GO
Loading...

Stampede of Mergers Could Mean Growth, or Irrationality, Ahead

Something big is happening on Wall Street that is making investment bankers richer. It is also supposed to signal better times ahead for the rest of the country.

A boom in mergers and acquisitions is taking place, and the stampede is expected to continue even after two headline-grabbing deals — Rupert Murdoch's bid for Time Warner and Sprint's attempt to buy T-Mobile — crumbled this week. A sharp upturn in deal activity is often thought to herald a stronger economy and a buoyant stock market. The theory: Corporate chieftains see strength building in their business lines, which gives them the confidence to pursue ambitious acquisitions of other companies.

Miguel S. Salmeron | Taxi | Getty Images

"The corporate sector has been kind of out of it in creating any sort of growth," Savita Subramanian, an equities strategist with Bank of America/Merrill Lynch, said. "So maybe this is the first salvo in a corporate-spending-driven economic recovery."

So far this year, $2.2 trillion in deals has been announced globally, according to data from Thomson Reuters. That total represents a 67 percent increase from the same period last year, and it is setting up 2014 to be a robust year for deal makers.

Read More Gabelli sees Fox, Time Warner nearly doubling

While the surge creates a hefty payday for investment bankers, it is also one more piece of data — along with figures showing job growth — that suggest the American economy is poised to accelerate out of the doldrums that followed the financial crisis of 2008.

"There's less talk of a double-dip recession or systemic failure," Chris Ventresca, a global co-head of mergers and acquisitions for JPMorgan Chase, said. "So an M.&A. deal feels much less risky than it did until quite recently."

Read More Sprint abandoning bid for T-Mobile amid regulatory challenges

But to some on Wall Street, the deal-making may not in fact be an indicator of golden years ahead. Optimism about economic growth may not be the sole driver of the boom in acquisitions, they assert. Instead, some chief executives may have come to view takeovers as the only way to obtain big increases in revenue in a still lackluster economy. If the deals then disappoint, the economy could also suffer.

And on Wall Street, a desire to strike while the iron is hot always plays a role in any boom. In this case, companies may be forging a lot more deals because the debt used to help finance many of the transactions could soon cost more, particularly if the Federal Reserve raises interest rates next year.

"M.&A. waves always start happening when the economy starts going into the next stage of development," Oleg Melentyev, a credit strategist at Deutsche Bank, said. "But corporate executives may be thinking, 'Cheap capital is not going to be around forever, and I'd better start doing something today.' "

Some investors say they already see signs of irrationality. David Einhorn of the hedge fund Greenlight Capital recently observed that some companies he is betting against — or selling short, in Wall Street parlance — have become the targets of takeovers, even though, in his view, they have significant weaknesses. "Companies we are short often have serious problems, of which the boards and management are probably aware," he wrote in a recent letter to investors in his fund. "This makes them more eager than usual to sell at any sort of premium."

Even so, analysts say that several of the big deals done this year make sense. Comcast's pending $45 billion acquisition of Time Warner Cable, for instance, offers a way for Comcast to gain a truly national presence, including in major cities like New York. And while Comcast's stock slumped after the deal was announced, suggesting shareholders were unnerved by the merger, it has since mostly recovered. In a sign that investors still have faith in this year's deal wave, shares of companies planning acquisitions have in general risen after their plans were made public, according to data from Bank of America Merrill Lynch. (Disclosure: Comcast is the owner of NBCUniversal, the parent company of CNBC and CNBC.com.)

"This suggests investors are rewarding companies that are focusing on growth rather than returning cash to shareholders," Ms. Subramanian, the strategist, said, referring to the increase in stock buybacks in recent years.

More from The New York Times:
How Obama can stop corporate expatriations, for now
In ambitious bid, Walmart seeks foothold in primary care services
Upstart Bank in China Rides High on Technology I.P.O. Crest

But some landmark deals seem riskier to investors. The tobacco company Reynolds American last month announced a $27 billion deal for the rival tobacco company Lorillard. Mr. Einhorn, the hedge fund manager, said in his letter that Lorillard might face regulatory restrictions on menthol cigarettes, its fastest-growing product.

The big question is whether the deals, once they are done, will benefit the wider economy. In theory, mergers stir up animal spirits, spur competition and divert capital to more effective management teams. But one of the reasons that companies combine is to slash costs, which often leads to layoffs. And large mergers often fail to bring about the gains that management teams trumpeted at the time of the deal.

Read More Dollar General mulls Family Dollar bid: Report

One of the big drivers of mergers this year has been the desire to lower corporate tax bills. American companies have been snapping up foreign companies in deals, known as inversions, that will most likely lower the overall tax rate of the combined company.

The Obama administration, which has sharply criticized inversions as unpatriotic, said this week that it was weighing whether to take action to curtail this type of deal.

Inversions have so far accounted for some of the biggest deals this year. Such deals, concentrated in the pharmaceutical and health care sectors, have included Medtronic's $43 billion proposed purchase of Covidien, a rival medical device maker based in Ireland, as well as the drug maker AbbVie's $54 billion bid for its European rival Shire. But inversions may tempt companies to try for mergers that may lack other substantial economic benefits. The acquiring company may then spend years struggling to absorb its prey.

The danger with a mergers-and-acquisitions boom is that chief executives could allow themselves to get carried away by the thrill of the hunt, reducing their focus on internal investment projects that might have a better chance of bearing fruit.

It is potentially a sign of health when mergers grow at the same time as companies' capital expenditures increase. But such expenditures have remained tempered in recent years, according to some analysts.

"It is sort of the missing link at the moment," Mr. Melentyev, the credit strategist, said. "You see all this M.&A. taking place on an almost daily basis," but, he said, a strong rebound in capital expenditures had not yet occurred.

Read More Walgreen confirms Boots takeover in non-inversion deal

Still, the upswing in deals still shows signs of being grounded. After Mr. Murdoch's bid for Time Warner, shares in 21st Century Fox fell. When he withdrew the offer, Mr. Murdoch acknowledged the drop, suggesting he was willing to listen to the doubts of Fox's shareholders.

Some investment bankers say their clients remain rational as they step into a hot market for deals. "Companies feel this is appropriate for this phase in the cycle," Mr. Ventresca, the banker, said. "They'll feed the next three to five years with M.&A., creating a multiyear growth story. Then they're positioned for when, or if, a more vibrant economy comes."

By Peter Eavis and David Gelles, The New York Times

Contact M&A

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More