IT IS often said that private sharemarket investors buy and sell at the wrong time, dumping stocks in troughs of gloom and buying at or close to market peaks.
The same tendency infects the behaviour of company directors: they approve acquisitions in bull markets and reject them in bear markets, as they are doing now.
Merger and acquisition data compiled by the Dealogic group records that in Australia takeovers valued at $US128.6 billion were announced in 2007, as a four-year-long bull market peaked. In 2008 as the global crisis gathered pace, M&A deal value fell back to $US86.5 billion and in 2009 it was even lower at $US69.3 billion.
As the market recovered, takeover activity rebounded, to $US126.8 billion in 2010 and to $US136 billion in 2011. But the return of the European debt crisis in the second half of last year has been a deal killer. So far this year, M&A worth just $US23.3 billion has been announced.
That's a miserable annual run rate of just $US77.5 billion, putting takeover activity in Australia back to where it was at the depths of the global crisis.
The story is similar in investment banking equity capital markets divisions, the modern version of the underwriting businesses that stockbrokers used to run.
ECM divisions organise floats, share issues and placements for companies, and they also either organise or directly provide debt. Takeovers are a crucial source of business for them, and as takeover activity has dried up, so has ECM activity. It was worth $US46.1 billion in Australia in 2007 and totals just $US4.3 billion so far this year, for an annual run rate of $US14.1 billion.
The slide in takeover activity signals either another missed chance to buy assets cheaply, or a prescient judgment by boards that the global crisis has changed takeover sums long-term.
On traditional measures, shares are cheap. Ahead of the crisis, fair value for share prices here was considered to be about 15 times expected earnings for the year ahead. The Standard and Poor's/ASX 200 index is trading now at 12.7 times expected earnings.
Another way of looking at that is to say that investors and companies were happy to buy earnings that represented a yield of 6.7 per cent of the price they paid for the ASX 200 index before the boom, and are buying earnings that create a yield of 7.8 per cent now.
The earnings yield on Australian shares fell below 2 per cent at the depths of the financial crisis as corporate profits were crushed. It is now back to levels seen before the crisis and fixed interest yields have meanwhile fallen.
Investors could get a yield of 6.2 per cent on 10-year Australian government bonds in mid 2007, but the yield moved below 4 per cent late last year and is still there, at about 3.8 per cent 4 percentage points below the ASX 200 yield.
Bank deposit rates have fallen less heavily, from 5.9 per cent for one-year deposits before the crisis, for example, to 5.1 per cent. Even then, however, the sharemarket's yield premium has expanded, from 0.8 percentage points to 2.7 percentage points.
Overseas markets are the same. The US sharemarket is on a yield that beats 10-year US government bonds by 5 percentage points. The yield premium on shares has expanded for a reason, however. It is compensating share investors for risk that is perceived to be higher in the wake of the global crisis. They want bigger returns because they are less confident that share prices and corporate values will recover and boards feel the same way.
The historical evidence is that successful takeovers occur in markets like this one. This week I asked M&A advisers to tell me which takeovers in Australia have been most successful. The list was long, but a few takeovers scored multiple mentions, and they were all done when markets were weak.
They include the $2.7 billion acquisition of Howard Smith by Wesfarmers in 2001. It created a hardware business that last year earned $802 million, valuing it at about $7 billion. BHP Billiton's takeover of WMC in 2005 for $US7.3 billion brought with it the Olympic Dam copper mine in South Australia, and even after falling 21 per cent from its 2011 highs the copper price is 168 per cent higher than it was when the deal was done, with an open-pit expansion that will triple copper production to come.
Xstrata's bottom-of-the-market $3.2 billion acquisition of MIM in 2003 occurred when coking coal prices were 20 per cent of their current level. Blood plasma group CSL spent $2 billion acquiring two other plasma manufacturers, ZLB of Switzerland in 2000 and Aventis Behring in 2004, created globally significant market power and watched its shares rise sevenfold.
Amcor's acquisition of Alcan's packaging operations during the global crisis is a more recent deal that looks set to fuel double-digit profit growth.
The open question for boards that are contemplating takeovers now is whether the markets can rally as they have in the past.
They might slump if the crisis escalates. Or they might rise and fall within a fairly narrow range as the sovereign debt overhang that the crisis exposed is gradually worn down.
Economic growth everywhere would be lethargic if that happened. Profit growth would be hard to find, the markets would be volatile as mini-crises were dealt with, and share prices would be held down as investors continued to demand outsized yields.
