Merger Mania

Well, not really.  Not yet anyway.  But M&A activity is up this year and that is good for stocks because, again, mergers and acquisitions reduce the pool of stocks.  And when the supply of something is reduced, the price goes up for the remaining supply.  Usually.  Not always but usually.  So the general rule is that increased M&A activity is good for stock prices.

It is also good for stock prices because one deal leads to another and so analysts and investment managers are looking for the next deal and trying to get in on that before the stock gets bid up.  If there is no M&A activity there is no searching for the next deal and the market just kind of sits there. 

CFO's and corporate treasurers make the same analysis that we did last week--if you can borrow at 4-5% and invest (buy a company) that produces 6-7% or more it is, to quote George Tenet, a slam dunk.  The CFO and treasurer trot into the CEO's office and he/she loves the idea because he/she wants a bigger company to brag about at the club and get his/her name in the paper.  And there are other reasons to buy--often the CEO hates the guy at the other company and wants to put him out of business. 

That can also be counter productive.  Dresser Industries and Halliburton  talked for years about merging but the two chairmen hated each other so much that there wasn't a deal until they retired and Dick Cheney came along.  The deal was actually hatched in a duck blind when our chairman went hunting with Cheney.  I would have been better off if Cheney had just shot our guy.  (Heard a joke about Cheney and his hunting accident going something like "I can't understand why everybody is mad at Cheney.  He did what we only dream about--he shot a lawyer.)  Ok, not great but not bad.

Other acquisitions are 'strategic.'  Filling a hole in the product line.  A perfect example of this was Pepsico buying Quaker Oats.  Pepsico wanted Aunt Jemima, Captain Crunch and oatmeal like a hole in the head but they did want something and that something was Gatorade.  They wanted Gatorade because traditional soft drinks are going down in sales as water and alternative drinks (Gatorade) are going up.  If you don't think so look at Coke's stock price over the last five years compared to Pepsico.  No contest.   For a more indepth look at Pepsico and Coke take a look at Category 12-Investments.

And some acquisitions are for show, the purchase of an intangible asset.  I don't know the value of AT&T but it is a shell of it's former self.  But the name has worldwide recognition while SBC does not so SBC bought AT&T and reinvented itself.  Not bad if the price was right.

Which brings us to how deals are valued.  If you have taken any finance course you know about discounted cash flow but you probably don't know the Dirty Little Secret.  That will come tomorrow but for now remember that M&A activity is good for stock prices initially because M&A activity reduces the pool of available stock to purchase.  Simple but true.  And M&A activity is up right now so another factor behind a rising stock market.

Overdone M&A activity can be bad for stocks because it gets out of control with out of control prices and this often signals a market top.  But, again, we are not there yet. 

Tomorrow we will look at how deals are done.