M&A deals are being done faster than ever – that’s not a good sign

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Monday was dominated by the news that Sainsbury’s is merging with Asda. But it was far from the only big deal done yesterday.

In fact, reports the Financial Times, a dozen takeover deals worth more than $100m each were announced over the last 24 hours.

Deal activity is expanding at a faster pace than before the financial crisis.

That’s a sure sign of irrational exuberance.

Why companies buy one another at the worst possible moments

The value of merger and acquisition (M&A) deals already done so far this year amounts to $1.7trn, says the FT. That’s now running ahead of the pre-financial crisis highs.

That’s a bad sign, in that you pretty much always get a lot of M&A activity near the top of the market, rather than near the bottom. There’s absolutely no question that M&A activity is pro-cyclical (in other words, it goes up when everything else is going up, and goes down when everything else is going down).

It’s easy to say in hindsight, but a better time to have done most of these deals would have been in 2009, say. Most things were half the price they are now. Now, the deals are all being done at a time when companies generally are expensive and the cost of borrowing is about to rise – possibly sharply.

That seems illogical. You would think that people would learn. But when you start to think about what drives M&A, it makes a certain amount of sense (although a lot of it is purely down to human nature).

After the financial crisis, companies went into lockdown mode. As a company CEO, you don’t know where the next blow is coming from; you don’t spend money unnecessarily. Any sort of move towards expansion looks outrageously risky in a shrinking economy.

It takes a pretty far-sighted CEO with a lot of confidence in their position and in the faith of their shareholders to act to snap up a bargain in that sort of environment.

And even if you do have those things behind you, securing financing is another matter. No one wants you to spend cash you might need; your crash-hit stock isn’t much use as M&A currency; and banks aren’t in the mood to lend.

So, at the bottom of the cycle, companies are cheap. But that’s precisely because no one has the motivation, the desire, the courage, or the financing to buy them.

As with any other cyclical phenomenon, as the recovery kicks in, optimism creeps back in. Companies and investors get a bit more upbeat on the outlook. And you eventually reach that tipping point where fear of missing out (FOMO) takes over from fear of getting wiped out (FOGWO – admittedly a less widely used acronym).

Once FOMO kicks in, it’s all about getting more exposure to the market rather than as little as possible. Suddenly, shareholders are clamouring for your expansion plans – why aren’t you growing faster?

You could increase investment in the company, but that’s time-consuming and incremental. A much faster route to expansion is to buy a rival company – maybe one that you have had your eye on for a while. And while your thoughts are turning in that direction, investment banks are already drawing up sales pitches, suggesting a range of companies for you to buy, and the benefits that might accrue from each transaction. All they ask in return is a small percentage cut of the deal.

Meanwhile, there is funding aplenty. Money is almost literally growing on trees. Whatever deal you want to propose, someone will come forward with the cash to pay for it.

And at a purely human level, empire building is fun. It gives the CEO a major project to work on – something fast-moving, and with the potential to boost their profile. It’s pretty good for the pay packet too: a bigger empire means a bigger wage.

In short, the incentives to go out and build an empire are much greater at this stage of the economic cycle, even if the risks are also far higher.

It’s only a matter of time before we get a big hubristic deal

I’ve noted before in the past that pretty much every big market top – from the Japanese bubble to the dotcom bubble – has been marked by a particularly hubristic deal of some sort.

I still haven’t seen the one that screams “top”. Indeed, several of the deals done yesterday are done more in the context of struggling giants in highly competitive sectors.

The Sainsbury’s/Asda deal is about surviving in the struggling UK supermarket sector. In the US, T-Mobile bought rival Sprint – this would create the second-largest wireless group in the country. Again, telecoms is pretty brutal right now.

And then you had Marathon Petroleum taking over refinery Andeavor. Again, it’s a deal in a sector that has been struggling, rather than one that’s at the top of investors’ radar.

However, at this pace, it’s only a matter of time before we get an epic deal. After all, borrowing costs are ticking higher and anyone hoping to squeeze in a deal before the cheap money window slides shut is going to have to get their skates on, even if they don’t quite realise it yet.

I’m still thinking something in the tech sector (arguably the bubbliest sector right now), involving an awful lot of debt. Whatever it is, it should be pretty obvious when it happens, so it’s unlikely to slip under the wire – although there’s a first time for everything.