M&A Frenzy

They are not crazy. They simply do not have any better ideas about what to do with their cash. There is just too much cash.

It is human greed and psychology. They want to have their toys and they afraid that somebody else will snap it before them; therefore, they do not mind paying more. It is similar to people overpaying for a rare painting – so they can have it but nobody else.

A big part of it, if I understand correctly, is the demand for bonds (commercial paper).

Many pensions, insurance companies, etc. were burned holding too much equity in the bear market, so now they have mandates for how much of their assets have to be in bonds (and for many, the “how much” is 100%).

If you had very high demand for bonds but couldn’t find anything to do with that bond money (e.g., businesses to run, businesses to start, capital to invest in, etc.) you could easily fall into the current logic…

If I have demonstrable demand for bonds, but can only buy equities easily, why not turn water into wine and buyout equities and turn them into bonds?

If i recall correctly, all academic studies show that surges in M&A activity are signs of a top, not a bottom.

The misconception is that because private equity firms are the buyers this time, not entrenched corporate management, it will work out fine because the private equity people are smarter. I see no reason to believe that they are any more immune to the herd mentality than anyone else.

When cycles are at one extreme or the other, it is simply hard for humans to forecast change. At bottoms, no one wants to take risk. At tops, no one prices risk correctly.

I have no idea when, but it will happen in this cycle too.

psychology, sentiment…

Just look at some of the “whoppers” getting $ thrown at them;

MS gonna buy Yahoo…oops
IBM gonna layoff 150,000…
BHP “no Problem” bidding $100 bil for Rio Tinto…

Isn’t kinda unusual for AA to be up on the deal if they’re issuing stock?

Buffet said he was “looking for” a big acquisition; he quickly qualified that statement by adding the he currently could not find anything at a fair price.

The Oracle has to put all that moneypile to work somehow, and he implied that he does NOT want to keep it sitting in US dollars or Treasuries.

My guess is he either a) doesn’t buy anything until a market pull-back, or b) buys a hard asset, or c) acquires a company that collects revenue in something other than US dollars.

Pins and needles…

I see it as a perfect storm of several factors:
SARBOX has had a double-barreled effect. First, the higher costs and administration of regulatory compliance is driving corporations to join together to lessen the impact. Second, the fallout from making corporate risk-taking borderline criminal is that corporate boards stopped taking risks. They took their balance sheets from one extreme to another. Private managers can now come in, buy these clean, cash heavy balance sheets, and immediately pull all their money out by leveraging the thing to the hilt.
The cycle of private equity is a big factor. PE boomed in the late 1990s and a lot of cash was raised into the early 2000s. Unfortunately, the deflation of 1997-2002 and its resulting recession and tech meltdown meant a lot of that money went uninvested. With hard timelines for PE funds to draw capital from investors, it is lijely that PE managers from 2002 & 2003 vintage funds are rushing to put money to work (they can only charge fees on capital drawn and often have a 5 year window to draw it).
Finally, I think the expansion of the view of PE as a separate asset class has influenced institutional and HNW individual investors alike.

Iscar which he has just bought is an Israeli company, so he is looking outside the USA.

It is the last great way to get rich before the crash. We talk of entities (Blackstone, etc.) but the actions are taken by people. If you are financially astute and things look to be ready to turn to crap, once some trigger happens, and you have the ability to do so, why not do whatever to make some fat money?

I’m not saying it is a good idea but people seem to be suffering from the ever increasing overhang of uncertainty in the world. Humans don’t handle uncertainty and they hate to lose. So they are taking actions to have one more win. You can believe that this is not a good sign.

Drinking and then driving is not a good idea but try to tell that to a drunk. By the way, Microsoft isn’t going to buy Yahoo and Warren Buffet isn’t going to pay the wrong price for a company. He’s researching now because sometime soon he may be able to pick up a company for pennies on the dollar. I’m looking at the housing market now because at some point I’m going to get a house for a much lower price if I have prepared correctly.

I don’t suppose that it ever occured to these companies with all of this cash…that they COULD return it the shareholders in the form of dividends? Guess not.

Instead they choose to burn it by making expensive and unnecessary purchases. It’s been noted in several surveys of company executives that a economic slowdown is looming…yet they make needless acquisitions?

I suppose they have nothing to fear anyhow, people just keep buying the stock. I am defintely missing something.

