Excess cash will result in problematic mergers and acquisitions

According to The Financial Times, the recent boom in mergers and acquisitions is unlikely to deliver large amounts of economic revenue or long term value for shareholders because it was funded by excess cash and stock and is now financed by debt.

Alongside reporting that US mergers and acquisitions broke dealing records last month, financial software company Dealogic also revealed that corporate bond issuance in 2015 has hit the record level of $543.4 billion. This has increased the investment grade debt-to-equity ratio, which is a calculation that offers one of the best representations of a company’s leverage, from 72% in 2010 to 85% this year.

Bankers involved in M&A’s predict that 2015 will have a different outcome than what occurred after similar activity in 2000 and 2007. On the other hand, policy observers believe that the boom will cool down later on in the year and closer to when US interest rates are set to rise.

The FT reports of this trend which acknowledges what has happened in the past and explains how the western financial system has excess cash and credit. “History suggests such a scenario rarely ends well. After all, the crucial point about the two previous M&A peaks is that they coincided with equity and credit bubbles. Shortly afterwards, those bubbles burst – with painful consequences,” the FT reported.

Since the 2008-financial crisis, American corporate profits have grown exponentially and Goldman Sachs have calculated that margins for the American stock market index, Standard & Poor’s 500 (S&P 500) are at 9%. This should have been a catalyst for an increase in investment but this has not been the case.

Investment as a proportion of operating cash flow has actually fallen from 29 per cent to 23 per cent in the past five years, Goldman says, apparently because companies are gloomy about the growth outlook,” according to the FT.

Businesses have been using this excess cash to purchase share buybacks. Records were wiped out again as S&P 500 companies spent $133 billion on buybacks this April.

As Dealogic found, vast amounts of money has been spent on M&A deals, which has sparked a debate amongst bankers surrounding whether or not this is a good idea. David Kostin from Goldman Sachs said in a note to his clients that acquisitions are a more exciting way of spending company cash. “In our view, acquisitions – particularly in the form of stock deals – represent a more compelling strategic use of cash than buybacks given the current stretched valuation of US equities,” Kostin said according to the FT.

Regardless of all evidence from past years of equity and credit bubbles bursting, M&A bankers are adamant that 2015 will be different to events that occurred in 2000 and 2007. The FT, however, are more pessimistic about the amount spent in mergers and acquisitions. “When future historians look back to May 2015, this $243bn record will be viewed as a portent of an overinflated financial world,” the FT reports.


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