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The merger mania that began in the middle of the past decade was hardly surprising, considering the tantalizing numbers. Global commodities prices were in the midst of a long upward trajectory, powered by such strong growth in China that not even the global financial crisis could stop the rise for long. Management teams blame the write-downs on labour inflation and cost inflation. But after the bad experience that many of the buyers have had, we might not see as many large deals in this space for some time. The new ‘mantra’ for the resource companies appears to be ‘profitable’ growth. This should be of long-term benefit to shareholders in these sectors as more of the profits in the good part of the cycle will go towards dividends and share buybacks as opposed to ‘blockbuster acquisitions.’
However, ‘merger mania’ is far from dead. Low long-term valuations for strong businesses and record-low financing costs have made 2013 the ‘year of the deal’ thus far. Berkshire Hathaway is part of a group buying consumer foods company Heinz for US$28 billion, while, in the media space, Comcast is buying the remaining 49% of NBC from General Electric for US$17 billion. In the technology sector, Dell Computer is being taken private by a group lead by founder Michael Dell for US$24 billion. The bottom line is that the trend in the mergers business (shown below) is on track for its strongest year since 2007, at an annualized rate of $1.48 trillion.
When stocks have risen in the first week of the year, it was followed by full-year gains for the year 33 of the past 39 years, an 84.6% accuracy ratio. The average gain in all of those years was 13.6%. The bigger question is which areas of the market will do best. Profits at economically sensitive companies have risen 55% since the 2007 peak, much better than the 24% gain among defensive names. Yet, valuations on cyclical stocks have shrunk more severely. Cyclicals recently traded for 11.9 times projected earnings, down from 15.4 times in 2007, while defensive-stock multiples ticked down to 13.5 from 14.9 times earnings.