The tide is turning for mergers and acquisitions

Up until recently, historically low levels of debt and cheap equity appeared to fuel a bumper year for M&A transactions, but the withdrawal of two big deals this week suggests a fresh bout of instability.

Much is being made offshore of the $US100 billion-plus of merger attempts that were taken off the table in the US this week. What has been a tide of global mergers and acquisitions activity this year may have reached its high point.

The two big deals that were withdrawn -- 21st Century Fox’s $US80bn bid for Time Warner and the $US30bn bid by Sprint for T-Mobile -- ended for different reasons. Fox was concerned about the negative impact of its proposal on its own share price and the refusal of Time Warner to engage while Sprint was facing major regulatory obstacles.

It isn’t, however, all that surprising that company boards and managers are becoming less gung ho and more sensitive to risks.

Until this week, this year had been a bumper year for M&A activity, with the value of deals announced said to be more than $US2 trillion -- easily the most active year since the financial crisis erupted. There have, however, been more than $US400bn of deals abandoned -- the most since the crisis -- which may also relate to that apparent increase in awareness of risk.

Until relatively recently, conditions were attractive for deal-making. Thanks to the world’s bigger central banks and their unconventional monetary policies, debt is at historically low levels and equity, inflated by the global hunt for yield and return, is cheap.

The turning point in attitude towards M&A activity, however, may have been the June meeting of the US Federal Reserve Board. The minutes from that meeting made it clear that the Fed’s bond and mortgage-buying program, which has been winding down from its original $US85bn a month in $US10bn a month increments, would end in October.

With the US economy showing encouraging signs of growth, the market is starting to look forward towards the first increase in US official interest rates since the crisis, with an expectation that it might occur anytime from the middle of next year.

In the absence of a fresh bout of financial instability or a downturn in the US economy, that would suggest that within the foreseeable and relatively near-term future interest rates will begin rising and that equity prices could at least stagnate.

Rupert Murdoch’s 21st Century Fox experienced something of a preview of what could occur because the disclosure of its approach to Time Warner had a marked and negative impact on its share price. (It was to be funded 60 per cent by scrip and 40 per cent with debt and cash reserves.) Taking on a large amount of debt at what may be the turning point of the interest rate cycle could have compounded the impact on shareholders’ value.

With corporate balance sheets generally in reasonable shape, there are a number of big Australian corporates -- most obviously Wesfarmers with its big bank of cash from divestments and growing cash flows and an under-leveraged balance sheet – which face a similar 'do we or don’t we' conundrum.

Share prices might be inflated and therefore equity might appear cheap, but equally the value of any target will also be inflated. The era of ultra-cheap debt created by the aggressive monetary policies pursued around the world might not yet be over, but it’s probably much closer to an end than its beginnings -- unless there is another bout of crisis. Conditions in markets might be quite stable today but could become very volatile overnight.

This week might turn out to be an aberration. It is conceivable that there could be another outbreak of mega mergers if the current settings remain stable.

Murdoch’s abrupt decision to walk away from Time Warner so quickly, whether permanently or with an eye to a return at some point in future, does indicate a more cautious attitude from someone who didn’t build a global empire by being cautious.

With the other big deals that have been pulled recently, it suggests the environment has become trickier and that a shift in mindsets from risk-on to risk-off might be starting to re-emerge.

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