Facebook, AstraZeneca and Vodafone are just some of the household names caught up in recent attempts to buy and sell large businesses for eye-watering sums. So have we returned to the era of the “mega-deal”?
Big ticket prices
The first quarter of 2014 saw mergers and acquisitions (M&A) deal value increase 39% compared with the same period last year.1 While the volume of deals increased, the main driver of this rise was an increase in transaction size.
Among the companies involved were some that were the subject of high-profile private equity exits, such as Facebook’s acquisitions of WhatsApp and Oculus VR, for $19bn and $2bn respectively. Private equity exits are often made at high valuations relative to earnings, in anticipation of rapid growth. However, the deals that often make more of an immediate impact on global markets are the mega-cap deals between large, established corporations.
One such deal recently took place when Comcast purchased Time Warner Cable for $45bn, but this paled in comparison to Verizon’s purchase of Vodafone’s stake in their joint venture last year. With a price tag of $130bn, it was one of the biggest deals in corporate history and made 2013 the best year for M&A since 2008. Verizon was happy to have taken control of a strategic initiative and Vodafone was able to return more than £54bn to its shareholders in cash and shares.
The value of global M&A deals that have taken place in 2014 so far stands at over $1.5tn.2 In North America there were over 1,182 deals worth a combined $299.6bn in the first quarter of 2014, which is the highest level of first-quarter dealmaking since 2007.3
Such activity could be seen as a sign of a healthy, well-functioning market. On the other hand, the M&A boom of 2007 eventually came to be seen as an example of the irrational exuberance that led up to the financial crisis. There is, however, a major difference between the M&A deals that were taking place in 2007 and those taking place now. In 2007, most deals were made in cash, often raised through excessive borrowing. So far in 2014, most deals have been made with shares or a combination of cash and shares.
The general level of interest rates in the developed world has been at a historical low for half a decade now, but as corporate balance sheets swelled with cash after companies became more cautious following the financial crisis, the need to borrow has been reduced.
Some see this as representative of a more sustainable approach, but others may see it as a sign that companies are having a hard time reinvesting their earnings into internally generated profitable projects.
Irrespective of your interpretation, it is clear that these deals are not always welcomed by all parties. If the acquirer has to issue additional shares to pay for an acquisition, it can dilute the value of current owners’ holdings. If the current management of the target disagrees with the acquirer’s strategy, they will oppose it, which could end up stopping it in its tracks or give rise to a hostile bid.
Hostile takeovers, where offers are made despite opposition from target boards fell to a decade-low at the beginning of 2013, according to Dealogic. At the same time, however, shareholder activism has been on the rise.
In a recent example, listed auction house Sotheby’s used a “poison pill” to defend itself against an attempt by activist investor Daniel Loeb to build a stake of more than 10% in the company to demand changes to the management and strategy. The “poison pill” defence is controversial and often contested in court. It allows company management to issue new shares to other shareholders as soon as a single shareholder amasses a position of a certain size, thereby diluting the shareholding of the activist.
In Sotheby’s case, their defence was upheld in court, but the company ended up giving Mr Loeb most of what he wanted anyway. As it became apparent that his representatives were likely to win election to the board irrespective of the size of his stake, the existing management agreed to offer him a place on the board alongside two other candidates of his choice. The act of taking a controlling stake in a company may simply not be necessary if institutional investors and corporate governance advisors are willing to club together to back the suggestions of persuasive investors.
Patience is a virtue
Many investors would like to hold potential acquisition targets not to agitate for new management, but because their share prices usually rise when offers are made. This is an understandable strategy, but we take the view that time spent trying to pre-empt such deals could be better spent on analysing investment opportunities on their own merits.
When we first built our position in AstraZeneca in the Jupiter Distribution Fund, it was not with any view that it was likely to be acquired in the near term. Rather, we spotted an opportunity based on the fundamentals of the business. After the board rejected a £60bn bid from Pfizer, we were perhaps not as surprised as others when we learned that the board had rejected it, as we had felt there was more value in this company for some time. The stock price rose sharply, however, from under £39 at the beginning of the year to over £48 (a rise of over 23%). But when AstraZeneca rejected a higher bid of £69bn a few days later, the price declined again. It is fair to say we were disappointed with this outcome, but it illustrates the risks of attempting to second-guess corporate dealmaking. Nothing is certain until the deal is done and this only makes us more confident in our own strategy of focusing on fundamentals and waiting patiently for value to be unlocked.
It is in the nature of an actively managed fund to look beyond the investments that are popular at any given moment to uncover hidden potential long-term values in companies that have recently struggled or are undergoing a difficult turnaround process. This is rather similar to what a corporate acquirer will be looking for and so we do not need to anticipate the actual deals that may occur. Instead, we hope to benefit by seeking out the best investments long before their performance has attracted the attention of others, when their price is supressed and their potential far from obvious. We are only too happy for acquirers to realise the value of these also.
1 Source: Monthly M&A Insider, Mergermarket, April 2014
2 Source: Bloomberg
3 Source: Monthly M&A Insider, Mergermarket, April 2014
This article was provided by Jupiter Asset Management and does not necessarily reflect the views of Citywire