Shareholders willing to ignore the

risks of gorging at the M&A buffet

Republish Reprint

THERESA TEDESCO | May 17, 2014 7:00 AM ET
More from Theresa Tedesco | @tedescott

Thinkstock/Getty ImagesTheresa Tedesco: Investors are encouraging this buying spree, rewarding companies
that embrace the pursuit by boosting their share prices rather than punishing companies that fail to return capital
directly to their pockets.
After years of restraint, stifled by credit contraction and tempered by cautious
shareholders, companies appear willing to give in to that most reflexive of all
corporate urges the pursuit of mergers and acquisitions. And more significantly,
investors have been heaping their approval, even though more often than not, they
get burned in the long run.
How big can merger mania get Is a trillion-dollar deal possible?

Its become pretty ordinary for global M&A activity to break the US$1-trillion barrier in recent
years. Even in the depth of the Great Recession, deal-making handily topped the mark.
But is a trillion dollar deal all by itself possible? That would be nothing short of extraordinary,
even at todays valuations, analysts say.
So far this year, the total value of global M&As is approximately $1.25-trillion
scaling that lofty height only for the third time since record keeping began in 1980,
according to Thomson Reuters data.
During the first quarter of 2014, the value of deal activity reached almost US$600-
billion, up 33.2% from the same three-month period in 2013. In fact, the start of
2014 has been the most active out of the gate since 2011, when US$613.5-billion
worth of deals were consummated, according to aMergermarket trend report.
In the U.S. especially, gun-shy corporate executives have put their fingers back on
the trigger. Data from Dealogic Ltd. shows 2014 has experienced the fastest start to
merger activity to any year since it began tracking deals in 1995.
In Canada, the volume hasnt hit historic levels but is still strong, with a total of 679
deals worth $41.6-billion in the first quarter of 2014 a 20% increase in volume
from last year and 12% bump up in value.
Even so, the robust numbers are still a long way from the frothy days in 2007 before
the financial crisis. Low interest rates, cheap borrowing costs, healthy cash reserves
and robust stock markets that have climbed almost 30% in the past year have made
M&A activity a more palatable option than in recent years. Not so much because
corporations are getting back into the game of empire building but rather, investors
are encouraging this buying spree, rewarding companies that embrace the pursuit by
boosting their share prices rather than punishing companies that fail to return
capital directly to their pockets.
Consider that stock prices of companies looking to buy have spiked 4.6% this year on
average the day after announcing a transaction. Historically, the shares of suitors
have tended to fall an average of 1.4% in the past 15 years while share values for
target companies have historically surged an average of 18%.
Investors, especially shareholder activists, want to see a return on their investment
and boards are aware they have to start deploying cash to meet those demands, said
Mark Adkins, a partner at Blake, Cassels & Graydon LLP in New York, specializing in
M&A. You can only play the dividend game for so long. Growth has to come from
somewhere and the way to deliver better returns in the long run is to deploy capital.

In the absence of underlying economic forces or circumstances that would make
now a better time than any other time, explains Stanley Hartt, the action is simply
opportunistic.
Mr. Hartt, counsel at law firm Norton Rose Fulbright, and former chairman of
Macquarie Capital Markets Canada Ltd., says M&A activity normally signals a
growing optimism for the future. But with a fair amount of economic uncertainty in
Europe and the U.S., he says cash balances in corporate treasuries are still enormous.
I dont see this as an expression of confidence as much as evidence of a recovery, he
said.
Even so, companies are responding to market conditions by taking advantage of
higher valuations knowing they can borrow cheaply to make quality acquisitions,
said Barry Schwartz, chief investment officer at Toronto-based Baskin Financial
Services, especially because there is a dearth of high quality firms available to be
picked off.
On average, M&A transactions register a negative return for the buyer of about 2% to
4%, said Alexander Dyck, finance professor at the Joseph L. Rotman School of
Management at the University of Toronto. Statistics show that an average acquisition
or merger generally yields a negative return for shareholders of the buyer: 60% of
M&A deals have a negative average return while 40% have a positive one. Thats
because in most cases, Prof. Dyck said, the acquirer doesnt get to keep the value,
much like overpaying for a house in a hot real estate market.
The market perceives there is value associated with the
transactions and more significantly, that the company is not
paying too much to achieve that value
Having said that, he argued there is a huge variation in the numbers, most notably
that investors tend to prefer deals driven by cost-based synergies, which have a
better track record at enhancing long-term value than other types, than those that
are revenue-based, for example.
The fact that were seeing a bunch of transactions with positive reactions from
shareholders suggests the market perceives there is value associated with the
transactions and more significantly, that the company is not paying too much to
achieve that value, he said.
This is especially true in the current M&A market which until recently, has barely
registered a pulse of activity. With the risk of overpaying low, the market is
interpreting these deals as having true underlying value in part because there have
been no bidding wars, Prof. Dyck explained.
However, if companies get drawn into the hunt, pushing up purchase prices and
getting tangled up in expensive competitive bids, especially in the equity markets
where multiples are rising quickly, shareholders will likely pull back on the reins.
Already, there is concern about an M&A bubble percolating in some quarters. They
point to the fact that much of the M&A action so far has been the result of a handful
of major deals eight in all that had a total value of US$166.3-billion. The average
deal size in the first three months of this year was US$374.4-million, the highest
average since 2009, and 33% more than during the same period in 2013.
Most industry experts agree that gorging at the M&A buffet can be risky for
companies and their shareholders. For now, it seems investors seem less concern
about potential indigestion and more about filling their plates with the prospect of
greater returns.