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
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Can the NYSE get any more inflated? How is that even possible? So the feds have done their job. Using all the funny money from the QE to prop up housing prices so that now all the under water banks securities can sell their zombie assets in mortgages at cost or higher while allowing all the home owners to toil and loose their shorts in the downturn. That was a much better idea than to work on lower principles and allowing the borrowers to save their homes. Then they can rent them at a higher price as they work 2nd jobs while being underemployed with two degrees they will be paying on until they are dead and buried.
I guess they’re not liking how they look now. Pretty soon we’ll be seeing promotions like Buy 1 suit and get 10 for free at our next Fire Sale. The deflation death spiral is just beginning.
No mention of the fat bonuses company officers paid themselves as a reward for their brilliant M&A strategy. Best to clear those through before reality sets in.
It occurred to me 20 years ago that most M&A activity is destined for detonation because it’s motivated not by any compelling business reason, but for the simple fact that it impresses investors and runs up the stock price. And makes it reek of a short strategy waiting to happen.
One has to admire the utter fearlessness of participants in the herd mentality, particularly as they’re bravely running off a cliff like a bunch of Homers chasing a donut. It beats doing your own thinking, at least until arrival at the bottom. Also remarkable is how greed so often and so easily switches off the Higher Cognitive Functions among people who you’d expect would know better.
Refrain: “Hmmmm … DOH-nut”.
Have you heard the one about the two CEOs and the three letters?
Banks sells very overpriced merchandise. They also try to bait and switch on their sales. While paying they try to get you to pay more by telling you your items were not the ones on sale. They didn’t get away with that with me, but I saw other customers walk out of the store.
You’re gonna like the way our new economy looks.. I guarantee it.
And if you dont like the new economy, you can keep your old one. right?
I can hardly remember a single M&A deal from the past fifteen years that made any sense whatsoever: the only one I can think off the top of my head was Husqvarna’s acquisition of Japanese engine manufacturer Zenoah from Komatsu and only because it gave the Swedish group access to very advanced engine technology they were struggling to develop in-house.
The rest has been more or less a valley of tears, except for those shareholders who cashed in their chips at the height of the frenzy.
So one has to ask: with fifteen years of failures in front of their eyes, why launch ill-conceived M&A deals one after another? Why not run a serious costs/benefits analysis, like in the days of yore? In the 90’s Suzuki Motors was pressured by their main bank to take over Kawasaki’s then ailing motorcycle division. The firm ran a costs/benefits analysis and turned down the offer: too expensive, too many risks of additional losses. And mind this was after the Zaitech Bubble popped, hence credit in Japan was already dirt cheap.
Men’s Warehouse effectively spent $1.8 billion (plus the additional losses that are piling up) to drive a competitor out of business through an M&A deal. If getting rid of Jos. A. Bank was such a priority it would have probably been far cheaper to simply sell at cost or at a loss, like Amazon does, or to go straight after JAB customers. However this would have required time, and people these days have zero patience.
Now it’s MW which runs the risk of sink together with the competitor they tried to eliminate. I am sure there are desperate enough investors out there ready to extend a helping hand to MW in return for covenant-lite bonds yielding 7-9% but lately it seems to me investors are losing their appetite for unrewarded risk. I know I lost mine after getting out of Shanghai just a few days before the bubble popped. Luck won’t always be by my side and making bad calls is far too easy.
Plus, it’s not that MW is the sole junk-rated company offering relatively high yielding bonds these days: the competition is fierce, starting from oil and natural gas companies. The supply is high, yields, even under the present financial repression, do not reflect the risk of default and the supply of greater fools is drying up. One only needs to look at stock markets: they are propelled upwards by a handful of investment grade stocks. Investors may be mad, but not so barking mad as to prefer buying Pinkopollus Biotech over Amazon or Apple. The mindless enthusiasm is over.
My M&A memory goes farther back than yours. None of the deals ever made money for the investors. They were all black holes of debt and losses.
I saw a merger/acquisition that made sense – I worked at the company (2nd gig out of college).
My company used the product of another company (lets call them Bean) to sell services to our customers (value add). My company (borrowed? – not sure of deal details) bought Bean (they were 10x bigger than us). Bean had hundreds of customers, some of which had tens (hundreds?) of install locations of their product.
A year or so later, we bought a start up that had a competing product with Bean (probably the plan all along). Bean product was originally developed in the late 70s / early 80s (not necessarily a problem), but it was also bloated and poorly managed. Bean’s customers, which notoriously stingy, tricked Bean into digging many holes with regards to their product, by making special customizations just for their business process for some fees, however the way it was done a complete unmitigated mess.
If you are a programmer type, Bean’s product had almost TWENTY versions of their product in production at customer sites which where permanently BRANCHED and CUSTOMIZED to add a little extra revenue (at the time). Imagine the staff you have sitting around, doing nothing, riding the ride, because you have to support all that and can’t change anything due to complexity between all the branches which will never merge back into the source trunk.
A few years after that, the start up had a product running and the customers of the company we bought were migrated to the new product. Over time, most of the employees of the company we bought were let go (as I understand – I left). The entire customers base eventually migrated to the new product built by the start up and Bean’s code base was retired.
I went to email one of those coworkers a while back, but got a bounce on the email address. This guy was a lifer, so I knew something happened, but never tried to follow up. I just looked and it seemed they spun off the “bean” parts of the company to PE firms due to declining market share. It also looks like my former company kept the debt and did some restructuring.
So … maybe I was wrong in my opening statement!
“Men’s Warehouse, which, after a six-month kerfuffle last year, finally managed to buy Jos. A. Bank in a $1.8 billion deal.”
Quality vs extreme low quality.