It’s all like everyone is trying to get rid of money, probably expecting that the value of money should decline.

Just about everyone has a point. REW has a skewer. The bubble is still expanding and this type of behavior is typical endstage. Can you imagine what happens when the contraction begins and these enterprises are thrown to the Chainsaw Al types. Oh, I forgot…no more contractions.

judging from his recent bet on railways, Buffet thinks that oil prices are going to stay high for long.

i bet he’s after some mid size oil or commodity company.

one can still find some at very good valuations, p/e 2 less than the market on average.

i recall you disclosed owing COP yourself Barry

~~~

BR:
I own BP (via alongstanding holding in Amoco) and after that deal, I asked about and looked for ready comparables. Someone (it might have been an Amoco big wig post merger) suggested Philips had the best numbers. That brought us to own Philips Petroleum (now Conoco Philips) which has been a long term hold.

I believe several factors are at play and most are well-covered in previous comments. To combine comments from V.L. and Jay, I believe that the human component of greed is the “disease” that is driving the “symptoms” of this illogical wave of M&A activity that seems to point to the final “leg up” in this market cycle. This may be an oversimplification, but there are two sides to every exchange — a buyer and a seller. In the big picture view, I believe that the sellers are making the better decisions at the moment and the buyers appear to have some combination of greed, big egos, large piles of cash, or lack of new and innovative ideas driving their purchase decisions. As for Buffett and other value-minded investors, I believe their purchase decisions are primarily based on fundamentals and are not driven by emotion:

Illogical M&A activity “EX-Buffett” is still illogical M&A activity…

The source for all M&A booms is that it’s cheaper to buy assets on Wall Street than it is to build.

One of the heavy industry companies in my portfolio is capacity constrained. They’d like to add capacity to take advantage of the high selling prices they’re currently experiencing. They confirmed on the last conference call that it will take at least two years to bring new capacity online and the replacement cost of its existing asset base is over 2.0x its current enterprise value.

Despite the housing recession, there’s a raging bull market in building materials like cement, copper, lead, nickle, etc. Backlogs at construction and engineering firms are so long rates are going through the roof (FWLT, FLR, CBI, JEC).

So, the choice is whether to buy a competitor with a seasoned management team and staff and begin realizing revenues from the date the acquisition closes, or do you build from scratch, pay 2.0x more than what it would cost to buy equivalent capacity by buying a competitor, wait over two years to have the project online generating revenue, and train a bunch of people to manage and run it.

Which would you do?

M&A is being driven by the continuing need to create debt for export.

Consumers are probably reaching (or exceeding) the limits of net new debt creation through CDO’s etc. In order for the current global imbalances to be maintained though, debt MUST be created for export, as a matter of simple arithmetic. With consumer debt creation showing signs of stress, the corporate sector is the next batter up.

What happens from here will likely be determined by perceptions about cashflows to service debt. As long as the consumer sector can continue to service existing debt at about current levels, the corporate debt creation channel can continue to produce debt for export.

At some point, the consumer or the corporate sector (or both) will reach a point where cashflows can’t service existing debt, and those channels will close. Assuming the global imbalances continue, the government sector will be the last remaining channel for debt creation.

Buffett is not that stupid. Going both feet into the M&A hot tub is about the exact opposite of his historical approach. I’d guess that he sees the crunch coming, and he wants as much dumb money out of the market as possible. Oh, and some fire-sale priced assets to nibble on with his huge (dollar-hedged) pile of cash.

I’m surprised nobody has mentioned the obvious. Over the past two years, private equity has proven successful at this gameplan:

acquire companies
spin off assets
leverage on debt
withdraw equity
sell releveraged co. to public markets
cash out

Success breeds imitation.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aQL67p9OgiC0&refer=home

Yeah, I think Momo Fader is on to something, here.

They didn’t get the nickname vulture capitalists for nothing, y’know?

Position: long capitalism, short bloodsucking leeches

2001-02 borrowing of commercial paper was at an all time low. During a bear market asset prices deflate (stock prices in this recent one). If your market capitalization fell then your overall worth to borrow against is low. Even though rates were falling the expectation was rates would fall even further. You don’t want to take out a loan against your assets if your assets are depreciating. It’s like holding a reverse mortgage. Besides demand for production was down. If you are having trouble maintaining productivity and profits in an economic contraction why would you increase in size? Why take on another company’s misery?