We know, in other words, that companies are reluctant to make takeovers, but don't know yet whether they are once again missing an exceptional buying opportunity, or wisely keeping their powder dry.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
Why has takeover activity in Australia dropped since the global financial crisis?
Takeover activity fell sharply after the crisis because boards and investors became more risk‑averse. Dealogic data cited in the article show M&A values sliding from US$128.6 billion in 2007 to US$86.5 billion in 2008 and US$69.3 billion in 2009, and takeover announcements have weakened again as the European debt crisis raised uncertainty. The piece explains that higher perceived risk has made companies reluctant to bid and has reduced merger and acquisition activity.
Are sharemarket takeovers more likely to succeed when markets are weak?
Historically, many successful takeovers have been completed in weak markets. The article notes adviser examples such as Wesfarmers buying Howard Smith in 2001, BHP Billiton acquiring WMC in 2005, Xstrata buying MIM in 2003 and CSL’s purchases in 2000 and 2004 — all done near market lows and later proving highly value‑accretive. That history suggests bargains can be found in down markets, though outcomes still depend on deal execution and future market cycles.
What do recent M&A and ECM numbers tell everyday investors about market conditions?
The article highlights Dealogic figures showing a cyclical slump: Australian takeover values rebounded to about US$126.8 billion in 2010 and US$136 billion in 2011 but then fell to just US$23.3 billion so far in the current year (an annual run‑rate of US$77.5 billion). Equity capital markets (ECM) work also collapsed from US$46.1 billion in 2007 to US$4.3 billion so far this year (run‑rate US$14.1 billion). Those stats signal reduced deal flow, lower corporate transactions and less underwriting and issuance activity — a sign of caution and lower liquidity in corporate markets.
How do current ASX 200 valuations compare with pre‑crisis levels?
On traditional measures the ASX 200 looks cheaper than pre‑crisis. The article states fair value was around 15 times expected earnings before the boom; the ASX 200 is trading at about 12.7 times expected earnings now. That translates into a higher earnings yield today (about 7.8%) versus the pre‑boom yield (about 6.7%), indicating lower price multiples relative to earnings.
How do share yields compare with government bond and bank deposit yields, and why does that matter?
Shares currently offer a larger yield premium over risk‑free bonds and deposits than before the crisis. The article notes 10‑year Australian government bond yields fell from about 6.2% in mid‑2007 to roughly 3.8% recently, while one‑year bank deposits fell from about 5.9% to 5.1%. Meanwhile the ASX 200 earnings yield rose from 6.7% to about 7.8%, expanding the sharemarket’s yield premium from 0.8 percentage points to 2.7 points. That wider premium reflects investors demanding higher returns to compensate for perceived equity risk after the crisis.
Which takeover examples from the article show long‑term gains for investors?
The article cites several takeover success stories: Wesfarmers’ A$2.7 billion purchase of Howard Smith in 2001 (later creating a hardware business valued at roughly A$7 billion), BHP Billiton’s US$7.3 billion acquisition of WMC in 2005 (adding Olympic Dam), Xstrata’s US$3.2 billion buy of MIM in 2003, CSL’s acquisitions of ZLB (2000) and Aventis Behring (2004) that helped its shares rise sevenfold, and Amcor’s crisis‑era purchase of Alcan’s packaging operations that looks set to boost profit growth. These examples illustrate how well‑timed deals in weak markets can pay off.
If companies start doing takeovers again, what could that mean for investors and markets?
The article says the outcome is uncertain: takeovers could signal a market rally if boards judge prices attractive, or markets could slump further if the crisis escalates. Alternatively, markets might trade in a narrow volatile range as sovereign debt issues are worked through, resulting in lethargic economic and profit growth and continued pressure on share prices as investors demand higher yields. For investors, renewed takeover activity could mean increased corporate re‑rating opportunities but also greater short‑term volatility.
Why has equity capital markets (ECM) activity dried up and why should retail investors care?
ECM divisions handle floats, placements, share issues and debt provision — and they rely heavily on takeover and transaction flow. The article reports ECM activity in Australia fell from US$46.1 billion in 2007 to just US$4.3 billion so far this year (annual run‑rate US$14.1 billion). For everyday investors, reduced ECM activity can mean fewer new listing opportunities, less corporate financing, and lower liquidity for trading and deal‑related investment events.
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