The frenetic level of deal-making these days is bound to make some investors nervous: Didn't deals spike before the dot-com crash in 2000 and again in the lead-up to the financial crisis in 2007?
In the first four months of this year, global mergers and acquisitions activity has totalled more than $1.1-trillion (U.S.), according to Dealogic. That puts 2014 on track for the best year since 2007, when deals topped out at $4.6-trillion.
Hardly a day goes by without a big announcement of some kind. Within the past week alone, Pfizer Inc. has made a bid for AstraZeneca plc, which values the British pharmaceutical firm at nearly $100-billion; Valeant Pharmaceuticals International Inc. has teamed up with hedge fund manager Bill Ackman in a $47-billion deal for Allergan Inc.; and General Electric Co. is reportedly after the energy business of France's Alstom SA, valued at $13-billion.
Other notables from earlier in the year include Holcim AG's $41-billion deal for Lafarge SA and Facebook Inc.'s $19-billion deal for WhatsApp Inc.
Generally, M&A activity is good news for investors when their shares are snapped up at a premium. Allergan surged 15 per cent last Tuesday and AstraZeneca was up 13 per cent in New York on Monday.
But for the health of the broader market, deal-making does raise questions, given the uncanny track record in recent years of companies splurging on acquisitions at the top of the market.
Just as 2007 marked the high point for deals, 2009 marked the low: The year that saw the bottom of the bear market in stocks also saw deal-making shrivel to just $2.3-trillion, or half the total of 2007. Similarly, deals totalled $3.3-trillion in 2000, a year that saw the top of the tech bubble, but then fell to just $1.3-trillion by 2003, near the bear-market low.
If there's a pattern here, it suggests that low levels of M&A activity point to a rising stock market and high levels of activity point to a peak, suggesting that deal-making is a contrarian indicator. The pattern even has some logic to it: Executives tend to make deals when they're feeling rich and confident about the future, which is when a bull market is charging.
The bigger issue concerns timing: As in, is it time to sell? Rising levels of M&A activity certainly add one more reason to be cautious about stocks – along with full valuations, a remarkable 180 per cent rally by the S&P 500 over the past five years and the prospect of tighter monetary conditions from the U.S. Federal Reserve.
But it's hard to see M&A activity as a switch for turning bearish. For one thing, while the value of deals is high so far this year, the number of deals isn't unusual; indeed, the number is relatively low compared to recent years.
For another, deals are being financed differently. As the Financial Times pointed out, 76 per cent of deals made in 2007 were cash acquisitions; now, just 47 per cent of deals are made with cash. This suggests that companies borrowed with wild abandon before the financial crisis but are now taking a more conservative approach to takeovers.
And lastly, there are few signs of outright frothiness in the market today. Acquirers have paid an average 30 per cent premium during takeovers historically, but the average premium slipped to 22.14 per cent in 2013, according to Dealogic. Among this year's deals, Valeant is offering a 7 per cent premium and Pfizer is offering a 14 per cent premium, suggesting that exuberance hasn't kicked in yet. Dealogic says that the average year-to-date premium is up only slightly, to 22.19 per cent.
For sure, M&A activity and the bull market in stocks are likely to peak together, just as they did in 2000 and 2007. But 2014 seems a bit early to mark the end of the good times.
David Berman