Stock Market “Exuberance” Drives Merger Valuations to “Highest Level on Record”

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Wolf Richter,
Pre-collapse year 2007 keeps popping up with eerie frequency.
“Announced” global volume of Mergers & Acquisitions – “announced” in quotes for a reason, more in a moment – has breached the $700 billion year-to-date for the first time since the crazy pre-collapse year 2007. This includes 125 deals of over $1 billion, totaling $455 billion. Three industries are at it with the most vigor: oil & gas, healthcare, and technology.
This surge in M&A “has been driven by cross-border acquisitions, which have doubled in the last 5 years to $288 billion in 2017 YTD,” according to Dealogic. They’re now also at the highest level since 2007.
US-based companies are on top of the heap of cross-border deals, with $95.8 billion in announced acquisitions so far – “the highest YTD level on record.”
What caused this surge in M&A? According to Dealogic: “Strong equity markets and valuations – which have soared to the highest level on record.”
These “valuations” are measured in EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization), a metric that reflects the target company’s operating performance by removing non-operating expenses.
For the first quarter, “14 times EBITDA is what the Dealogic figures show as the median EBITDA multiple,” explained Dealogic’s head of M&A Research, Chunshek Chan. “That’s something we really haven’t seen over the course of the data that we have. Historically, we’ve been bouncing between 10 and 12 times, sometimes even 13 times. So 14 times EBITDA is certainly a premium to pay for acquisitions.”
Major stock indices are hovering near all-time highs, he said. Hence the high volume and the all-time record premium.
“This is really a translation of the exuberance in the equities market,” he said. This merger boom is “really driven by valuation.”
In other words, higher stock prices beget even higher premiums that acquirers are eager to pay. Over the longer run, M&A rarely produces positive results except for the stockholders of the acquired companies, executive bonuses, and Wall Street investment banks that manage these deals and extract their fees. Many mergers turn into abysmal operational failures, followed by layoffs and often enough, ironically, spin-offs (Wall Street wins again).
Companies are struggling with the tough environment beyond cheap credit and sky-high stock prices. They’ve been stuck in an earnings quagmire for years. Combined earnings of the S&P 500 companies in Q4 2016 were back where they’d been five years earlier, in Q4 2011.
Even after financial engineering is applied with all its might via share buybacks and other strategies, and even by using Wall Street’s favorite most hyped liar-metric, ex-bad-items “adjusted” earnings per share, the combined “adjusted” earnings per share of the S& 500 companies are back where they’d been in January 2014.
In this environment, Corporate America cannot come up with earnings growth – despite or because of the huge wave of M&A. So what’s the solution? More M&A, at record prices and record multiples.
But there’s an additional kink in the equation: the collapse of “announced” merger deals. These mergers were announced with great fanfare. Their huge premiums were hyped with glowing words. They fired up the entire sector and even stock markets for a few days, as analysts were pronouncing the next potential targets, whose shares then jumped.
But then the proposed mergers run afoul of regulators who are worried belatedly about monopolies or oligopolies. Or the proposed mergers run into the buzz saw of other issues. And suddenly the merger collapses and is withdrawn,
Just on Wednesday, the $14-billion merger between two stock exchanges, the London Stock Exchange and the Deutsche Börse, was withdrawn after regulators had a hissy-fit. This brought the total of withdrawn mergers in Q1 to $271 billion, according to Dealogic, the second largest amount of withdrawn mergers ever in a first quarter, behind only Q1 2007.
If pre-collapse year 2007 keeps popping up, it may be for a reason.
This quarter included the second largest withdrawn merger ever. It was proposed, shrugged off, and revoked within a couple of days in February: Kraft Heinz Co.’s $155 billion bid for London-listed Unilever. It’s behind only Pfizer’s $160-billion effort to acquire Ireland-based Allergan, which collapsed in April 2016, after the US government started targeting “inversion” deals that were primarily engineered to dodge US income taxes.
Last year had already seen the highest withdrawn deal volume since 2008, in total 769 deals for $842 billion, “partly reflecting heightened regulatory pressure,” as J.P. Morgen put it.
And J.P. Morgan had an additional explanation for the merger boom, beyond the crazy stock market valuations: “Buyers capitalize on low cost of funding.”
Cash deals – funded by borrowing money, rather than issuing shares – accounted for 62% of the deals in 2016, up from 54% in 2015. And this year, despite rising rates, “the cost of capital is unlikely to be substantially impacted (emphasis added), and we do not think any increases will impede M&A activity.”
So full steam ahead. Overpaying is a virtue. Bogged down earnings, no problem. Record debt levels and leverage are signs of corporate health and confidence, as Wall Street likes to say. Exuberance reigns. Eerie sounds of 2007.
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