Cheap finance has encouraged a spate of megadeals, but are they good news for investors?
Despite recent market volatility, the megadeal rollercoaster which this week saw Royal Dutch Shell complete its takeover of BG Group is expected to continue in 2016.
Last year (2015) was a year of superlatives for mergers and acquisitions. We saw the biggest-ever UK deal, with Anheuser-Busch InBev’s £70bn-plus offer for rival brewer SABMiller and the biggest-ever pharmaceutical deal, with Pfizer bidding $160bn (£105bn) for Allergan. Globally, this is also the second-largest deal ever, trumped only by Vodafone’s takeover of German group Mannesman, back in 1999, which consequently led to one of the largest ever write-downs. In December, chemical industry behemoths Dow Chemical and DuPont announced their intention to join forces in an all-stock ‘merger of equals’.
The number of megadeals, defined as above $1bn, has also been rising: Dealogic reports more than 67 deals globally last year were valued at more than $10bn and 10 were worth more than $50 billion during the year. The pace of deals was also pretty brisk. On one manic merger Monday in November there were 28 acquisitions worth $35.7bn, three of which – Shire Pharmaceuticals’ bid for Ireland-based Dyax, Visa Inc joining forces with Visa Europe and King Digital Entertainment, the company behind app game Candy Crush, being taken over by US company Activation Blizzard – were valued at more than $5bn apiece. In addition, in January 2016 the acquisitive Shire subsequently went on to bid $32bn for Baxalta, a company producing drugs for rare diseases.
Powering the deals: cheap finance
The large number of megamergers means that the value of bids and deals in 2015 comfortably surpassed the record set in the heady days of 2007, before the credit crunch hit. Dealogic’s statistics show there was more than $4.8tn of deals, up by a third on 2014 and 5% ahead of 2007.
Elaine Coverley, Head of Equity Research at Brewin Dolphin, says one of the key reasons for the increase in bid activity is the availability of cheap finance. “Since the financial crisis, companies have been restructuring balance sheets and reducing their debts so they are now in a strong financial position,” she says. Interest rates are low across developed markets and companies with a good credit rating can issue corporate bonds at low rates or borrow cheaply.
Coverley adds that bid activity is being spurred by the squeeze on margins amid sluggish economic growth, low – or even falling – inflation and fierce competition for customers. “An acquisition not only brings in a new source of sales, it also gives the opportunity to shave costs and therefore boost margins,” she explains.
Kirsty Wilson, Global Research Editor at Mergermarket, says the rise in the number of large deals is partly a reflection of the sectors that dominated the deal flow last year. Pharmaceutical companies accounted for 13.7% of the deals in 2015, up from 11.7% in 2014, while technology M&A activity rose 6.9% to 9.7% of the total – both sectors with high-value companies.
Benefits are often easier to see on paper
Of course, these theoretical benefits are not always borne out in post-merger results, but such doubts tend to be overlooked by boards in the adrenalin of the deal. Academic research consistently shows that acquisitions are more likely to destroy, rather than create, value. Coverley says each deal should be judged on its own merits; while some, such as bank deals in the run up to the financial crisis, were disastrous, other companies, such as AB InBev and Unilever, have a better record of integrating acquisitions.
“The logic of two rival companies merging, reducing costs and expanding market share sounds compelling, but all too often such deals are flawed, either because they are driven by fear or greed – vested interests such as executives that will receive big bonuses, investment banks and advisers who will also receive big payouts, or a misguided sense that eradicating some cost duplication will automatically lead to better shareholder returns. This is simply not the case.” says Coverley. “Company cultures often differ radically, there can be problems integrating systems and staff and this can lead to stuttering performance and lower productivity.”
Recent deals have been dominated by commodity and energy companies, pharmaceuticals and brewing. Coverley expects some of the sectors to remain active in 2016 although the brewing industry has now effectively reached the limits of consolidation following a number of mega-deals. Whether 2016 will also be a good year for deals depends on everything from the pattern of global interest rates to the outlook for economic growth.
Wilson says: “There is no sign of a slowdown in the rate of activity any time soon. Of course, everyone is apprehensive about future interest rate moves but that is not yet hindering merger activity.”
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