Not one, not two, but three big merger and acquisition deals were the source of investor consternation on Wednesday, undermining some of the confidence in the ability of cheap credit, corporate cash, animal spirits and eager executives to bolster stock prices by consolidating.
Moreover, Walgreen (WAG) said that while it would still buy up the remaining share of European pharmacy chain Alliance Boots, it wouldn’t relocate its tax base overseas to escape the higher U.S. corporate tax rate.
Aside from a relief rebound in 21st Century Fox, the stocks of the companies involved all took a hit. The largest was the near 19% drop in Sprint, which boosted the two put option position in the stock I recommended to clients back on July 31. The Aug $8 puts are up more than 310% while the Sep $8 puts are up more than 252%.
Aside from short-term profits for traders, the news could represent a sea change in what has been a major supporter of stock valuations in recent months: the rise of M&A activity to a frantic pace.
According to Reuters, through the first half of 2014, global M&A transactions increased to a level not seen in seven years.
What’s different this time — and in a possible sign that investors were getting overconfident — prices of both acquirers and targets and been moving higher on announce deals. That goes against history, which suggests that acquirers tend to see share prices suffer since oftentimes, M&A deals are more about expanding the empire of overzealous executives rather than adding value to shareholders.
Moreover, after paying the premium to seal the deal, acquirer shareholders are relying on the synergies of the combined company to recoup costs and add value. That’s highly uncertain.
Through the end of June, year-to-date global deal volume totaled $1.75 trillion, up 75% from year-ago levels, Thomson Reuters data says. Prices paid were higher as well, with buyers on average paying 13 times operating earnings in the first half of 2014 vs. 11.8 times last year — the highest since 2008.
In addition to the lure of higher stock prices from a well-publicized deal and the low synergy hurdle thanks to cheap financing, a big motivator has been the ability to use M&A deals to offshore a company’s tax base thanks to holes in the U.S. tax code. There been a lot of activity here in the healthcare sector.
And while the specifics of the three M&A deals that fell through on Wednesday are different, there is evidence that the two primary motivators — cheap bond market credit and the ability to shift one’s tax base offshore — appear to be closing slightly.
For one, President Barack Obama has said he will act unilaterally, without the support of Congress if necessary, to stop the usage of M&A as a way to bilk the U.S. government. Moreover, the bond market has been coming under pressure as we move closer to the day the Federal Reserve starts raising interest rates — something that hasn’t happened in eight years — in response to improving economic data.
While it’s too easy to call the end of the M&A boom, and while there are opportunities on the short side with companies like Sprint, the boom certainly is nearing its end.
As a result, the market’s enthusiastic reaction to M&A activity will begin to fade.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he had recommended S puts to his clients.