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Date: August 15, 2014

M&A Hot Means Market Not?

Merger and acquisition activity has long been a trusty sign of a maturing equity market cycle

By Jeff Benjamin

Jul 16, 2014 @ 11:55 am (Updated 3:54 pm) EST

Twenty-First Century Fox Inc.’s offer Wednesday to pay $92 billion for Time Warner Inc. is all the proof anyone needs that the M&A market is hotter than ever.

In mid-day trading, Time Warner shares were up almost 16% in an otherwise flat equity market.

As economic indicators go, merger and acquisition activity has long been a trusty sign of a maturing equity market cycle, which can now be added to a long list of frothy-market indicators.

The latest data from Intralinks Holdings Inc. show that 2014 merger and acquisition activity is on track for its first year-over-year increase since 2010. The estimated total of this year’s announced deals could be up as much as 10% over last year, according to Matt Porzio, vice president of strategy and product marketing at Intralinks. The company does not share data on numbers of deals, just movements by percentage.

“Now that we’re halfway through the year we can see what the announced deals are likely to look like,” he said. “The M&A market has been pretty much flat or down since the end of the financial crisis, but finally the announced deals will be up.”

According to the Intralinks Deal Flow Indicator, through June there was a 16% quarter-over-quarter and 12% year-over-year increase in early-stage global M&A activity.

The company’s forecast for increased activity in announced deals throughout the end of the year is based on due diligence activity that it monitors on its platform, which enables companies to quietly research and negotiate deals.

“The combination of a good lending environment and high quality assets and companies for sale are driving this growth,” Mr. Porzio said. “Deal volume continues to go up and we expect to see a good number of high profile deal announcements through the end of 2014, especially in sectors like manufacturing and telecommunications, media and entertainment.”

While M&A activity is a reliable indicator of market cycles and patterns, it doesn’t always translate well to investment opportunities, according to Paul Schatz, president of Heritage Capital.

“Merger arbitrage strategies are above most investors’ and most advisers’ pay grades,” he said. “But, typically, during the life of a bull market, seeing M&A activity steadily increasing suggests a maturing market, especially when the buyers are not paying with cash.”

In periods like right now, when equity market valuations are high and debt is inexpensive, acquisitions can be fueled by and easily financed with stock and debt, Mr. Schatz added.

“When money is so cheap, why pay with cash when you can float bonds and use company stock?” he said. “This is a normal progression of a bull market, but it doesn’t mean it will end tomorrow, just that it is progressing along.”

Joseph Witthohn, portfolio manager at Emerald Asset Management, agrees that the pace of M&A is strong and will likely get stronger as the economic recovery continues.

“I suspect all the recent activity is simply the case of companies realizing that they better get moving before some other company comes in, makes an acquisition and changes the playing field,” he said. “With the U.S. economic recovery appearing to be strengthening, not allowing competitors to increase market share becomes an even more important goal.”

Despite all the activity and indications of more to come, it remains a tough racket for most average investors, based on the performance of two of the highest-profile M&A-strategy mutual funds. The $2.5 billion Arbitrage Fund (ARBFX) has gained just 1% since the start of the year, while the $5.6 billion Merger Investor Fund (MERFX) has gained 2.8%.

Both funds, however, are “market neutral,” which means they are not expected to post outsized gains or significant underperformance.

Over the same period, the S&P 500 Index has gained 7.9%, and the market neutral category, in which the merger funds are categorized by Morningstar Inc., has gained 1.3%.

Author:

Paul Schatz, President, Heritage Capital