The £22.1bn bid by US cable operator Comcast bid for Sky has a end of an era feeling to it. Maybe it’s the memory of the last big round of media company mergers (Worldcom, anyone?) or maybe it’s Warren Buffett’s recent condemnation of a ‘purchasing frenzy’ of M&A activity. Perhaps it’s just the end of the era of cheap debt. Could markets be about to lose this all-important support?
In his annual letter to Berkshire Hathaway shareholders, Buffett said that corporate buyers had become less and less price sensitive, with the result that pretty ordinary businesses were now selling at top drawer valuations. He put the blame squarely at cheap debt and macho CEOs, whom shareholders were encouraging to do deals. As he said: “it's a bit like telling your ripening teenager to be sure to have a normal sex life."
Merger and acquisition activity has been buoyant, exceeding $3 trillion for the fourth consecutive year (source: Thomson Reuters). 2017 finished with three mega-deals - CVS Health’s $69bn bid for healthcare insurer Aetna, the sale of global shopping centre business Westfield to France’s Unibail-Rodamco for $24.7bn and Rupert Murdoch’s decision to sell a chunk of 21st Century Fox to Disney for $66bn.
Rampant merger and acquisition activity has often characterised the end of a bull market. Russ Mould of AJ Bell recently noted that January was the best month for global merger and acquisition activity worldwide since 2000. These mega mergers tend to suggest companies flush with cash, who are less discerning about where they allocate capital.
At the same time, we are seeing a shift in the economic climate, and a likely tightening in monetary policy conditions across the globe. If corporate borrowing rates go up, then investors could expect some pull-back. It is difficult to know the extent to which M&A has supported markets, but it may have provided a floor for recent falls.
However, investment bankers don’t appear to be concerned. Marc Nachmann, co-head of global investment banking at Goldman Sachs, told the Financial Times that “the momentum around large deal activity would continue into next year as we see a number of industries undergoing massive strategic shifts and further consolidation.”
This is key. Merger and acquisitions are a key way for companies to defend themselves against disruption. CVS Health’s bid for healthcare insurer Aetna was fuelled by the prospect of Amazon’s entry into the pharmacy business. The Sky/Disney/Comcast deals reflect profound changes in the media and broadcasting industries in recent years. For many companies, making deals is the only way to hold back the predatory influence of Big Tech.
Then there is US tax reform, which is likely to see more corporates with more cash. The structure of the tax reform encourages US companies to repatriate large cash balances held offshore. Not all of this will go on M&A activity, but some almost certainly will. A recent report by consultancy BCG said: “Increased corporate earnings power and quality, as well as liquidity, will create a more stimulative investment and M&A environment.” Plus “Higher earnings power will make year-end 2017 valuations look less lofty.”
However, this won’t be confined to the US. Thomsen Reuters reports more deals in Asia. Activity in the Asia-Pacific region has climbed 11% over the past year to hit $911.6bn.
While it all feels a little toppy and ‘end of cycle’, there is plenty to suggest that the M&A bonanza can continue for some time. It doesn’t mean that companies are necessarily making the best decisions, but many continue to see deal-making as the best defence against disruption.
