Thursday, August 13, 2015

Merger Activity - A Record Year?

Tuesday's Wall Street Journal contains a very interesting article on this year's merger activity. (See Merger Activity is on Pace for Record, by Dana Mattioli and Dan Strumpf).  Citing Deal Logic as a source, the authors note that if the current pace of deals continue, it will outpace 2007 - the last record year.  Illustrative of this is Berkshire Hathaway's $32 billion deal to acquire Precision CastParts Corp.  the largest deal in Berkshire's history.

What interests me most about the article are the reasons cited for the large number of deals.  We've covered most all of these in these posts - and also urged caution.  Some of the main issues are noted below:

  • Low interest rates - and the fear future rates will rise
  • Executive confidence
  • Fear of being left behind
  • The desire to boost growth through acquisitions (as growth from other sources becomes limited)
  • The "economy isn't in free-fall"
  • Accumulated cash on acquirer balance sheets

I firmly believe these concepts are on the minds of today's executives and I don't doubt they are driving deal activity.  What concerns me is that with the possible exception of confidence none of the reasons are valid by themselves for doing deals.

Sure, low interest rates are better than high rates, but if a deal doesn't make strategic sense, low rates are not a sound motive for doing deals.  (See Any Deal is a Bad Deal at Some Price; Not Every Deal is a Good Deal at Some Price).  The same is true of fear of being left behind.  On the face of it, it implies a 'keeping up with the Jones' mentality. It could also imply an 'eat or be eaten' mentality.  While shifting landscapes are certainly catalysts for deals, it is important to understand the economics behind these shifts.  Again, deals that fit the strategic plan of the company are best and sometimes the best deals are those you don't attempt.  In some situations, selling the company is actually the best move for shareholders.

Joe has talked extensively about the attempt to boost growth through acquisitions.  If the benefits don't exceed the costs, the deal is bad, even if it produces a short term boost to earnings.  Unfortunately, it can be easy to get caught up in deal fever and overestimate benefits and understate the difficulty in integration.  (See A Man Hears What He Wants to Hear).

The economy not being in free fall is a good thing, but hardly enthusiastic support for doing deals.  Finally, accumulated cash is absolutely no justification for doing deals.   Each company must ask - can I earn a superior return on this cash for my shareholders.  If not,  it should  be returned to its owners - the shareholders.

So this brings us back to executive confidence.  Confidence can be driven by many desirable qualities - knowledge and experience come to mind.  Confidence can also be driven by emotion and influenced by every one of the other factors in the list.  Bottom line - only attempt deals that make strategic sense and that are justified based on a hard look at the costs and benefits.  Without this step, none of the other items matter.

All the best,


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