Is A Coming M&A Boom Good News?
Bloomberg has an insightful article today about a coming mergers and acquisitions (M&A) boom. The logic is pretty easy. Firms have been hoarding cash during the crisis. The deep recession has devalued companies. Lower valued firms plus lots of excess cash means lots of M&A as the economy heals. I'm not convinced this is a good thing.
Here's a little detail on Bloomberg's explanation:
As the economy emerges from the worst recession in 70 years, cash flow may rise from the $1.5 trillion reported by the Commerce Department for the year ended in June, according to data compiled by Credit Suisse Group AG and Bloomberg. The amount reached a record in the past 12 months amid the biggest wave of firings since World War II and central bank interest rates near zero percent.
Cash relative to share prices will climb to the highest in at least two decades next year compared with yields on corporate bonds, the data show. The previous high in 2005 preceded the two busiest years ever for takeovers.
From that analysis, it sounds like we could see a truly unprecedented amount of M&A activity over the next few years. I'm sure investment bankers across Manhattan are drooling over the news. M&A activity has already begun to pick up lately with such notable transactions as Disney's purchase of Marvel, Kraft's purchase of Cadbury and Dell's purchase of Perot Systems. Merger madness is definitely beginning, and it might continue for some time.
For obvious reasons, Wall Street loves M&A. It lines their pockets, not only from the fees, but traders and investors who own the target stocks often collect a hefty premium. But while bankers celebrate, a recent Wall Street Journal piece suggests the rest of the world should not. The piece titled "Wall Street's Biggest Con Is M&A 'Advice'" argues that virtually all mergers are bad for everyone involved. Here are a few snippets:
M&A is a mostly empty exercise built on promises of profits and efficiencies that rarely come to fruition. Companies almost always overpay for their targets, hurting their shareholders and enriching few except the CEOs who do deals and the investment bankers who goad them into the next must-have merger.
Multiple studies have shown no evidence that shareholders of acquisitive companies do better than their stingier counterparts. Some companies are able to wring costs from acquisitions, but usually don't. Close to 90% of European mergers fell short of their objectives in 2007, according to Hay Group.
The piece goes on to make a pretty strong argument that most mergers are ill-fated, or at least won't come anywhere near the expectations the firms involved had. But it could be worse -- what about the broader economic consequences?
For starters, there's the too big to fail problem. The obvious example here is with financial institutions. Perhaps if Citigroup, Bank of America and others hadn't acquired so many other institutions, they wouldn't have become so massive and systemically risky. Maybe then we could have more easily stomached the failure of a few of them, instead of bailing out the whole system. In fact, with more major market participants, maybe then we would have had more alternative, cynical views of the real estate market and the bubble would not have grown so out of hand.
But this goes beyond systemic risk. I wrote a while back about the fact that former Treasury Secretary Hank Paulson likely had insufficient knowledge of how mortgage-backed securities worked, even as the CEO of Goldman Sachs. That's because firms like Goldman have become so complex, with so many moving parts, that it's virtually impossible for its executives to have a firm grasp on all of its businesses. And this extends even beyond banks. Maybe if the auto companies had been smaller, and focused more on specific niches, certain ones would have been more successful than others, and some would have failed, but others survived and flourished. There's something to be said for specialization.
I want to be careful. I don't mean to suggest that all acquisitions are bad. Certainly some are very good and sensible. But I am sympathetic to the WSJ piece's thesis that most are probably not. I've argued before that antitrust regulators should consider whether systemic risk is an issue when allowing firms to merge. Maybe the test for a merger should be harder in general. Is a more oligopolistic market likely to develop? Is it unreasonable to assume that the CEO, CFO and other top officers will understand all of the businesses the firm is in? Answering either of these questions in the affirmative would pose economic problems.
I'm a huge advocate of the free market, but I'm also a believer in economics. If a merger has clearly negative economic consequences, then that should matter. Bigger isn't always better. In fact, sometimes it's clearly worse.