A quick look at a timely topic of interest - with a brief review of why it could matter to investors.

Chart of the Week
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May 12, 2014

The surge to merge
Announced M&A transactions

chart

Source: Bloomberg, as of 4/30/14. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Merger and acquisition (M&A) activity has accelerated recently, reflecting several important changes about future expectations – which could be important for investors to take on board.
  • The pick-up in M&A could be a result of companies' renewed optimism that the global economy is improving—deals look more attractive when the outlook is brighter – and increased demand for deals could help support current equity valuations.
  • On the other hand, it could also suggest that organic growth—growth that comes from a company's existing businesses—is still hard to come by. In that view, M&A is a way for companies with the financial means to find growth through accretive acquisition rather than investing in their own lines of business.
  • There could also be pressure from the record amounts of cash on corporate balance sheets—and the desire to put this money to productive use. That would be a potentially positive development for the prospect of future growth, but that growth could come at the expense of existing balance sheet fundamentals in the short run.
  • M&A activity might also be picking up due to a possible growing belief that interest rates will rise—the low current level of interest rates being a big incentive to pull deals forward while the cost of financing them is still low.
  • And as valuations move higher along with expectations about the future, the importance of finding the true sources of value increases. A core part of the value investor's challenge is to understand the investor expectations already embedded in security prices, to determine where the remaining value may be found.

The chart:

  • The chart shows the rolling 12-month total (in US$) of announced M&A transactions for April 2004 – April 2014.
  • The Non US series is derived by subtracting the US series from the global series.
  • Note that US M&A has been generally accelerating for the past 18 months, but Non US activity has accelerated even more rapidly in percentage terms over the past year.
  • Both US and global activity jumped notably in April, the US by 6.6% and Non US by 10.4%.
  • On a year-over-year basis, US M&A transactions in April were up by 16.5%; global transactions rose 22.5%.

Context & Perspective:

  • According to International Strategy & Investment Group (ISI) there were 148 deals totaling over $1.2 trillion announced between February 6 and May 2, 2014.
  • Corporate cash levels in the US and Europe are at or near record highs—at the end of 2013, US corporate liquid assets totaled a record $1.984 trillion; as of May 2014—according to the latest filings—companies in the Stoxx Europe 600 Index had €2.04 trillion ($2.85 trillion) on the books, which was near the 2012 record of €2.16 trillion.
  • M&A activity has been especially strong in Europe recently—as of May 2014, deal volume involving a European target was reported at $312 billion, more than double the pace for the same period in 2013 and the highest since 2008; volume was up 41% in Asia and 18% in North America.
  • Expectations for Fed tightening may be increasing, which could provide an incentive for companies to do deals before interest rates rise. As of May 2, fed funds futures for October 2015 implied a 28.5% probability that the federal funds rate would be 0.75% in October 2015 and a 25.7% probably that the federal funds rate would be 1.00% in October 2015.
  • M&A could provide a pillar of support to US equity markets if companies being acquired are purchased at a premium. Another indication of potential price support is that deals in the first two months of 2014 were met with historically elevated near-term optimism as acquirer share prices increased more than usual based on the average 2-day and 1-week changes in US acquirers' stock price around the M&A announcement.

Definitions:

Mergers and acquisitions (M&A) is a general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

M&A announced transactions, Global (Bloomberg ticker: MAATGLOB) is the daily sum of mergers, acquisitions, divestitures, self-tenders and spinoffs announced globally.  All amounts not in US dollars have been converted using the spot rate on announce date of the transaction.  The values are based on a seven day week that begins on Saturday and ends on Friday.  All daily values for Monday include activity from the previous weekend.  These exclude terminated transactions.

M&A announced transactions, US (Bloomberg ticker: MAATUS) is the daily sum of mergers, acquisitions, divestitures, self-tenders and spinoffs announced involving either a US target or acquirer. All amounts not in US dollars have been converted using the spot rate on announce date of the transaction. The values are based on a seven day week that begins on Saturday and ends on Friday. All daily values for Monday include activity from the previous weekend. These exclude terminated transactions.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The Federal funds rate ("Fed Funds) is the interest rate at which banks and other depository institutions actively trade the balances they hold at the Federal Reserve (Fed). The Fed sets its Fed funds target rate as part of overall monetary policy, and  engages in trading (called "open market operations") in the financial markets to keep the fed funds rate near its target.


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