Stocks are off to a fast start, logging a 7.6% return year-to-date, more than one might expect for an average full year.
So what's driving Wall Street?
It's all about the M&A this year on Wall Street, and investors should love it!
Why Mergers and Acquisitions Drive Wall Street
Wall Street is all about activity. Investors should cheer it on. As public minority stockholders, we're at the whims of corporate management and majority owners. Occasionally, someone new wants to take 100% of a company and keep the profits or losses all to themselves.
Why is that so good for investors? Several reasons:
- Buyouts are done at a premium – The best part of getting bought out is getting bought out at a premium. Shareholders of Heinz (HNZ) enjoyed a 20% premium bid by Warren Buffett and 3G Capital, for example.
- Bids draw attention – A buyout bid can draw attention to a whole industry. After Heinz received a buyout bid, other consumer staples companies rose immediately as investors sensed another big deal might be just around the corner.
- Many followers – No one wants to be left out of the deal making. Wall Street has a hive-mind all its own, and it loves to continue to build on momentum that someone else starts. By the very nature of the word leader, there has to be many followers.
Why 2013 Isn't 2007
It's well understood that buyouts (and share repurchases) typically peak right at the worst times. Deal making activity (mergers and acquisitions) last peaked in 2007 when companies were buying each other out hand over fist.
What's different about the most recent deals is that they were done with cash, not stock. General Electric sold the remaining stake in NBC Universal in a $18.1 billion deal that was all cash or debt. Warren Buffett and 3G are buying out Heinz in an all-cash transaction funded with their own equity and new debt financing. Dell is being taken private with cash and debt.
These buyouts and take-private transactions are a sign of confidence. Making bids with cash shows strength, something very different from the ridiculous buyouts in history including AOL's all-stock, $160 billion merger with Time Warner in 2000, among many others. Buyers aren't paying with stock of questionable value; they're using stockpiled cash and debt financed with record low interest rates to make premium-priced acquisitions.
Acquisitions Are Only Getting Started
There's plenty of reason to believe that the pickup in recent mergers and acquisitions is only the beginning. A few trends play in investors' favor:
- Debt is cheap – Cheap money makes it easy for private equity firms to make levered buyouts. Buying future earnings with cheap financing is good business. Inexpensive financing also makes it possible for firms to make acquisitions with foreign money through financial engineering. Companies can borrow in the US against cash held overseas and pay zero taxes in exchange for a minute amount of interest.
- Corporate wallets are loaded – Non-financial firms in the S&P 500 reported more than $1 trillion in corporate cash, cash which could be used to buy out a rival or add a company to a vast conglomerate.
- Private equity funds have to move – Private equity funds have as much as $355 billion to put to work, according to research from Cambridge Associates. If this cash goes unused, it has to be returned to investors. Private equity funds are compensated for investing, not returning cash. Expect this money to be levered up and put to work.
Expect the deal making pace to keep up or accelerate, driving the stock market higher. When everyone is making deals, investors win big. Barring any black swan events (Europe has been awfully quiet lately, hasn't it?) mergers and acquisitions should lead the way to rising markets.
Learn to love those buyouts. It's this kind of activity that leads to bull markets and wealthier investors.
What are your thoughts on the latest trends in recent mergers and acquisitions?