The Outlook for Mergers and Acquisitions in 2012

The key issue in the area of mergers and acquisitions in 2012 is still uncertainty. There seems to be a lot of anticipation that the activity in this area could pick up during the year, but, like last year, there may be little to come of it. (http://www.ft.com/intl/cms/s/0/a29392 10-41d0-11e1-a1bf-00144feab49a.html#axzz1jqA4rKTp)

Many corporations still seem to have a “ton” of cash around.  Furthermore, the corporate bond market is flush; companies “sold $44.2 billion of both high- and low-rated corporate bonds this year, the highest on record for the time period….” Investors are “snapping up bonds…pushing the cost of borrowing for some issuers to record lows.” (http://professional.wsj.com/article/SB10001424052970203750404577171341742782200.html?mod=ITP_moneyandinvesting_3&mg=reno-secaucus-wsj)

“The yield on below-investment-grade, or ‘junk’ bonds fell to 7.93% Wednesday, the lowest since August 5 according to a Barclays Capital index.  An index for investment-grade bonds, which are of a higher credit quality, was at 3.62%.  In comparison, on Thursday the 10-year Treasury note yield rose to 1.972%.”

Funds are available. 

Corporate breakups are likely to continue or even accelerate in 2012.  Economic growth is not picking up speed.  Europe looks as if it is in another recession and this does not bode well for the rest of the west.  Companies are finding that the conglomerate structures they built up in recent are not very helpful in times like these, especially for those organizations that are suffering under the burden of too much debt. 

The western world is re-grouping from the excesses of the past ten to twenty years.  Those that still have the time to adjust are downsizing…laying off employees and discarding non-central businesses.  Those that don’t have this time are attempting to sell outright.

Those looking for deals have the ammunition to pull off these deals and they know that this is a “buyers” market with depressed valuations available.  They have the capability of being aggressive.   Whether or not they activate this aggressiveness is another question.

This is because a cloud remains over the M & A market, a cloud that kept many firms on the sidelines in 2011.  First off, a great deal of uncertainty exists with respect to the future of the economy.  Government stimulus policies, both monetary and fiscal, have not worked to any degree and it is debatable whether or not any additional actions will achieve much more.

In addition, Europe appears to be in recession right now and, given its sovereign debt crisis and the state of its banks, any recovery seems to be some way off.  It is uncertain how the situation in Europe might play out in the United States. (http://seekingalpha.com/article/317268-issue-number-1-for-2012-recession-in-europe)

Second, there is the upcoming election in the United States.  The uncertainty surrounding the policies of the American government with respect to business and finance over the past three years has been enormous…and largely uncalculable. At this time, we just don’t know how much the uncertainty in this area has retarded the recovery of American business and economic growth. 

Further uncertainties exist with respect to the impact of other actions of the federal government in areas like health care, the environment, and foreign affairs.  Some people are just learning about the expenses they are going to have to absorb with respect to Medicare, doctors fees, and health insurance.  As people learn more and more how their budgets are going to be affected, adjustments will be made to spending patterns and they won’t be up.

Third, in addition to the uncertainties created by new financial regulations and the complexity of these new regulations, there appears to be a growth in the government’s application of the anti-trust laws.  The recent treatment of the AT&T/T-Mobile merger is a case in point.  The government, ‘feeling its oats’ from this action, will probably step-up its aggressive behavior in this area, leading to even greater uncertainty relative to M&A activity.

Early in 2011, it looked as if there might be a big pickup in merger activity for the year.  Many of the same conditions we see today existed at that time.  And, what happened?

M&A activity did pick up in 2011 from previous years but we did not see the ‘big jump’ that many of us expected.  Instead of buying companies, many firms used their cash on hand or their ability to borrow at ridiculously low interest rates to buy back their stock.  This, of course, helped stock prices but it did not help the economy.

But, even a pick up in M&A activity will not do a lot to help the economy, especially in the short-run.  Buying companies outright or buying pieces of companies will initially result in efforts to achieve greater corporate efficiencies, higher levels of productivity, and will mean more reductions in employment.  This is a part of the “creative destruction” of a market economy.    

And, this should not be surprising.  The American economy has been subject to fifty years of credit inflation.  In such a time, among other things, businesses come to focus more on finance rather than production, they acquire other businesses that are not related to their core operations, and they hoard labor. 

