Let’s Make a Deal – The State of M&A 2018
By David Nelson, CFA
With over $2.1 Trillion in deals inked so far, 2018 looks to be another record year for M&A. AT&T’s (T) $85 Billion takeout of Time Warner is in the books and Disney (DIS) has beaten out rival Comcast (CMCSA) in their quest for Fox assets. Smaller deals like Express Scripts (ESRX), Sprint (S), Andeavor (ANDV) and CA Technologies (CA) range from $18 – $52 Billion adding to the monster total already larger than the nominal GDP of all but the world’s top 8 countries.
Get big or go home seems to be the prevailing mantra inside the boardroom as companies look to gobble up competition or bulk up to fend off predators. Investment bankers scramble from Wall Street to Silicon Valley with pitch books in hand, hoping to ink the next blockbuster deal.
Make no mistake, this is still big money for Wall Street. FactSet data shows $140 Million in advisory fees for the target Time Warner split by Allen & Company, Citigroup and Morgan Stanley. AT&T had their own advisors, so you can at least double the figure. Most reports put total fees close to $390 Million, so there’s a huge incentive for the bankers to drum up business.
Deal making has been with us since the beginning of time, so why should investors be concerned today?
The Worst Deals in History
Let’s take a walk down memory lane and explore some of the worst M&A deals in history. At the top of anyone’s list has to be Time Warner’s disastrous decision to merge with AOL. In January 2000 the deal is announced for $165 Billion and the biggest merger in history. The rationale of course was the convergence of old and new media. In the end AOL records the largest loss in corporate history coming in just shy of $99 Billion following a write down of good will. It should be noted that eventually Verizon (VZ) buys AOL for just $4.4 Billion.
A couple of years earlier Daimler Benz decides to take on Chrysler which eventually becomes the first of the Big 3 automakers to end up in the hands of private equity. In 2007 Daimler paid $650 Million to unload Chrysler to Cerberus Capital Management looking to exit its exposure to billions in ongoing losses and health care costs.
Microsoft (MSFT) for Nokia, Nextel – Sprint, HP – Autonomy and of course who can forget Bank of America’s (BAC) purchase of Angelo Mozillo’s Countrywide. It’s easy to construct a list of promising deals that turned south very quickly. My point is, all too often CEOs turn to M&A to shore up slowing organic growth with a competitive take out or vertical integration. Synergies can drive cost savings in the early years, but all too often don’t produce the expected growth that was on page 19 of the pitch book. Culture clash is often an issue and sometimes as in the case of HP’s infamous take out of Autonomy, you find the books were cooked.
The one thing many of these bad deals had in common is that they came in the middle of or near the end of a bull market.
S&P 500 10 Years
At best were a decade into a late cycle bull market so most M&A activity is going to come at a premium. Just a few years ago Facebook (FB) purchased What’s App for a staggering $19 Billion. They’re still trying to figure out how to monetize the application. And of course, just last week we had Elon Musk’s tweet indicating financing was secured to take Tesla (TSLA) private at $420 per share, over $70 Billion. I don’t see how he does a leveraged buyout considering there isn’t any cash flow to service the debt. That means more dilution from an equity offering.
The good news is that today, shareholders aren’t always a doormat for management to walk over without confirmation that this is a great deal designed to enhance shareholder value. Just last week Albertson’s and Rite Aid (RAD) called off their merger after taking the pulse of investors. Learning that their shareholder vote would fail they decided to walk away and cancelled the proposed Merger. Activist investor Carl Icahn is trying to end Cigna’s (CI) purchase of Express Scripts (ESRX) hoping to block the transaction. Shareholder advisory firm Glass Lewis has given the deal their blessing, so it appears at least for now Carl won’t prevail. However, it’s encouraging that there is at least a conversation that in past years seemed all too absent.
Interest rates are still low enough to drive financing for tomorrow’s blockbuster deal with no shortage of funds looking for a home. Expect the next wave of deals to be largely domestic as cross border transactions become increasingly difficult. No one wants to get caught on the wrong side of a tariff dispute and the administration is looking carefully at every deal, perfectly willing to use National Security as a concern to halt a transaction.
All in it looks like another record year for M&A with no shortage CEOs looking for a deal and an army of bankers hoping to pitch it. What could possibly go wrong?
*At the time of this article some funds managed by David were long T, MSFT and CMCSA