Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Dealmaking in 2016 hasn't had last year's gusto, and that's probably no bad thing.

In the years between the financial crisis and the M&A rush that started in 2014, companies cautiously hoarded tremendous amounts of cash. When CEOs were confident enough to start spending it (instead of earning practically nothing in bank accounts), we had a deal boom.

But while the conservatism of the post-2008 years wasn't ideal, the sudden swing to a frenzied deal chase has hardly been more reassuring. Indeed, it seems that Corporate America still doesn't understand moderation.

Chugging Along
Merger activity isn't slowing down -- it's normalizing. Last year's record pace was unsustainable in the long run, especially given all the debt companies are now left to contend with.
Source: Bloomberg
M&A transactions only. Excludes terminated offers.

This is highlighted by some troubling new research from S&P Global Ratings (which settled last year with the Justice Department over its own part in the crisis). It shows U.S. non-financial corporations rated by S&P have a decade-low ratio of cash to debt, if you strip out the contribution from the top-25 companies. It's important to exclude that group, because it includes cash-rich giants such as Apple and Google, who distort the numbers.

Lopsided
Strong balance sheets at the top 25 companies rated by S&P "mask" a low cash-to-debt ratio for the rest, the agency said. Below are the totals, but note that it's even more pronounced upon excluding that top 1%.
Source: S&P Global Ratings
Nonfinancial corporations only.

Even more alarming, in 2015 the total debt outstanding for all U.S. corporations -- including that elite 1 percent -- climbed about 50 times faster than cash did. Fifty.

It's the latest evidence that the takeover binge is making companies less robust financially. I've pointed out before that amid skyrocketing M&A valuations, goodwill is also surging to unforeseen levels. A high amount of goodwill after an acquisition can be a sign that the buyer overpaid and may end up taking a writedown at some point. And while the torrent of deals has eased this year, acquirers are paying equally heady prices.

Of course, mounting debt isn't due entirely to recent deal activity, but that's no more consoling. Risky energy companies exposed by cheap oil were at the center of the latest junk-bond selloff. And defaults have spread beyond commodities to retailers, for example, which are struggling to remain relevant to today's shoppers. Some distressed retail chains are being toppled by debt stemming from leveraged buyouts they were subject to years ago.

S&P says the "pronounced imbalance" between cash and debt raises the likelihood of defaults over the next few years. The most vulnerable are obviously speculative-grade issuers, which doesn't describe most of the biggest acquirers out there. Then again, few predicted Valeant's downward spiral. 

Valeant became "a symbol of an easy-money era that spurred trillions of dollars of corporate borrowing," Gadfly's Lisa Abramowicz and Max Nisen wrote in February. Serial acquisitions, more ambitious each time, took it from a little-known drugmaker to one with an almost $90 billion market value last August, well on its way to a goal of hitting $150 billion and joining the ranks of pharmaceutical giants like Pfizer and Merck. That was until a series of controversies tied to Valeant's dealmaking left it valued at only $9 billion -- and it now owes lenders more than triple that.

We don't want any more Valeants. But the leaders of many large corporations have faced intense pressure to drive investor returns even though organic growth is scarce. In many cases, they've turned to M&A. Some deals have been smart, some not. Shareholder activism focused on short-term gains (and low borrowing rates) is partly to blame for the debt indulgence.

So if dealmakers are taking a breather, good. We might be due one.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net