In December, we projected a significant pick up in mergers and acquisitions activity in 2013. The thrust of our conviction was that the solving of the fiscal cliff and the macro economic progress in Europe, the U.S. and China were supplying the one key ingredient that had been absent during the past two years: confidence.
While a month and a half does not a year make, clearly the year has started strongly for M&A, and we believe that this is just the beginning of what will turn out to be a very active 2013. Granted, there have been those naysayers who point out that three of the most visible recent deals are one-off events. While it is true that Dell (Dell), Heinz (HNZ) and the Office Depot (ODP)/Office Max (OMX) merger are each special situations, much the same can be said about many deals over time.
The real point is that the various parties, including corporations, private equity, bankers and debt markets are confident enough now in the economic environment to make business decisions that assume a return to normal economic times. Additionally, they are willing to plan and manage looking beyond a three month time frame. With such greater confidence in place, M&A players are taking advantage of many highly favorable conditions to help stimulate activity, including:
- Low interest rates and easing credit availability for good borrowers;
- Cash-rich and often under-leveraged corporate balance sheets;
- Attractive stock market valuations;
- Abundant strategic, and earnings synergies available to many companies looking for incremental growth;
- The substantial likelihood of an acquisition being immediately accretive, thanks to low financing rates, exceptionally low interest rates paid on cash balances and attractive purchase prices;
- A still early economic recovery, which means that acquirers can forecast out a longer time period for realizing the benefits of a sound acquisition.
Besides these factors, the market is creating a self-fulfilling positive environment, as many recent strategic deals have been greeted very favorably as sound and appropriate ways to enhance company value and prospects. We believe that this self-fulfilling positive reaction will spread to a wider array of deals as the year progresses further encouraging more activity by both willing acquirers and potential targets. In addition, as more private equity firms get more active, we believe it will motivate other players who have been sitting on the sidelines to start to put their money to work.
Among the many positive implications of M&A activity is that in some respects it represents the canary in the mine shaft for the overall stock market. Especially in the early stages of a pick-up, M&A activity should be seen as a powerful validation of the state and, equally importantly, the direction of the economy.
As an industry that depends upon confidence, M&A activity also imparts this confidence both to businesses and to lenders. For businesses, greater M&A activity can indirectly help with such bellwether issues as capital spending and hiring.
For the capital markets, increased M&A is an indication that debt markets are functioning properly and that the stock market, as a whole, is selling at a reasonable valuation and, in certain sectors, very attractive valuations. When the market believes valuations to be reasonable, there is less inclination to force major downward swings in value, and there is also a greater openness to upward stock price movement.
Direct stock market winners from M&A, besides the companies involved, are primarily investment banks and universal banks, in which they derive not only M&A fee revenue, but also stock trading and fixed income activity.
Less directly, the overall market benefits as a rising tide of M&A activity lifts all boats so that industries that are the most likely primed for consolidation should see even greater gains in anticipation of potential takeovers.
In 2013, we think that the sectors and industries most involved in M&A will likely include energy, health care, industrials, media, retail, and select technology.
We reiterate a few of the names that we listed in December as possible takeover candidates. The first group focuses on those stocks that we like on an ongoing basis that could also attract a takeover interest: Devon Energy (DVN), Harris (HRS), Southwestern Energy (SWN) and Zimmer (ZMH). Two less meritorious names as independent investments that could nevertheless attract outside interest are Monster Worldwide (MWW) and Staples (SPLS).
On Tuesday we will provide some additional names that we think are of interest, as well as some color on the investment case for each and for the companies included in the first group. In addition we will discuss the pros and cons of the stocks in the latter group.