Markman Capital Insight

The dark side of merger frenzy

Boutique research firm TIS Group was out late Wednesday with a note observing that this year is shaping up to be the biggest year in mergers and acquisitions since the market top in 2000. If Dell’s $67 billion deal to buy EMC goes through, it will put 2015 at $1.68 trillion for announced deals, just below the $1.73 trillion in the booming dot-com era.

With profits in the U.S. looking toppy, TIS analysts interpret this frenzy of activity as desperate, and yet "somewhat genius" on the part of the participants. With stock prices artificially boosted by Zero Interest Rate Policy (ZIRP) -- which central bankers are threatening to bring to an end -- organic growth weak, and cash levels high, the analysts figure board rooms are making the very logical decision to create the illusion of growth through merger, cost cutting, and the ever-nebulous “synergy.”

The premiums announced on the deals are rising steadily, as well. As investment bankers are most assuredly advising their clients to get their deals in quickly before the Fed raises rates, value and caution are going out the window, TIS argues. Premiums have increased all year long, and are now consistently in the 30% range.

Looking at the type of deals that are taking place leads TIS to conclude this is late-cycle behavior. The EMC-Dell deal is the largest technology acquisition in the sector’s history. They work in the personal computer and storage markets, which are both facing incredible competition and a shrinking market share. It is the merger of two companies at the end of their business life cycle.

Similarly, the SABMiller/Anheuser-Busch deal represents old technology in beverages, TIS notes. These companies have specialized in mass-appeal, mass produced products for decades. However, the booming micro-brewery trend, which produces specialized, high-margin products, is killing the market share of the old school brands.

The deal would be the largest in U.K. history, if it goes through. BUD’s offer was 50% above the closing value on September 14th, the day before takeover speculation began to rise.

Regulators are going to be a problem, of course, so the beer deal might not go through. Combined, the new company would be the world’s-largest consumer staples producer, and would have the #1 or #2 brand position in 24 of the 30 largest beer markets in the world. In China, it would account for 40% of the beer market.

So far this year the industries that are most active are Real Estate with $180 B, Beverages $138 B, Media $122 B, Oil & Gas $121 B, and Pharmaceuticals $110 B, according to TIS data. All these industries appear to be struggling with a serious lack of pricing power and subsequent margin pressures. This does not look like companies buying assets to improve technologies, processes, or extract gains through vertical-integration. These deals are about retaining market share, and cost cutting, the analysts conclude.

SABMiller’s 2016 EPS estimates have been falling steadily for two years. With prospects decreasing 20% since late 2013, management must have appreciated the chance to give shareholders back any value, whatsoever, TIS argues, aptly.

More evidence that the M&A cycle itself appears to be in the throes of a late-cycle top. In 1997, the Wilshire 5000 had over 7,600 names in the index. Today, however, the number is below 4,000.

Mega-mergers in summary tend to peak at the end of a business cycle, and thus are one more reason to exercise caution in our viewpoint toward the end of the year and 2016.

-- Jon D. Markman


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