The wild mania in global mergers & acquisitions has surpassed the $4-trillion mark for the first time ever in a year-to-date period. It’s higher even than the last year-to-date record of $3.93 trillion in bubble-year 2007, according to Dealogic. 56 deals hit or exceeded $10 billion, accounting for 37% of the total dollar volume, another record.
In the US, M&A has already blown the doors off all prior records. At $1.97 trillion year-to-date, volume is 43% higher than the prior year-to-date record of $1.38 trillion set in 2007. We know what happened after 2007.
Merger manias occur shortly before the stock market peaks. They occur because stocks are overvalued and debt is cheap which allows companies to use their overvalued currency and cheap debt to acquire other overvalued companies. They occur because CEOs think big is better. They occur because activist investors, hedge funds, and Wall Street are clamoring for them to get rich off them. They occur because acquisition accounting allows for all kinds of sleights of hand.
And they hardly ever work out.
Today’s example: Men’s Wearhouse, which, after a six-month kerfuffle last year, finally managed to buy Jos. A. Bank in a $1.8 billion deal.
Men’s Wearhouse issued an earnings warning Thursday after hours, blaming its hotly pursued acquisition for the debacle. Third-quarter comparable sales at Jos. A. Bank stores plunged 14.6%, “far below the Company’s earlier expectations,” due to “primarily” a drop in traffic after it began abandoning Jos. A. Bank’s signature promotion of Buy-One-Get-Three-Free suits.
After spending $1.8 billion, MW apparently figured out that selling four suits for the inflated price of one is not a very profitable deal. And fourth-quarter comparable sales at Jos. A. Bank stores are expected to plummet between 20% and 25%.
This is going to hit earnings.
At MW’s legacy stores, third-quarter comparable sales, now that competition from Jos. A. Bank has been effectively annihilated, increased 5.3% in Q3, and are expected to increase 3% to 4% in Q4. But it’s not enough to fill the hole. So the company slashed the range of “adjusted” earnings per share by over 30%. No telling what actual earnings per share, as reported under GAAP, will be.
“While we expected top-line volatility,” said CEO Doug Ewert, “we did not anticipate that the impact from the traffic decline would occur to this degree.” He now called the very thing that had made Jos. A. Bank what it was an “unsustainable promotional strategy.”
So after spending $1.8 billion up front and getting hit with additional losses from the acquisition, as the tab gets longer and longer, MW is suddenly “focused on and committed to rebuilding the Jos. A. Bank profit model.”
Investors are ruing the day.
MW shares are crashing: down 45% as I’m writing this. At $22.06, they’re back where they’d been in 2010. Down 66% from their peak in June.
The Jos. A. Bank deal was funded with a lot of debt that was eagerly lapped up at the time by ZIRP-blinded, yield-desperate, Fed-brainwashed institutional investors and subsequently stuffed into conservative-sounding bond and loan funds tucked away in retirement portfolios and pension funds.
To fund the deal, junk-rated MW (B+/Ba3) issued a “covenant-lite” floating-rate leveraged loan of $1.1 billion in April 2014 at 99 cents on the dollar. “Covenant-lite” because it didn’t give investors the traditional protections.
During credit-bubble times, investors take on anything without even thinking about the future, including “covenant-lite” junk-rated leveraged loans to fund misbegotten acquisitions.
MW has since issued a fixed-rate leveraged loan of $400 million to pay down some of the floating rate loan. The floating-rate loan dropped from around 100 cents on the dollar before the announcement to 95 cents on the dollar Thursday late afternoon, sources told S&P Capital IQ LCD.
The junk bonds MW issued in June 2014 at par (100 cents on the dollar) to help fund the acquisition are getting clobbered too. MW’s 7% notes due 2022 plunged as much as 8.5 points Thursday afternoon to around 96 cents on the dollar.
This is a vivid example of what the current acquisition binge by Corporate America entails. Whether it’s Microsoft, IBM, Valeant, or any of our corporate heroes that have spent nearly $2 trillion so far this year to buy each other out: acquisitions are always pitched as the best thing since sliced bread in a plastic bag (which has destroyed the delicious nature of bread).
Then reality sets in. Companies fail to unearth the illusory “efficiencies” and “synergies” they promised investors. The operations fall apart – à la Men’s Wearhouse. Associated losses are oozing to the surface, usually expressed in that ludicrous fantasy of “one-time non-cash charges.” And acquirers shut down operations, axe projects, close stores, and lay off people.
It’s the same thing after every merger boom. That’s why they occur near the peak of the market. They drive up stock prices. But afterwards, the individual hangovers from these mergers are taking down the shares of these companies one by one – and often enough, when the debt blows up, the companies themselves.
And it’s now it’s getting serious in the US energy sector. Read… Giant Sucking Sound of Capital Destruction in US Oil & Gas