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By Marine Cole
Merger activity has picked up in recent months and will gain momentum if the economic recovery continues, analysts say. But in contrast to the previous M&A cycle, transactions this time around could pose less of a threat to the credit markets.
While M&A activity remains rather tepid, Barclays Capital believes it will heat up. Globally and in the U.S., the size of transactions is down 50% to 60% from levels in the third quarter of 2008, with transactions in the past year concentrated in the telecom, financials, beverage, media & entertainment and tech sectors. But the number of deals count is down only 15% to 25% versus the comparable quarter a year ago. So although deals are smaller, the pace of transactions has proven fairly resilient. And the number is likely to increase if a recovery takes hold.
"We expect the pace of M&A activity to blossom as economic growth resumes, capital market conditions improve further and risk appetites normalize with executives having stockpiled sizeable cash balances," Jeff Meli, head of investment-grade strategy at Barclays, wrote in a note published last Friday.
That might be a worrisome trend for the credit markets based on spreads of credit default swaps following some recent transaction announcements. Widening spreads reflect investor fears that an increase in M&A activity could lead to worsening creditworthiness because of debt taken on to finance the deals.
Comcast's CDS traded at 107 basis points before it was reported that it might acquire NBC Universal at the end of September. They are now trading at 130 basis points. Spreads on Xerox's CDS moved from 159 basis points before its announced acquisition of Affiliated Computer Services to 170 basis points at present. Kraft's CDS also widened after it announced its offer to acquire Cadbury, from 33 basis points to 77 basis points.
"Notably, several of these transactions have the potential to be ratings events depending on final terms - as evidenced by the magnitude of spread widening following the announcements," Meli wrote. "That said, we do not believe the implication for the overall credit markets is decisively negative."
The analyst explained that deal-making activity is unlikely to come close to the frenzy that that characterized the previous M&A boom. Instead, acquisitions will be smaller and limited largely to companies with solid credit ratings, he wrote. Also, Meli expects buyers to use more stock to finance deals and to approach them strategically, meaning they will pay smaller premiums for assets than did the private equity buyers that dominated the last M&A boom.
"Most acquirers will have a lower tolerance for risk/leverage, cheaper access to financing, and potential investments trading at lower purchase prices versus a few years ago," Meli concluded. "In summary, we think the bulk of the opportunities will be idiosyncratic and the overall impact on credit markets will be modest over coming quarters."
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