By Mark Bern, CFA
M&A activity is off to a heady start in the first
quarter of this year; up 60% over the same period last year. Last year many companies held off combining
waiting to see what the highly anticipated tax reform legislation would
bring. This year there is nothing to
hold them back.
Globally, there were $1.2 trillion in M&A announcement
in Q1 2018 already. A full 40% of that
activity involves companies in North America (U.S. & Canada). The full year forecast is for 2018 to be the
second best year for M&A activity in history, just off the record set in
2007 of $4.6 trillion.
That probably means that some of the best run companies (and
some of the worst with underutilized assets) will be gobbled up by larger
companies or combined with equals. What
is driving the frenzied activity? Glad
you asked. There are several factors but
the big ones are:
1.
Interest rates are still low but rising, so
those executives considering using debt to make acquisition will be prompted to
action this year.
2.
Tax reform has created a lot more cash flow for
U.S. companies to invest. Since the U.S.
economy’s industrial facilities are still operating at only 78% of capacity
there is little need to expand production capacity. Therefore, companies are more likely to
acquire future growth and profitability.
3.
Tax reform also lowered the taxes on U.S.
foreign operations and repatriation of cash held overseas. This means that as much as $3.5 trillion will
be available to corporate executives in the U.S. that otherwise had to be
reinvested overseas or sit in short-term investments in foreign financial
institutions. Some will be used to raise
dividends; some will be used to buy back stock; some will be invested in
equipment and facility upgrades to improve worker productivity; some will go
into research and development projects; and some will go into M&A
activity.
4.
The global economy is growing stronger, with GDP
growth expected to be 3.8%, up 0.2% from 2017.
The U.S. economy is expected to grow at a nearly 3% pace this year, up
considerably from the lackluster average of 2% since the financial crisis.
It won’t all get spent at once but
2018 should be a banner year in the U.S.
Some will point to 2007 and its aftermath to try to scare investors out
of stocks too early. While it is true
that a peak in M&A activity can occur at market peaks it is not always the
case. The fact is that our economy in
2018 does not resemble that of 2007.
First off, financial institutions in the U.S. are in much better shape
now than then and is not employing nearly as much leverage. The housing market is heating up but the
subprime lending is not as big a problem at this stage. Mortgage and loan underwriting is still much
more stringent than during the years leading up to 2007.
In addition, this time around interest
rates are already much lower and tax reform is about to put a lot more cash
into corporate coffers. The next leg up
in equities is not a slam dunk but we believe it is highly probably. The big question is how long it will last.
There are headwinds that could
hold the economy back from overheating.
That will be the topic of next week’s missive along with when I expect a
recession could begin. I am not a market
timer but I do keep track of trends and I keep an eye on potential catalysts
that have the potential to undermine our economic growth prospects.
Respectfully and Candidly,
Mark Bern, CFA
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