It is better to circle the wagons and keep what little cash you have in reserve to maintain operations or improve efficiencies.

Come 2003-2007 you have an economic expansion. The Fed injects liquidity in to the market and signals increasing rates. Commercial paper borrowing goes through the roof. Like every corporation at once refinanced old debt and borrowed heavily against assets and stock. Why? Not to buy value, but to expand faster. Almost all boats are rising with the tide but some rise faster and you don’t want to be the one who is only performing at the same pace as the rest of the economy. You are going to get eaten by the bigger and faster growers.

It is extremely important for you to realize that investors and business owners do not necessarily look at the value of a company the same way. Investors want to buy value and expect growth in stock price in one way or another, be it stock buyback, takeover, or better earningsprofits. Investors want to buy the company when it is undervalued or not in the spotlight. Business owners look at companies in terms of their own survival and is relative to the pace of others in their industry. Most do not want to be take over targets because they loose control of their operations. They want to be leaders not part of the pack.

M&A activity happens when markets are their strongest because profits are high and cash is freely available. Market share is almost completely absorbed by all players and the only way to gain more is to innovate or gobble up a competitor. the problem is that your competitors are going to be relatively profitable as well if your industry is strong and was as weak as you when the industry was doing poorly.

Investors don’t really care to hear that they are outperforming the market because they are down 10% and the S&P is down 17%. They don’t want to loose money at all. Business realizes that it is part of the economic cycle.

I must disagree with those who post here and elsewhere that the tipping point is nigh as consumers (or companies) can no longer service their debt. The Fed is intentionally devaluing the dollar so that debtors can repay their debts with less value.
It is the lender that suffers during an inflation, not the borrower. This brings us back to BR’s question. The M&A deal is about leveraging corporate balance sheets. Why do they do this now? Because these smart capitalist see the inflation and are trying to take advantage of it.

Letting foreign CBs set become the dominant price setters for interest rates will go down as one the worst decisions since the 1970’s. The private sector has to set the price of money. CBs do not have enough personal skin in the game.

Shrek – agreed. There’s a risk it becomes a national security issue at some point.

It’s the conundrum. Not A conundrum, but THE conundrum. After pondering the conundrum for the last few years, businesses are finally discounting the persistence of low interest rates into the future. This reevaluation is outpacing that of the public markets. Ergo, acquirers value the targets more highly than the markets do, using the usual models with a lower discount rate. I believe these low rates will long outlive recent discussion of excess liquidity, due to underlying deflationary trends (yes, ex- ex- ex-, etc, but I’m talking about the longer run here).

Industry consolidation ahead of a Democratic administration may be an additional independent factor. Deals beget deals to some degree, as the bankers begin to smell blood in the water and CEO testosterone levels rise. But there haven’t been many glaringly stupid deals to date. Upon the announcement of a deal to assemble the next conglomerate, consider the bell rung.

Lathering 99 percent of Americans and now a large percentage of well run American corporations with tons of debt in order to provide growth to the ROW is not a longterm solution, in fact its probably a recipe for a severe hard landing. All I hear all day long is “global decoupling” is for real, blah blah blah. Its not going to happen until this silly dollar and interest rate price fixing stops going on. Only then are we going to figure out how much progress is being made. My guess is much less than most people assume.

Part of the M&A activity is a variant of panic buying- I better buy it before someone else does! Game Theory. All the valuations, numbers, are based on the current reality. The exogenous event happens and changes all that. New Game.

Awesome, awesome discussion here.

I am kvelling . . .

There are many fascinating views expressed here by many intelligent and well-educated posters. Let me express the views of one not nearly so well educated but thus not tainted by a formal economics education based on Keynesian model.

There appears to me a simple explanation for all the activity at this time – there are left no other choices to sustain the scheme.

To address a few comments – the Federal Reserve has no control over the value of the dollar. They cannot debase the money directly; however, they can conspire to do so. Debasement is expanded money supply; money is debt. Period. Holding onto the target rate means granting the powers of money supply to the borrowers – the fed cannot pick and chose who gets to borrow.

Repayment of debt contracts the money supply. Does the Fed wish this to occur?
