not just targets that enjoy a stock price boost from the prospect of a control premium being paid. Even acquirers’ share prices are being bid up on announcement and this is happening with unprecedented regularity.
Fear more than greed, then, is the driver. It’s a murky picture and at times not easy to read, but the threat of disinflation is real.
Analysts at Société Générale suggest that the biggest driver of M&A activity is companies’ increasing need, in the face of deflation, to regain pricing power by taking out competitors. It’s just that they can never openly say this for fear of triggering anti-trust investigations.
Until the second half of last year, corporate executives could always find a reason not to do M&A deals, when their bankers pitched ideas to seize the initiative and re-shape their sectors. Uncertainty over something – the eurozone sovereign crisis, the US budget cliff – kept their money in their pockets.
But now they are driven to act. Will good, value-creating M&A deals be done? Stock market optimists will hope that a long-delayed and much-needed restructuring phase will now benefit the corporate winners across a series of sectors. Debt market pessimists must fear that the low-return hurdles set by artificially repressed financing costs will lead to justifications being plucked from the air to do plenty of bad deals.
Investment banks, of course, will profit from deals of both type.