It has been a good quarter so far for merger and acquisition (M&A) activity on Wall Street. After a dearth of activity in recent quarters, we’ve seen one huge deal after another during the past month or so. Here a just a few of the notable transactions we’ve seen recently:
- A group of investors is looking to take Dell (NASDAQ:DELL) private for $24.4 billion.
- Berkshire Hathaway (NYSE:BRK.A) and 3G Capital have offered to buy H.J. Heinz (NYSE:HNZ) for $23 billion.
- Office Depot (NYSE:ODP) said it will buy OfficeMax (NYSE:OMX) for $1.19 billion.
So why do investors care so much about M&A activity? What does it tell us about attitudes and perceptions on Wall Street and in corporate boardrooms across the country? It tells us three things:
C-level Confidence is Growing
One concern that weighs on the minds of most CEOs is what kind of a legacy they are going to leave behind when they step down. CEOs want to be remembered as giants of industry that were able to grow their companies and pad the pockets of their shareholders. For many CEOs, being able to grow their companies and increase their own fortunes by acquiring another company is considered to be the penultimate achievement they could attain in their career. However, mergers and acquisitions are risky, and CEOs tend to approach them with extreme caution. After all, just as a successful acquisition would be a prized feather in any CEO’s cap, a failed acquisition would be a hair shirt that would never go away.
This is why investors start to get excited when they see M&A activity starting to pick up. It tells us something about the mindset of C-level executives and their boards. It tells us that they are growing increasingly confident in the state of the general economy, the state of their industry and the state of their own business. When those with insider knowledge start to show signs of confidence, it tends to rub off on everyone else, and when traders on Wall Street have their confidence bolstered, they keep buying stocks.
Keep watching for more deals to be announced in the near term. With interest rates as low as they are and economic confidence on the rise, the coming months have a great chance of providing a fertile landscape for more and more M&A activity.
Productivity is All Squeezed Out
During the past few years, companies have been streamlining operations, investing in new technology and laying off employees in an effort to squeeze more and more productivity out of fewer and fewer workers. So far, this strategy has been working quite well. Even in an environment with declining top-line revenue numbers for many sectors, management teams have still been able to surprise and beat expectations for bottom-line earnings numbers.
However, it looks like management teams have squeezed just about all of the additional productivity they can out of their workers. We’re seeing productivity gains slowing on a national level, and CEOs are looking for a new way to gin up additional growth.
When you couple this dynamic with the facts that CEOs are becoming more confident in their outlook for the future and that they are sitting on huge piles of cash, you can see why many are on the hunt for potential acquisition targets.
This can be good from an M&A perspective, but it is also a warning sign to investors. If companies can’t start achieving additional growth – either through M&A or organically – we could see stock growth slow at some point in the future.
Stock Supply is Shrinking
The last impact that increased M&A activity has in the market is a reduction in the supply of stocks that are available to be bought and traded and an increase in the amount of cash that is chasing those limited shares.
Look at the H.J.Heinz deal for example. When that deal closes, $23 billion worth of stock will be taken off the market, and $23 billion in new cash will be looking for some place to be invested. That is a $46 billion shift in the supply-and-demand relationship of the market.
So where does all of this money go? It goes in search of new investments. Oftentimes those new investments are in the same industry group, or sector, as the company that was just acquired because the fund managers have a specific mandate to keep the funds they oversee in that industry group. This can have a bullish effect on the remaining stocks that see this influx of cash.
The Bottom Line
Rising M&A activity is generally bullish for the market, and is specifically bullish for the sectors in which the activity is taking place. If we continue to see more and more deals announced, we will most likely continue to see traders on Wall Street climbing the wall of worry – as they push stocks up to higher and higher levels, even though there are still looming concerns over “sequestration” and the debt ceiling.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.