Does anyone? How can a debt bubble be expanded without fresh debt? The fed understands well that a money contraction and subsequent credit crunch would bring this game to a sudden and catastrophic end, so they have no desire to lower the dollar value to have debt repaid.

I would even go so far as to say the Fed is a meaningless player at this point, except for the short term emotional reaction bias built into the markets, but as to actual sway over what happens they are powerless. Interest rates are driven by the massive worldwide bond markets while the Fed has abandoned their chance to contol money supply – where is their power to do anything but be a “bully pulpit”? They do not control interest rates; they do not control money supply. What is left?

The consumer is reaching the point where no more short term credit is available to them; the housing market is in recession and home prices will continue to fall; Mew can no longer be counted upon; capex is dwindling; subprime has collapsed and banks and mortgage companies are tightening lending standards.

Where does the debt come from to provide the currency expansion necessary to sustain the bubble? If there is less money in circulation, tighter lending, and higher interest rates do you think the markets would rise? Money must be created to sustain the rise or more likely simply to prevent a collapse. Money=debt. Debt=money. No new debt, no new money, no more bull market.

But there is a Catch-22 in this scheme. New debt=new money=money debasement (commonly termed inflation.) So you get to pick which kills you, a collapse or inflation.

Looks to me as though LBOs have been forced to cover for subprime and the general housing market collapse. The loan standards are similar to subprime as is the hype. And the underlying risk is very similar. And the money simply must be created by new debt. I would even guess that the reason the fundamentals of these buyouts is so weak and risk is so high and the lending standards so loose is that the risk in not being weighed against the individual deal but against a greater risk of not creating new debt.

And this is a global phenomenon – money supply expansion is running double digits everywhere you look. Every single dollar, eruo, franc, or krona is the product of debt – that debt has to be paid. How? Either with new debt or with currently held capital. What happens if currently held capital reduces a debt to zero? That money disappears, is subtracted from money in circulation, goes back into the black hole from which it was born. If instead, the company borrows the money to pay the debt, an equal amount of new currency is created, adding to the supply of liquidity. As long as the company can borrow cheaply enough they can use currently held captital as investment capital to offest the cost of borrowing and still profit.

I take back an earlier statement – the Fed does have one power left: they could raise the target rate high enough to make borrowing unprofitable, thus contracting the money supply and lowering debasement (inflation). But then, we know what a money contraction would do – pop the bubble. So although a real power, it is one the Fed will not use.

To those who accept a raging bull market in commodities I suggest this from economicpolicy.com.

“On Wall Street, the chorus is getting louder that rising metal supplies are outpacing demand. From Goldman Sachs Group Inc. to JPMorgan Chase & Co. to Societe Generale, there are warnings of a mania that is showing all the signs of a climax, Millie Munshi reports for Bloomberg..

‘This is a real bubble,’ says metals trader David Threlkeld, who first got the world’s attention in 1996 when he showed that Sumitomo Corp.’s copper hoarding would lead to a market collapse. Once again, `we have an enormous amount of unsold copper,’ says Threlkeld, president of Resolved Inc. in Scottsdale, Arizona.

Nickel stockpiles tracked by the London Metal Exchange, the world’s largest metals bourse, rose almost 60 percent since dropping on Feb. 6 to 2,982 tons, their lowest since July 1991 and barely enough to supply the world for a day.

Lead inventories are also rising, gaining by 42 percent since March 13 on the LME, to 43,825 tons. A surplus of 25,000 tons of lead may exist next year, from a deficit of 35,000 tons forecast this year, Natixis Commodity Markets Ltd. said in a quarterly report on May 1.”

Bubble built upon bubble built upon bubble.
When will it pop? That is the real question.

Oh, what a tangled web we wove
when paper first replaced our gold.

Do remember that Warren Buffett likes to play fair. He had to convince Washington Post that he was investing and not taking over. He is now looking for much more than a take-over target he is looking for a legacy.

Based on the amount of above ground gold reserves according to the World Gold Council, Warren Buffett’s $40 Billion could hypothetically buy 11% of it. I think the thought alone should make Ancient Kings jealous.

If anything starts rising quickly, pay attention Buffett may be getting on-board.

2, 3 or 4 years ago, money was cheap
but it wasn’t so easy.

The subprime crisis alerted Private Equity
to a huge opportunity they’d been missing –
that the rules had changed: money
had lost all concern for risk. Repaying
borrowed money simply no longer mattered.

Having figured that out, and still posessed of common sense, a mad dash had
to be made before that unusual window
slide shut.