(Buffalo
Springfield-For What It’s Worth- 1966)
Another question raised at the Amsterdam Acquisition Finance
course concerned the persistent muted level of M&A activity. Global 2013 M&A
volume, despite a promising start, remains depressed at near 4 year lows. U.S. volume is up 6% largely driven by the $124B
Vodafone-Verizon transaction. Europe had its worst year since 2009. The U.K.
market is at its lowest level in over a decade. This is surprising given the
following ordinarily supportive factors:
1)
Rising corporate cash balances and cash flow.
2)
Record private equity (PE) dry power and fund
raising. PE firms have over $800B to invest of which $140B expires by YE 2014.
3)
Favorable financing environment.
4)
Positive shareholder responses to recent
acquisition announcements.
5)
Limited organic growth opportunities and
substantial industrial excess capacity.
6)
Robust stock market with strong buyer stock
price performance-the S&P 500 is up over 22% thru early December this year
and is trading at record levels.
The possible rationales for this puzzling state of events
include:
1)
Buyers lack confidence to make substantial long
term commitments due to their uncertainty about the economic recovery and our
dysfunctional national government. This becomes less convincing given the
steadily improving news about both the economy and the government.
2)
The substantial stock market recovery makes it
difficult to find attractively priced targets. This makes some sense, and is
reflected in current low premiums being offered. Usually, premiums over the
pre-bid price are in the 30% range, whereas currently they are just under 20%.
Given the 20%+ recent price increase for targets the effective premium could be
viewed as closer to 40%.
3)
Stock repurchases rather than acquisitions have
become the preferred corporate finance alternative for many firms. For the LTM
stock repurchases have reached almost $450B-the highest level since 2008. Some
of this is being driven by activists pressuring firms with bloated cash
balances like Apple to use or return the cash.
As previously noted (see Repurchases)
I believe stock repurchases are frequently misused. As Warren Buffett notes (see Price
Matters) they should only be used if the firm’s stock price is priced below
its conservatively determined intrinsic value. The current record stock price
level makes it difficult to believe many firms are under priced. Thus, if they
want to return excess cash to shareholders they should increase their dividend
payout or declare a special dividend. Possible tax benefits of repurchases are
probably a secondary consideration given the institutional ownership of most
shares. To be fair, some firms like 3M, are using a combination of repurchases
and a dividend increase (see 3M).
Many firms may be deferring acquisitions in favor of
repurchases for incentive compensations purposes. A successful acquisition
typically takes a few years before having positive earnings per share (EPS)
impact. A repurchase, however, has an immediate positive EPS impact due to the
immediate decline in outstanding shares. This is important as many senior
management incentive programs are tied to EPS growth. Managers lacking
confidence in EPS growth from acquisitions relative to repurchases will favor
repurchases over acquisitions.
This could be the
reason for the depressed level of M&A activity. Researchers like Ralph will
need to determine whether this is in fact the case. Perhaps they can see if
firms with incentive programs tied to EPS growth are less likely to acquire. I
welcome any comments you may have in helping resolve this open question.
Thanks, and I wish you all Happy Holidays.
j
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