Deals

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

M&A wasn't going completely gangbusters even before Brexit threw the world order a curve ball -- but unless you're a banker, that's not such a bad thing. 

A report out of Goldman Sachs's equity research department Wednesday said there's increasing risk that the M&A cycle has already peaked, and so the analysts downgraded most of the boutique banks they cover to a "neutral" rating.  These stocks, which include the likes of Lazard and Moelis, had already staged a massive selloff post-Brexit because market volatility is one of the biggest threats to their line of business.

Boutiques Get Brexited
The boutique advisory firms -- many of which went public just before the merger boom -- have each lost at least 15% this year. They rely on M&A underwriting fees moreso than the big, diversified banks.
Source: Bloomberg

But as the saying goes, everything is different and nothing has changed. Uncertainty, the enemy of dealmaking, is certainly ubiquitous right now. Britain's decision last week to leave the European Union stunned financial markets. We're also in the middle of an incredibly divisive and bitter U.S. presidential race. Regulators are pushing back hard on some big corporate tie-ups, while investors have turned their backs on junk issuers and a burst of acquisitiveness by Chinese suitors has so far failed to result in many done deals. All that being said, acquisitions are still the only way most major companies can grow these days, and for those that can borrow, money remains cheap. Plus, thanks to Brexit, the U.S. dollar is becoming a stronger currency for cross-border dealmaking.

Buying Growth
As long as organic growth remains slow and interests rates low, CEOs will continue to pursue M&A. It just might not be at the frenzied pace we saw in 2015.
Source: Bloomberg
Forecasts provided by economists in the private sector

Takeovers announced in the first half of this year totaled $1.32 trillion, which is no small number, relatively speaking. But it's also well short of the pace needed to reach last year's record. In fact, 2016 might not even live up to 2014, which was the early innings of the global merger spree. 

Peak M&A
The deal craze just wasn't sustainable.
Source: Bloomberg

But let's face it, we were due for a pause. Companies and their shareholders need to digest all these transactions, which were larger and more expensive than ever, and separate the smart deals from the ones mainly in the interests of persuasive fee-hungry bankers. Goodwill and debt is piling up on companies' balance sheets, and that could be a cause for concern but few are talking about this. S&P Global Ratings rang the alarm in a May report that said the "pronounced imbalance" between cash and debt held by U.S. companies is raising the likelihood of defaults. As it is, one of the ugliest, debt-heavy deals of the year -- a merger between oil pipeline giants Energy Transfer Equity and Williams Co. -- finally ended this week despite Williams's desperate plea to not get dumped by its suitor.

M&A Hangover
Below shows just how leveraged U.S. non-financial corporations have become. S&P Global Ratings says that if you ignore the top-25 cash-rich issuers like Apple, then the ratio of cash to debt is at a decade low.
Source: S&P Global Ratings

Even with slowing deal demand and mounting debt, takeover valuations for U.S. targets remain at a record. For a while, investors were so enthused to see companies with anemic growth prospects being proactive dealmakers that acquirers' share prices surged on deal announcements. Little fuss was made over how much they were actually paying for these deals -- there always seemed to be some pretty synergies estimate as a justification. But as the tone turns more cautious, we'll probably start to see valuations come down. The median Ebitda multiple for U.S. targets this year is more than 15. That is to say, buyers are essentially paying for more than 15 years worth of Ebitda, a tremendous markup.

Elevated Prices
Even though deal activity has returned to less frenzied levels, acquirers are still paying rich prices. Too rich? We'll find out in a couple of years if writedowns start to occur.
Source: Bloomberg
U.S. targets only. Based on company financials for the 12 months preceding the deal.

So Goldman's right to call a top in the M&A cycle, but we also knew the mega-deal mania was never sustainable. And much data point to why it shouldn't be anyways.

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

  1. The analysts kept a "buy" rating on Evercore Partners. Its earnings are "more achievable than most" because the advisory firm still looks to be busy this year, they wrote.

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

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net