A mergers and acquisitions M&A binge would be like a tonic for market psychology right about now, as confidence is lacking and big deals provide a feel-good antidote. The recent mini-wave of announced deals, including Intel’s bid for McAfee, HP’s bid for 3PAR, and BHP Billiton’s effort to acquire Potash, makes it timely to consider whether an M&A boom is at hand.
Corporate cash is at staggering highs
The most compelling argument in favor of a rising M&A wave is the huge amount of cash parked at U.S. corporations. Following the surge in earnings over the past year, total corporate liquid assets are at staggering half-century highs.
Moreover, cash and short-term investments held by S&P 500 companies now amount to 34% of the S&P 500 equity capitalization, far above the 40-year average of 20%. And, as anyone trying to save knows, the rates of return available to cash are pitifully low, making other uses for cash more attractive.
Potential for growth and consolidation
So why use that cash on M&A? With organic growth difficult to come by in this tepid recovery, many companies may feel motivated to buy growth. Likewise, opportunities exist for acquisitions where cost synergies may be abundant. The latter argument is increasingly compelling with industrial utilization stalling in the mid 70% range and excess capacity fairly widespread. Shareholders are pushing harder on corporate managers to find profitable ways to re-invest in their companies, or else return the capital as dividends.
Conversely, cash offers a cushion
That said, there are counterarguments to contemplate before heralding an M&A boom. The all-too-recent collapse of financial markets and the near-freeze of the banking system make it more attractive for corporations to hold cash and stay liquid. After all, a company can miss Wall Street earnings estimates quarter after quarter, but run out of cash once only once. As such, when economic uncertainty rises to high levels, as it has recently, many companies look to “self-insure” their own survival by holding excess cash. Secondarily, a lot of the cash we see on balance sheets is held overseas in lower tax jurisdictions and is not available for M&A unless companies pay a sizable tax bill first. So the cash we observe may not be as “available” as it appears.
Regulation is a head wind
The regulatory scenario may also present head winds. In the 1970s and 1980s, large merger waves were often the consequence of deregulation. Both the Carter and Reagan administrations extended deregulation into many business sectors. In contrast, the Obama administration is legislating in the opposite direction, with vast new regulations on health care, energy, and financial institutions. More active enforcement of anti-trust laws by the Department of Justice and Federal Trade Commission also makes it more challenging for deals to be approved. In short, today’s regulatory environment does not appear favorable for mergers.
M&A enthusiasm should continue
In sum, it’s likely we will see M&A activity continue to accelerate, even if fevered years like 1999 or 2007 are not repeated. Activity might be most pronounced in specific sectors, like technology, with a number of pristine balance sheets and aggressive management teams. The regional banking sector, with over 8,500 banks in the United States alone, is another area ripe for activity. With credit unlikely to be a growth industry again for years, rationalizing costs through bank mergers makes a lot of sense.
Given abundant corporate cash, available acquisition financing, and management motivation, expect Monday morning merger announcements to remain exciting.