Deals and IPOs

In a Flurry of Deals, the Beginning of the End?


The first day of Wall Street's workweek normally comes with the announcement of a corporate merger or two, hence the nickname "Merger Monday." But these days, a more appropriate moniker might be "Manic Monday."

There was more than $170 billion of deal-making unveiled on Monday. Dell agreed to acquire EMC, the storage provider, in a deal worth about $67 billion, and Anheuser-Busch InBev said it had raised its bid for SABMiller to about $103 billion. Add in a few smaller transactions and you have one of the biggest days ever in Wall Street deal-making.

Mergers and acquisitions are on track for a record year. So far in 2015, there have been nearly $3.5 trillion worth of transactions, according to Thomson Reuters. One Wall Street banker described Monday as feeling "a little bit like 1986 or maybe 2007."

Michael Dell, chairman and CEO of Dell at 2015 WEF in Davos, Switzerland.
David A. Grogan | CNBC

If that's right, these deals do not portend good things, and will likely represent the end — or at least the beginning of the end — of a bull market.

That doesn't mean the market is going to falter tomorrow, or even in the coming months. If history is any guide, there is likely a year of more deal-making, and with interest rates likely to remain low, it is possible it could go on even longer. When Wall Street banks announce their earnings over the next two weeks, expect talk of an unusually long list of deals in the pipeline. But to many astute financial minds, this level of deal-making is unsustainable.

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Consider what's behind Monday's announcements: businesses that are under siege and trying to transform themselves. In the case of Dell-EMC, Dell is trying to move away from its personal computer business while EMC has been struggling in the face of a changing environment for computer storage. According to my colleague Peter Eavis, Dell's private numbers reflect a net loss of $768 million, compared with a $570 million loss in the same period a year earlier. Revenue was also down, falling to $27.5 billion in the latest six months, from $29.5 billion in the year-earlier period. The deal may very well work — in fact, it's probably what both companies should be doing — but the transaction is hardly being struck from a position of strength.

The same is true of the possible Anheuser-Busch InBev-SABMiller tie-up. Market share has declined for both companies and sales have fallen in developed countries, where microbrews are stealing significant market share. The rationale for merging is very clear: cost-cutting.

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Both of these deals may turn out to be good for shareholders, but they both say a lot about what's driving the current round of mergers and perhaps more important, the larger economic forces at work. Big companies that have been cutting their way to profitability for the last several years have run out of costs to cut. So what do they do? Merge to cut costs even more.

"Corporate consolidation can perhaps provide some last drops of stock market intoxication," Spiros Malandrakis, an analyst at Euromonitor, wrote last month about the potential beer merger.

If you were to lay the performance of the S.&P. 500 over a chart of deal volume over the last 30 years, you'd see that deal-making is a lagging, not a forward-looking, indicator to the stock market. In other words, a rise in deal volume follows a rise in the stock market; it doesn't come ahead of it. Also, there is often a spike in deal-making in the year and a half before a major market correction. The biggest deals tend to happen at the end of a bull market cycle, like the 2007 leveraged buyout of the Texas utility TXU, which ended with a bankruptcy filing last year. Of course, deals would make more sense at the beginning of a cycle, but chief executives are usually too worried about their own businesses to take a large risk.

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Dell is certainly taking a big risk, as the deal for EMC will saddle it with $50 billion of debt. Meg Whitman, the chief of Hewlett-Packard, used the transaction's heavy leverage to take a jab at her rival. "To pay back the interest on the $50 billion of debt that the new combined company will have on their balance sheet, Dell will need to pay roughly $2.5 billion a year in interest alone," she wrote in a note to her employees. "That's $2.5 billion that they will allocate away from R.&D. and other business-critical activities, which will keep them from better serving their customers."

That might be true, but Moody's is actually planning to upgrade Dell's debt based on the deal, contending the numbers make sense: "Despite the significant increase in debt and initial leverage, Dell's overall credit profile will be enhanced with the acquisition of EMC, a merger that will create the largest private technology company in the world based on revenues."

Surely, the Dell-EMC deal and the potential beer combination are far more logical than pie-in-the-sky deals driven by illusory goals or fantastical synergy claims, such as the infamous AOL-Time Warner merger in 1999, widely considered the worst deal ever. We haven't seen anything that silly — yet.