This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket, chief investment officer of Psigma explains what recent M&A activity means for global markets.
Healthcare has been the sector most in the spotlight with a total of $83 billion of deals announced last week and confirmation this morning that the UK-listed behemoth 
AstraZeneca (AZN) has been approached by Pfizer (PFE). We continue to like healthcare investments, with M&A part of our ‘buy’ thesis. However, many other sectors have also seen proposed transactions. In addition to the flurry of deals announced in the last couple of weeks, there are rumours of a number more in the offing – some major, such as French infrastructure company Alstom by the US giant General Electric (GE) – confirming the anecdotal evidence we had gleaned from contacts and clients in the legal sector that the M&A departments of big London law firms are working full throttle.
Investors love takeovers and it gets the animal spirits coursing through markets. Deals announced get private investors hunting for the next one and keeps interest in stocks high. The obvious reaction/ logic is that if corporate buyers think there is value to be had then it must be right to buy themselves forget the fact that most takeovers end up being inefficient uses of capital by the acquirer.
In no small part, the equity market rally that commenced in 2003 was prolonged by the late-cycle deals and proposed mergers from 2005 onwards. We can all now laugh at the Rio/ BHP debacle, but on the positive side who can forget “Manic Merger Monday”, when it was announced on one fine morning in 2005 that three companies from the FTSE 100 were to be acquired on the same day. Nobody cared that some of our finest companies were being acquired by foreign suitors as everyone was making so much money.
We feel strongly that this recent outburst of corporate marriages can continue, offsetting the possible downdraft in markets from unimpressive earnings and geopolitical fears. There is pressure building on corporate managements from shareholders to do something with the mighty cash arsenals they have acquired in the last few years and they will have taken note of the positive share price reaction that acquirers have been enjoying.
Sensible deals should be very accretive to earnings, given that most companies can issue debt to credit markets and at wonderfully low rates. Indeed, given the cash-flush nature of US pension funds and the insatiable appetite for liability-matching yield, some US companies can issue 30 year paper cheaper than for 10 year bonds. Indeed, most companies can get their hands on whatever they want, as shown by the massively oversubscribed issues from Altice and Numericable last week, which leapt on the open of their trading, a regular occurrence when the bonds are so over-subscribed.
Along those lines, it is worth noting that the other asset class which can benefit from a surge in M&A is high yield credit. We have noted many times in the past that most areas of corporate credit markets look eye-wateringly expensive, but bid targets often see their bonds go up in price on the announcement of a deal. Given that most deals announced are by investment grade companies snapping up their high yield brethren and their bonds often weaken in the event of a purchase, it is another reason to avoid insanely expensive investment grade bonds at this time.
So with growth hard to come by in a ‘low opportunity’ and ‘high risk’ world, corporate management teams will likely see the attractions in buying themselves growth pipelines from outside their companies. While debt remains cheap and shareholders are welcoming such transactions, there is every chance that future holidays will be interrupted by news of big deals. Long may it continue.
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