Wednesday, May 30, 2007

When Will The M&A End?

From the Financial Times:

Buy-out groups in the US are having their busiest month on record after launching nearly $82bn-worth of bids since the beginning of May.

The frenzy of activity defies predictions of a slowdown in the private equity-driven deal boom but could also signal a desire by buy-out funds to rush into deals before credit markets take a turn for the worse.

So -- when will this end? Cramer of Mad Money Fame offers five signs the boom will end.

1. Interest rates on the long end going to at least 6%-7%. At that point, I believe it will get too risky.

2. The equity market being closed to the IPOs of the companies that need to be flipped. It's wide open right now.

3. Not one, not two, but maybe three or four, or even five deals going bust. Can't we wait for even one to go belly-up before we get too nervous?

4. Valuations ramping up more. With the S&P 500 selling for about 17.5 times next year's earnings, there is plenty of room to keep buying.

5. Private equity funds running out of money. Very unlikely.

Let's take these one at a time.

1.) Credit is still cheap. While I wrote below about increasing interest rates, the 10-year Treasury is still below 5%. That's really cheap credit by historical standards. In addition, corporate credit is also very cheap, especially by historical standards. Until rates move higher, companies can access the credit markets for funds.

2.) I can't speak to the IPO market's liquidity, but there has been a complete black-out of news stating IPOs are getting canceled in a big way.

3.) It takes awhile for mergers to complete -- at least a year and that's assuming everything goes right (which it won't). Easing the assimilation process is the large number of intra-industry mergers. So long as mergers are within the same or complimentary industries it's doubtful we're going to see deals go bad in a big way. And when they do go bad, there's is a more than minimal chance the reason will be company/merger participant specific (say a CEO who just isn't people/culture savvy) as opposed to a bad overall idea.

4.) According to Barron's, the DOW has a PE of 17.89, and the S&P is at 18.18. According too Margetguage, technology is the most expensive are with a PE of 30. We have several industries with a PE in the 20s and 5 with PEs in the teens. In short, the market isn't cheap, but it's not expensive right now either.

5.) There is a ton of liquidity right now. As if the Japan/US carry trade wasn't enough, we have a very clean corporate balance sheets allowing increased debt issuance, $2.5 trillion in foreign government investment funds available and an increasing money supply.

So, there is a great deal of evidence to back-up Cramer's analysis.