Why merger mania is nothing to celebrate
U.S. equities pushed higher on Monday as investors responded to merger excitement, headlined by the $85 billion tie-up between AT&T (T) and Time Warner (TWX). Overall, $125 billion worth of deals were announced.
But will the opening of corporate coffers reinvigorate investor interest in stocks? The Dow Jones industrials index is trading in a tight two-month range, capping a year-long flirtation with the 18,000 level it first reached in 2014.
New research from the Federal Reserve shows net cash outflows from U.S. domestic equity funds every month between March 2015 and August 2016. They’ve averaged nearly $18 billion each month for a total outflow of $310 billion over the last 18 months. Moreover, trading volume so far this October is on pace for the lowest in 40 years.
To be sure, some big sums are being spent on corporate dealmaking.
AT&T’s half-cash/half-share offer values Time Warner at $108.7 billion and is the largest single merger of the year. Management believes the deal will add to earnings and free cash flow in its first year, building on the momentum of AT&T’s recent DirecTV acquisition. However, regulatory scrutiny will surely follow.
Other deals announced include a $6.4 billion buyout of BE Aerospace (BEAV) by Rockwell Collins (COL), a 25 percent purchase of Hilton (HLT) by China’s HNA, a $4 billion purchase of Scotttrade by TD Ameritrade (AMTD) and a $2.7 billion deal by China Oceanwide to acquire Genworth (GNW).
BE surged 16.4 percent on the news, Ameritrade fell 4.4 percent and Time Warner fell 3.1 percent. AT&T fell 1.7 percent to continue a share price drop that started in August and now totals roughly 14 percent.
Investors’ reactions get to the heart of concerns about big M&A deals, such as the historic $164 billion acquisition of Time Warner by America Online at the height of the dot-com bubble.
That’s because they’re often more about executive vanity and empire building than boosting corporate performance and investor wealth. In fact, an analysis by McKinsey found that large M&A deals are successful, in terms of value creation to shareholders, only 44 percent of the time, with particularly poor results for big tech and telecom deals.
This also fits into a theme lately of companies relying on financial shenanigans like share buybacks, dividend hikes and M&A instead of old-fashioned investment in their own businesses. In fact, the year-over-year change in gross investment in the economy has dropped into negative territory (chart above) -- something that has been a solid predictor of recessions over the past 40 years.
So while the AT&T deal made for splashy headlines, the evidence suggests investors would do well to remain skeptical. Especially because the volume of deals over the last six months, totaling $500 billion, has been higher only four other times in the last 20 years and could be a sign of overvaluation and executive overconfidence, according to the team at SentimenTrader.
