The air is rife with merger news. Southwest Airlines is bidding for Air Tran, Walmart is planning to buy Massmart Holdings of South Africa and Unilever just sealed a deal to acquire Alberto Culver at a 19% premium to Friday’s closing price. It almost feels like the Go-Go Eighties, with the Wall Street Journal struggling to squeeze all the deal news on its front page. The big difference is, this merger fest probably won’t result in higher stock prices.
In the Eighties, companies and corporate raiders embarked on acquisitions to unlock value, siphon cash from overfunded pensions, leverage the balance sheet of slow-growing companies and make other tactical moves to get a quick payback. Those possibilities soon had a wider effect on the markets because pension funds and other big investors began to consider anew all the hidden values that corporate raiders were capitalizing on. Share prices marched higher.
Mergers today are more about buying growth or consolidating within industries to adapt to lower demand. It’s strategic, and that means a long-term payoff. Unilever, for example, says it will now be the world’s largest maker of hair conditioner and a big heavyweight in some related markets. While that’s a mark of distinction that also brings extra heft to its production and distribution capabilities, it’s not necessarily a quick value creator because even as Unilever gets bigger in markets, competition (think Proctor & Gamble) remains intense.
Southwest Airlines, for its part, gets into the Atlanta market and also will gain some smaller markets. Investors liked the move and the shares of both companies rose in Monday trading, but there were also concerns that Southwest could use this acquisition to add capacity as it enters new markets. In other words, many investors are doubtful about the long-term prospects for airlines–there are just too many planes flying. Finally, Walmart’s bid for South African retailer Massmart, if successful, will give it a competitive edge over other global retailers; it also further broadens its footprint outside the slow-growing U.S. market. But, again, it’s all about buying growth or fortifying market positions.
So here we are with mergers heating up as companies scramble for growth, not bad but neither is it bullish outside of the fact that mergers could shrink the total number of shares outstanding .
You might be surprised to hear that managers are needing growth because corporate earnings are coming in surprisingly strong. That nice surprise, notes Merrill Lynch chief strategist David Bianco, results largely from foreign sales and the fact that U.S. companies have cut costs so dramatically that their operating leverage, i.e., ability to make big profit gains on just a small pickup in sales, is now impressive. “Companies cut back employees, inventories, and capacity during the recession and have been very slow to bring it back,” he notes. Bianco thinks the investment community, which is forecasting 3rd quarter earnings to come in below 2nd quarter earnings, may be proved wrong . “Reads from pre-season [earnings reports] suggest a strong 3Q earnings season with a good likelihood of 3Q earnings per share coming in close or ahead of 2Q,” he writes in a new report. That’s pretty good news if it happens, but it remains to be seen how U.S. companies will keep growing through 2011 if U.S private demand doesn’t perk up.
So if you’re betting this stock market rally will persist, watch the earnings reports and the economic reports, not the merger news. Investment bankers, of course, should follow the money.