Opinion: Why Merger Mania May Be on The Cusp in a Post-COVID World

Mergers and acquisitions are one and the same. It’s the classic big fish swallows the little fish. And on Wall Street, when M&A starts to really get going—well, that’s what’s called “merger mania’.

I think we’re on the cusp of a new merger mania, accelerated by the COVID-19 crisis and everything that’s happened because of it.

Some of the secular reasons behind a possible new “merger mania”:

  • Rock bottom interest rates have made borrowing cheap
  • Anti-big business sentiment is rising, which could lead to big antitrust break-ups (the opposite of a merger, counterintuitive I know but I’ll explain)
  • A new presidential regime means a likely increase in corporate taxes
  • A big, new stock market boom could lead to more M&A

I know a lot of these ideas sound controversial, maybe even crazy. A new stock market boom on the heels of a rising market since 2009? What is this guy, insane?

Of course I could be wrong, but with the onset of the coronavirus and how it’s rocked our world, there are many ideas that I think haven’t gotten attention because it’s hip to be a doomer these days.

But if I’m right, and some of you act on these opinions, it could make some people a lot of money.

The History of Merger Mania

First, some perspective and history. I covered, quite extensively, the leveraged buyout boom that seduced the stock market in the 1980’s.

There were lots of factors behind that, but to put it in layman’s terms:

Lots of businesses borrowed lots of money to buy lots of other businesses.

That’s a merger mania in a nutshell.  Now, a big contribution to that time period in the 1980’s was the prevalence of high real (inflation adjusted) interest rates. I’ll quote billionaire George Soros again because his explanation is so simple yet profound:

“High real interest rates render financial assets more attractive, and physical investments less attractive”

Another hot LBO (leveraged buyout) period happened at the tail end of the 2007 housing boom, as the punch was flowing and the party was going. As shared by Investopedia, many of the biggest LBOs of all time happened during that time period.

The funny thing about mergers, acquisitions, buyouts, etc. is that they tend to drive markets higher, and the higher markets tend to drive merger mania higher.

It becomes a “reflexive” process, again another idea borrowed by George Soros, where each thing (M&A’s and the stock market) feeds on and influences each other.

Low Interest Rates…. I Thought You Said High??

I mentioned above that high real interest rates helped drive the merger mania of the 1980’s. So how could low interest rates do the same?

Well, low interest rates and buyout sprees aren’t mutually exclusive.

The mega mergers of 2006-2007 also happened in a time period of low nominal interest rates, but at a time of rising real interest rates.

  • Nominal = the actual interest rate number
  • Real = the inflation adjusted interest rate

So if interest rates increase faster than inflation, or even if inflation slows, that can push up real interest rates to spur corporate M&A activity.

With COVID-19 providing deflationary pressures, and nominal interest rates sitting at rock bottom lows—even a small uptick in either influencing force could cause real interest rates to mirror the 1980s or 2005-2007.

Anti-Big Business Could Mean More Mergers… huh?

The hatred towards big business has been around since the 1880’s with John D. Rockefeller’s massive oil empire built by his Standard Oil Corporation, as described in the riveting book The Prize.

This sentiment reared its head again in 1982 when “Big Bell” got split into 7 “baby bells”.

Today, the big tech or “S&P 5” companies like Apple, Google, Microsoft, Facebook, and Amazon are facing increasing pressure on anti-trust lawsuits—from claims of predatory practices in app stores to worries that they control too much of the public’s attention.

So these big split-ups very well could happen (which historically ends up being good for long term shareholders of those businesses).

But in the meantime, a merger mania could also brew as these big companies get put under the microscope.

Maybe I’m just speculating here, but maybe a successful big breakup will be enough to show that a politician “did something” (or did “enough”), while the rest of the M&A activity can happen behind the scenes at a smaller scale.

New President = Higher Corporate Taxes = More Buyouts??

I don’t think I need to comment on when a presidential candidate is likely to raise taxes. They usually make it pretty clear.

From a stock market perspective, higher corporate taxes mean less of an incentive to keep retained earnings, as much of it goes to the government.

So instead, a company might be better served to borrow more (since interest expense is tax deductible, and so the higher tax rate means deductibles are “worth more”).

That’s not to say every management views leverage this way…

But it could be enough to spurn another merger mania.

After all, all of the new money from borrowed funds has to go somewhere. And so why not grow revenues and earnings almost effortlessly with an expensive, debt-fueled buyout??

Especially when the market rewards such behavior, as they can be guilty of at times.

A New Stock Market Boom Could Fuel M&A… Wait, what boom??

Well, I’m not a very popular person when I say that the stock market could be on the cusp of a new boom when unemployment headlines scream that things are as bad as the Great Depression.

But despite the nasty headlines (which don’t depict the reality if you actually read the reports), there’s a few reasons why the stock market could still boom:

  • The last “bad” market ended in 2013, not 2009

We tend to think of today’s bull market (as of July 24, 2020; post COVID initial lockdowns) as having started in 2008, or 2009, or 2010…

That would put the bull market at a primordial 10-12 years, which seems long in the tooth especially considering the 2000-2007 bull market.

But I got this idea from Vitaliy Katsenelson’s fantastic book The Little Book of Sideways Markets, and I’d like to link a chart from there:

Let me be clear, Vitaliy didn’t make this conclusion—I’m making it.

But if we consider that the last observable sideways market was from 2000-2013, then another secular bull market could be on the way, which could run 16, 17 years, or more or less….

But that means an additional 10 years from today of a booming stock market isn’t out of the realm of possibilities here.

So yeah, I think a new bull market could go from here.

  • Interest rates can stay low for a long time

I covered this in my post about corporate restructuring (and the LBO history), as I also took a stab at interest rate history.

Turns out that there have been times where interest rates stayed rock bottom for 5-10 years even!

When it happened in the U.K. during the late 1880’s, it lead to one of their most prosperous times of all time!! It was known as the period of easy money, and investors in equities made a fortune!

In the aftermath of the Great Depression, nominal interest rates also stayed rock bottom low for about a decade, and we all know that was a great time of recovery for the stock market and economy.

That’s why I think, even though the Fed Funds Rate is at basically zero, mortgage rates are at record lows, and interest rates globally are rock bottom, I think it could keep going for a while.

5-10 years more shouldn’t be out of left field here.

And that, drumroll…

Would fuel a stock market higher, for quite a while—as low rates are great for economic activity and lots of other things.

And when stocks are hot, companies like to use shares to buy other companies, which can lead to….

Another merger mania.

Investor Takeaway

Look, I could go on and on about my reasons to be bullish for the next 10 years.

But really, any of the factors I discussed above could lead to a boom in M&A activity. And that’s generally good for stocks, especially if you own one that gets acquired.

So my takeaway for you is:

Note: this post was originally written on 7/24/20. The thoughts and opinions of the author reflect only his own and not necessarily those of the other fantastic contributors on this site.

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