The other side of the business structure created by credit inflation is the need to unwind and restructure what was built earlier.  That is what we face now. 

Let’s hope the boom in M&A business does take place.  Let’s hope that the corporate cash and corporate borrowing do not go just to corporations buying back their own stock.  Let’s hope that the unwinding and restructuring takes place because that is one prerequisite for business to get back to the capital investment activities that do drive economic growth. 

Another Sign of a Weak Economy: Stock Buy Backs?

Over the past year or so, I have been arguing that the substantial build up in the cash balances of many large United States corporations has been for the purpose of merger and acquisition activity.   And, earlier this year, M&A activity seemed to be proceeding aggressively. (See my post “The Latest Merger Binge and the Economy,” http://seekingalpha.com/article/269056-the-latest-merger-binge-and-the-economy.)

Now, it seems as if these cash balances may be trending into more stock buy-backs than into the buying of other companies, at least in a relative sense. “US companies are buying back their own stock at the fastest pace since 2007…” (http://www.ft.com/intl/cms/s/0/381e8c26-9c14-11e0-bef9-00144feabdc0.html#axzz1Q0PX4bjp)  

Today’s attention on stock buy-backs has been caused by the announcement made yesterday by electronics retailer Best Buy of a proposed $5 billion buyback program. (http://professional.wsj.com/article/SB10001424052702304070104576400062744226034.html?mod=ITP_moneyandinvesting_10&mg=reno-secaucus-wsj)

Analysts have been wondering what these large corporations were going to do with the huge cash balances on their balance sheets.  These companies were producing profits, they were able to borrow at ridiculously low interest rates, and ample liquidity seemed to be available to them around the world.  Also, there were a lot of other companies or divisions of companies “out there” that were really struggling and seemed to be possible “sitting ducks” for growth hungry large corporations. 

Of course, one of the reasons for the build up of cash in some of these companies was the tax implications associated with bringing monies earned around the world back into the United States.  But, this was not really the major reason.  For example, Microsoft, a cash rich company, did not have to go out and borrow more than $10 billion in the United States, the first time Microsoft has even made use of the bond markets in its history. 

Many economists were hoping that this build up of cash would result in a boom in corporate investment in physical capital, a stimulus to further economic spending and subsequent economic growth.

This physical investment has not yet surfaced. 

My belief has been that this cash build up was for acquisition purposes.  The companies that had the cash were strong and were “on the hunt” for their weaker brothers and sisters hoping to build their economic base by acquiring companies that were not in good positions, had too much debt, and were struggling to make ends meet.  What a way to build markets and enlarge the company’s footprint!

This seemed to be happening…and I believe will continue to go forward.

However, the world economy seems to be stalling.  Perhaps economic growth will not be as robust as originally thought…even three months ago.  Thus, even though the merger binge may continue to some degree, the pickings may not be as lush as once thought. 

And, the stock markets seem to have reached a near term peak.  All the major indices, the Dow, the S&P 500, and the NASDAQ, peaked at the end of April.  Many analysts are saying that with the stagnant economy and the high levels of under-employment, the chances are not very great that the stock market will show much resilience in an upward direction. 

Thus, there is some drop off in the corporate enthusiasm for more and more acquisitions.

So, what does a company with a lot of cash on hand and with dwindling appetite for acquisitions do with all their loot?  Managements with so much cash around and with very little hope that the economy will become more robust, just does not see these excess balances as a good use of resources.

The only viable alternative is to buy back their stock.  They see this as the “best” investment available to them.  And, so they buy back their stock.

Neither one of the latter two uses of the cash really do anything for the economy and the acquisition path could even result in worse economic results…at least in the short run.

Acquisitions, of course, can lead to plant closings, layoffs, and other efforts to combine firms, which increase productivity in the longer run, but does not contribute to capital investment or human employment in the short run.  Obviously, these outcomes are not what the policymakers are looking for.

Stock buy-backs also do not stimulate capital investment or a reduction in unemployment in the short run and may not achieve either of these goals in the longer-run.

Therefore, if the economy is weak and more and more corporations seem to believe that the “best” investment of the cash they have accumulated is to buy back their own stock.  it would seem that this is evidence that more and more corporations are not seeing a very bright economic future ahead of them.  In my mind, this is not very good news.