Something weird is going on – that’s all everyone knows.
October was merger-mania month with a pre-election surge during the waning days: five of the largest 11 US-focused Mergers & Acquisitions in 2016 were announced in the last 10 days of October, including two that broke all-time industry records.
The mania was topped off by two big announcements on Monday:
- GE’s $25-billion acquisition of Baker Hughes. Since 2008, the M&A-meister, financial engineering specialist, and industrial powerhouse has gobbled up 51 companies of $1 billion or more in value.
- CenturyLink’s $24-billion acquisition of Level 3 Communications.
In the prior days, three big deals made investment bankers salivate:
- AT&T’s $85.7-billion deal to acquire Time Warner, announced on October 22, the hugest deal in the history of media, even huger than the prior hugest media deal ever, the AOL Time Warner deal that ended as a spectacular success along with the rest of the mania at the time. But Wall Street instantly refuted what everyone had been thinking from the very first moment, that this was most decidedly and in fact, doubtlessly, not the next AOL Time Warner.
- Qualcomm’s $39.2-billion acquisition of NXP Semiconductors, announced October 27, the biggest deal in the history of the semiconductor industry.
- British American Tobacco’s $46.9-billion acquisition of Reynolds American – the 57.8% it didn’t already own – announced on October 21.
This pushed US deal volume in October to $330.3 billion, the second highest month on record, after July’s $332.3 billion! And this comes after the all-time record year 2015.
It pushed global deal volume in October to $502 billion, according to the Financial Times, and to $489 billion, according to Bloomberg, which pointed out that October was the busiest month in 12 years (Bloomberg chart via Christine Hughes, OtterWood Capital):
This sort of deal making where billions simply don’t matter is eerily reminiscent of the last-minute frenzies in 1999-2000 and 2007, before it all came unglued. Everyone knows that after a record-breaking M&A boom, stock markets tank. The only thing no one knows is when this will happen, when the M&A frenzy will go into its final paroxysm and collapse.
Everyone is trying to come up with their own theories to predict this event and put a timeline on it. One thing is a given: Never in history has there been that much central bank manipulation; never have there been $12 trillion in bonds that traded with a negative yield; never have central banks printed so much money. It’s a new era, and none of the old models will work. Something new and unexpected will be taking place instead.
But the red flags keep cropping up. According to TrimTabs Investment Research, cited by USA Today, US companies committed $105 billion in cash (in addition to stock) to pay for these takeovers in October, beating the prior all-time monthly record of $97.5 billion set in October last year:
“The flurry of cash mergers is a cautionary long-term signal for US stocks,” TrimTabs CEO David Santschi told USA Today. “Cash merger activity has a tendency to peak around market tops.”
Have cash mergers, and M&A in general, peaked in October? Or was it just another record on the way to more records? Something weird is going on – that’s all everyone knows.
And then there’s the lag time between the record-breaking mega merger data that blows a hole into the ship, and the sinking of the ship. The lag could be a year or longer.
For example, last time: Private equity firms KKR, TPG Capital, and Goldman Sachs Capital Partners announced in February 2007 that they would acquire the Texas utility TXU; the deal became final in October 2007. It was the biggest, most leveraged, craziest buyout ever, and it would ultimately collapse into bankruptcy. With hindsight, it was the final deal-making paroxysm. The stock market turned south the moment the deal became final, at first in a very casual manner. It took another 11 months before Lehman imploded and all heck broke lose.
None of the October deals are “final.” So if October is the peak in deal-making, as some are saying, then the timeline starts now, and goes for maybe 12 or 15 months before it all comes unglued again.
But it assumes that this time will be like last time. Yet, this time will not be like last time. Nothing will be. Central banks have seen to it that something different will happen, and that it will happen differently, on a different timeline and scale, with far more debt and derivatives than ever before, and a far greater willingness by central banks to muck it up even further.
We know one thing for sure: This M&A frenzy will lead to record debt issuance mostly in 2017 to fund it all, assuming these deals get completed and things don’t come unglued prematurely.
So far this year, companies in the US have already issued $1.4 trillion in bonds, according to Dealogic, a record pace, to fund acquisitions and stock buybacks, rather than do something productive.
CEOs are driven to make these deals to offset slowing sales and profits. They need the benefits of “acquisition accounting” to bury inconvenient data deep underground. And they can do it because stocks – the currency with which they buy other companies – have been inflated, and because borrowing costs even for riskier companies are artificially low.
Global bond offerings, at $5.8 trillion so far this year, are up 9% from the same period in 2015, which had been a record year. Everyone is getting nervous about the speed with which debt has been piling up even as the economy has been languishing.
“It is very analogous to 2005, 2006 and 2007,” explained Jon Duensing, deputy chief investment officer of Amundi Smith Breeden. “What happens to the markets when global interest rates start to move higher?”
Better not even think about it.
To fund the current M&A announcements, bonds and leveraged loans will pour into the markets around the world. They’ll be gobbled up by yield-desperate investors – institutional investors, such as fund managers – who no longer look at risks and cannot even imagine that they exist and who don’t even dream anymore of being compensated for taking risks, huge risks. They’ve been brow-beaten by low yields or even negative yields and infused with a bubble mentality that in this central-bank managed world, nothing can ever lose value or implode in the classic manner, and that if it does, it’s just other people’s money that goes up in smoke and that it will all be “contained.”
But with QE and negative interest rates skewing every sense of reality, everywhere, no one knows how or where this might end up.
Why is this economy not yet in an official recession? Read… What’s Really Different this Time: Business Investment Drops to Lowest September since 2010