Merger And Acquisition Fever Likely To Continue

In 2011 so far, we have globally seen over US $700b worth of mergers and acquisitions (M&A). This shows some momentum following a rebound in 2010, after a lean period on the corporate activity front.

M&A activity was rife during the economic boom a few years ago. Takeovers, mergers and hostile debt-fuelled bids for companies by private equity firms were regular occurrences in the business pages leading up to late 2007. This was an extremely busy time for markets, and was profitable for both investors and investment bankers alike, with many takeovers executed at high prices.

During 2007 to 2009, M&A activity fell by almost 60% in Australasia. Management teams were all of a sudden more focused on defending their existing market positions instead of worrying about growth and there was so much uncertainty clouding the outlook that businesses began to take shelter and to try and ride out the storm as best they could.

It was no longer considered ideal or efficient to have a balance sheet with a lot of debt. It had become a threat to corporate survival. Companies went to their shareholders to raise new equity and reduce their reliance on debt funding.

Economic conditions improved dramatically during this period. There are still challenges, but banks are willing to lend money to those that can repay it, economic growth is stable and the high levels of uncertainty from the peak of the crisis have reduced. Company profits show growth in the US and the confidence to invest returns.

What remain quite subdued in many cases however, are sales. The easy gains have been made from cost cutting, as businesses have streamlined operations, improved efficiencies and emerged from the crisis much leaner.

Another driver of companies looking to expand and potentially grow by acquisition is shareholder pressure. Shareholders expect to see the money they have invested being put to use. If no such opportunities exist, many companies will look to return those unused funds to shareholders, either by increasing dividend payouts, paying special dividends or engaging in on-market share buybacks.

There is always an element of danger and risk when investing in stocks simply in the hope that a takeover bid will emerge, although it can provide a nice windfall when it happens to companies that we want to own anyway for their stand-alone fundamentals.

I would not expect companies to return to levels of indebtedness that were seen a few years ago, as I feel a more conservative slant to capital management will prevail, which is a good thing for investors. However, with confidence improving and plenty of balance sheet capacity, further merger and acquisition activity could well continue as the year goes on.

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