by Robert Teitelman | Published February 29, 2012 at 1:14 PM
The Financial Times today raises some fundamental questions about M&A based on a relatively slow start in 2012 dealmaking, after a pretty lousy second half of 2011. The questions are always fun to bat around like a shuttlecock. Is this downtime in M&A cyclical or structural, based on exogenous factors like a tightening in antitrust or the euro-zone mess, or endogenous ones that suggest a more permanent decline in activity? Before we take our shots, let's line up the caveats. M&A activity, like the stock market, which it's closely tied to, has this habit of shifting dramatically, often when the trend seems clearest. The media loves to extrapolate; it's not so good with changes of direction or with separating out a random walk, that is noise, from a real trend, the signal. The pundits also love declaring a big new merger wave (thus kicking off an absolutely reflexive set of handwringing stories, mostly involving the folk wisdom that most M&A deals don't work) every time a few sizable deals are announced, usually on a Monday. I'm not sure that looking at the first few months of the year is necessarily a relevant time period, even if you throw in half of last year. It's certainly not time to panic, particularly with stock markets up and a number (though not all) economic signs, at least in the U.S., improving.
That's not to say that a "structural" downturn in M&A is out of the question. After all, we've grown accustomed to fairly high, and growing, levels of M&A since the '70s, with the real takeoff in the '80s. There had been other M&A waves, notably the '20s, but the activity diminished between the Great Depression and the late '60s. Why the fluctuation? Obviously, the economy had something to do with it. An M&A deal is a risk and in perilous times a major risk that most boards and CEOs will eschew (particularly those lacking shareholders demanding performance: the stakeholder governance of corporations in that era, and the predominance of individual investors, may arguably have made them more, not less, conservative). M&A usually requires a powerful currency, like a high stock price, or cheap financing, both of which may evaporate in difficult times. In particular, after 1929, equities spent nearly three decades in the doghouse. It took until the mid-'60s for institutions to rediscover the performance equities can provide. And crisis periods often lead to some tightening of regulation, often in terms of antitrust.
One of the broad effects of these trends, which are associated with significant and long-lived slumps, is to shift the balance of power to already established companies. These companies have the internal resources to handle a merger or acquisition, perhaps from its equity, but mostly from strong internal cash flows. They are autonomous, cash-generating fortresses, though not necessarily growth vehicles. (One of the signs that things were changing was the '60s fad for the Nifty Fifty, sizable companies that were also growing fast. It didn't last.) This produces an extremely top-heavy economy, as we had from the '30s to the '60s, and relatively stagnant stock market in terms of volume and performance. (The determinative factors behind that structure are speculative of course: It was also an industrial age, with powerful economies of scale.) In a sense, it's a form of corporate inequality: Large companies have advantages that overshadow smaller players, from startups to midmarket companies. The rich, corporate-wise, get richer.
Are we there again? Well, it's true, the developed world -- Japan, the U.S., and Europe -- absorbed a tremendous shock in the financial crisis. Europe in particular has extended the aftershocks and instability into 2011 and 2012. European banks are in perilous straits, uncertainty and volatility in the euro zone is very high, and recession looms, if it's not already begun. That's a major dampener of M&A activity for a number of reasons -- banks can't lend, CEOs won't make the leap, investors are increasingly risk averse -- that can infect the U.S., particularly psychologically, as it did after August. It's also true that we've seen a broad tightening of antitrust, after a period in which few deals were seriously hassled, not to say scotched. It doesn't take much for CEOs and boards of large companies to hesitate. The failure of big consolidation plays like AT&T and T-Mobile, and the New York Stock Exchange and the Deutsche Börse rippled through the M&A world, but the argument that they represent a permanent resetting of the game is a stretch. Likelier that the market has to get comfortable with slightly tougher rules, although in some sectors, such as banking and finance, scrutiny from the Federal Reserve looks much tougher. J.P. Morgan Chase & Co. CEO Jamie Dimon's admission that no deals are in the works isn't a shock.
But will that last, even in banking? The fundamental driver of this entire complex mechanism remains share prices and performance. To suggest that we're entering a long period of structural decline in M&A is to say that we're also entering an age when our performance metrics are significantly reduced and that shareholders will happily settle for reduced returns (another way to say it: that shareholders won't have anywhere to turn to get better returns). That doesn't seem the case. Just today, BlackRock's Larry Fink in the FT is begging companies to help workers save and invest, because so much hinges on both renewed activity in the stock market and a revival of performance. For all the conventional wisdom that M&A is uniformly bad and self-interested, the truth of the matter is that it's the easiest and most direct way for companies to regain growth. Everything feeds off growth. Again, if you declared that M&A could not occur, you would eventually have to dramatically lower growth projections across the corporate sector. M&A might always be a risk -- transformative M&A is always a major risk -- but it's not as risky as trying to reinvent maturing companies through R&D, marketing or regular prayer. Like technologies, products and services run out of steam; they have to be supplemented, improved or replaced. You can cut costs for awhile, and you can engage in consolidation, but eventually you will have to tackle the more fundamental question of amping up organic growth. And it's not only faster, but rational, to look around to buy another company, or five, that may be closer to where you want to be. Otherwise, old age steals over you quickly. And that senescence increasingly afflicts the real economy.
Historically speaking, that sense of senescence and decline, usually accompanied by falling share prices and unemployment, kicks off renewed interest in deregulation. That's what occurred in the '70s. Somehow, despite the uncertainty, we don't seem to have those ingredients for secular stagnation of M&A. There remains tremendous pressure (pent-up pressure) for performance. Some tightening of antitrust, particularly on high-end consolidations, a) does not seem to be widespread despite the panic and b) may require only a short period of adjustment. M&A remains a tool to cope with rapid change, which in increasingly global markets continues. If M&A is heading to secular decline, why are there so many energy deals? For all the gloom from the likes of the NYSE CEO Duncan Niederauer about his failed consolidation play, there's still a diverse bestiary of global exchanges, clearinghouses and firms below that level (and undoubtedly safer from antitrust) that seems to be engaged in the mating rituals of incipient M&A. As for private equity, which drove the pre-2008 boom, there's no doubt that in some regions, certainly Europe, conditions have reduced M&A and PE. But as our own Matt Miller wrote in the Deal magazine last issue, there's a world of indigenous PE shops popping up in a number of emerging economies. As for the threat that carried interest will be hiked, that would seem to be a driver of deals, an attempt to get in before the tax increases. But there have been few signs of that.