Why All the Major Mergers?

It has Nothing to do with the Stars

“Since the crisis, one by one, the stars came into alignment, and it was only a matter of time before you had a week like we just had.”
– James B. Lee Jr.,vice chairman of JPMorgan Chase

There is indeed an alignment of the credit and stock markets to foster multibillion dollar mergers and acquisitions:

High stock prices have raised the confidence of chief executives. The Standard & Poor 500-stock index briefly hit its highest levels since November 2007.

Banks can offer historically cheap credit to buyers because of the unprecedented easing by the world’s central banks.

JPMorgan’s James Lee has been in the middle of much of this activity. His bank has advised on four big deals in recent weeks, such as the Dell bid and Comcast’s 16.7 billion offer for the rest of NBCUniversal that it did not already own.

Wall Street deal makers and chief executives have regained their confidence. The announcements on the same day last week of the acquisition of H.J. Heinz for approximately $28 billion and the merger of American Airlines and US Airways — making the world’s biggest airline — show M&A activity has roared back to life.

That’s in addition to Michael Dell and private-equity backers’ plan to spend $24 billion to buy out Dell Inc.

More than $158 billion of mergers and acqusitions have been announced so far in 2013, according to Thompson Reuter data. That is more than double the amount in the same period last year.

Possibly the single biggest factor driving the return of corporate takeovers is the banking system’s renewed health. Generally, the ability of corporations and private-equity firms to undertake multibillion-dollar transactions depends on the willingness of banks to lend them money.

Last month on Bloomberg TV, Warren Buffett said banks’ “capital ratios are huge; the excesses on the asset have been largely cleared out.”

Instead of being mired in bad loans and toxic mortgages, banks’ excellent balance sheets have opened up their lending spigot at record low interest rates. Junk bond 10-year yields recently fell to a record low 5.75 percent.

Banks have an economic incentive to take part in mergers and acquisitions. They earn significant fees from both advising on transactions and lending money to finance them.

Bankers have another “ace in the hole.” They can quickly sell their newly acquired bank loans to yield-hungry investors.

Corporations that make up the S&P 500 have accumulated more than $1 trillion in cash, but cash balances are earning very little in bank accounts today. To generate higher earnings per share, executives are looking to acquire businesses that earn more than they are generating from their cash and short-term investments.

The private-equity deal-making machine is also revving up. The world’s largest buyout firms have hundreds of billions of dollars of “dry powder” — money allotted to deals, in Wall Street parlance.

Hopefully, CEOs will not make the same mistake as in the go-go era of the late 1990s or mid-2000s, when inexpensive financing, profligate lending by banks and aggressive private-equity investing led to some poor acquisition choices.

As John Chambers, Cisco’s CEO, said last April on the Charlie Rose Show, “90 percent of acquisitions in the tech area fail.”

James Lee also should remember that the stars are always moving. I would like to point out that M&A bankers are renowned for their optimism, no matter the conditions.

We might even have some dark clouds on the horizon, such as the federal sequester, which could begin March 1.

Douglas Elmendorf, the director of the Congressional Budget Office, warned lawmakers that the $1.2 trillion across-the-board cuts could halve economic growth and result in a loss of 750,000 to 1 million jobs in 2013.

Could today’s deal makers end up with ketchup on their faces tomorrow?