It’s boom times for investment banks again – investors beware

The biggest leveraged buyout ever attempted was the near-$50bn purchase of Canadian telecoms group Bell Canada Enterprises (BCE) by a group of private equity firms (a leveraged buyout is when a company is bought mainly using lots of debt, rather than cash or shares – hence the term “leveraged”).

The deal was signed off at the end of June 2007, literally weeks before the credit crunch began in earnest. It was to be financed with just over $30bn of debt.

But, as Bloomberg puts it, the deal “proved the last, glorious gasp of the past decade’s buyout frenzy, when debt-fuelled purchases for hot companies hit ridiculous heights.”

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By the time Lehman Brothers collapsed, just a little over a year later, so had the BCE deal.

Why am I bringing it up now? Because it looks as though the buyout market (along with everything else) is getting excitable again.

Deal-making is hitting record levels again

Private equity groups Blackstone, Carlyle and Hellman & Friedman have raised almost $15bn, reports the FT, to fund a $34bn buyout of Medline, one of America’s largest medical supply manufacturers.

This isn’t 2007 levels yet in terms of size, but it is the biggest such deal we’ve seen in the post-2008 era. And in terms of numbers of deals and overall value, we’ve already surpassed the 2007 record.

The safeguards for lenders are also very weak by historic standards. This has been an ongoing process in these days of reliable bailouts.

“The environment could not be better for borrowers,” the FT quotes Christina Padgett from credit ratings agency Moody’s. “But it is generating a lot of old school aggression. Some of it feels reminiscent of 2007.”

It’s not the only bubbly area. Something else is shooting up to record levels – investment banking fees. This year, the big banks and advisers have already made more than $110bn from a combination of IPOs, merger and acquisition deals, and acting as underwriters for debt issuance.

Now to be fair, this combined activity surpassed the previous 2007 record some time ago, in 2017. But in the last two years, it’s really shot higher.

In short, we’ve got record equity issuance, record IPO volumes (in the US at least), record deal making – this is a hot market, with comparisons to the dotcom era and the pre-financial crisis days abounding.

This is something for investors to cheer right now; deal making tends to make share prices go up. It might be irritating if a company you hoped to hold for the long run gets bought out today at a price which doesn’t fully reflect your hopes – but, let’s be honest, most of the time none of us sheds too many tears if a company we own receives a bid.

It’s particularly good to see that even if no one else seems to recognise the value in the UK market, private equity investors certainly do.

Why record deal activity is a red flag

However, we do need to sound a note of caution.

There’s a reason deal-making activity and investment banking fees tend to hit record levels before crashes, and then collapse in the aftermath. As with the market for petrol or apples or toilet roll, supply and demand is a major factor driving the price of shares (and debt) too.

When demand is high (ie, share prices are high and rising and debt covenants are lax and only getting more so), then the City and Wall Street want to feed the machine. Just as a miner will dig more holes and vomit out more rocks when commodity prices rise, so bankers will bring more deals to market.

And just as a manic commodity boom sees oil companies proposing to plumb the depths of the Mariana Trench with nary an eyelid batted, or miners getting their spades out for ever-more tenuous patches of war-torn soil, so the quality of deals in a financial market boom deteriorates.

When will supply overwhelm demand? Who knows, is the simple answer. All you can really tell from this data is that we’re a lot closer to that point than we were a few years ago.

So it’s just another indicator among many to add to your “where are we in this particular cycle?” bucket.

I suspect there’s a bit to go yet. The world’s dependence on cheap credit has rather tied the hands of central bankers (even if they are loath to admit it) and it will only take a wobble to send them back to the drawing board on raising interest rates.

In the meantime, as we’ve already noted, it’s another solid reason to have at least part of your portfolio invested in the UK.

Private equity buyers might be seen as smarter than average but at the end of the day, they’re only human, and their herding instinct is just as strong as anyone else’s. If they see deals being done, they’ll want to know what they’re missing out on. And right now the UK is one of their favoured locations.

This is something we’ll more than likely be discussing at the virtual MoneyWeek Wealth Summit in November. Don’t miss it!