Investments

By Kanaly Staff

M&A markets are heating up 

Activity in the investment field known as mergers and acquisitions has become a daily news item. So, what does this mean for you -- and you as an investor?

In theory, academics argue that investment professionals who seek opportunities to buy outright, acquire or merge operations of any business make our financial markets highly efficient and effective. That means this group of professionals is providing a service to all of us to assure we get the best possible investment returns from the best-run companies, which are remaining highly competitive in the global marketplace.

What is inefficiency? Some businesses can benefit from a change in management or the way they finance operations. Others can become more efficient by combining or merging operations with another ongoing concern -- becoming a stronger business as a larger new company. By eliminating or reducing these inefficiencies, a business can become more profitable for investors.

This is similar to being a shareholder in company stock. As a stockowner, you share in the ownership of a business. As an owner, you seek the best possible profits and enlist the company management to accomplish these goals.

M&A experts desire the same thing. Armed with available funds, they seek to discover opportunities that existing shareholders and managements do not realize exist. They aim to acquire the business in hopes of unleashing this hidden potential to claim a greater profit.

Not all deals are successful. Most business school studies reveal that 80 to 90 percent of all deals fail or never produce the projected returns.

So, why do investors continue to attempt or invest in M&A deals?

 Because we all want to do better than the market and want to believe that there is some way to gain access to returns greater than what is otherwise available. Some investors are willing to pay extremely high fees in the hope that superior intelligence, talent or luck can consistently generate better performance. In doing so, greater returns and, therefore, risk taking is needed to overcome the expenses and fees. That leads to even greater failures.

What are the drivers?

Available liquidity is the essential element. There is $1.37 trillion in circulation (as measured by M1 monetary figures; this figure expands to $7.24 trillion through the magic of depositing a portion of the first amount into the banking system which, in turn, lends your money out while still claiming to owe you your deposited funds. This is known as the multiplier effect.).

The “true value” of available dollars is many multiples of these figures, as money is borrowed and lent by a multitude of global financial intermediates repeatedly and not just limited to the banks.

Holders of excess liquidity seek to invest their funds in hopes of superior returns.

For a large corporation, which generates a large amount of profit from selling goods or services, it can use that excess to: a) distribute it as dividends to shareholders b) provide funds for current operations – keep paying the bills or c) reinvest by expanding operations.

To expand your operations you can buy a new factory or your competitor down the street. By buying a competitor, you gain their market share and eliminate the headache of them as a competitor. By integrating the companies correctly and eliminating unnecessary operational duplications, gained efficiencies help lead to enhanced profits and returns.

Bottome line...

M&A activity is good for competitive and free markets. It assures that overlooked opportunities are consistently and constantly being reviewed and considered. It assures investors that the companies you own and invest in are being run in the most efficient manner.

Why does there appear to be more M&A activity during certain periods than others?

Liquidity is the key driver. There is now a global excess of available capital seeking investments. This excess liquidity empowers greater inspection of all alternatives. There is a heightened awareness across every sector, industry and company. Any opportunities that exist will attract aggressive investment professionals or the attention of investors.

Cycles accentuate the M&A experience. In the late 1990s, technology companies were accumulating large profits. Most desired to reinvest these profits as a means of increasing future growth and sales. The rush to acquire and keep growing ended as most extreme cycles do – through some form of a market crash.

In hindsight, the overbuying becomes obvious, the extremes excessive. History repeats itself, although not exactly.

What is important is to stay both invested and diversified. Studies show the importance of being invested during the strongest market cycles.

Sound money management disciplines protect investors who realize returns are a function of expected returns and not market speculation. Excessive speculation requires perfect market timing -- two things proven not to exist consistently over time.