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Why Companies Do M&A and Buyback Stocks at the Worst Times
Have you ever noticed that companies love to announce share buybacks when stocks are at record highs?
How about planned acquisitions at record prices like all of 2021?
It seems counterintuitive and counterproductive. But there’s a reason why this happens.
You see, companies pull off these deals through owned or borrowed cash.
And cash tends to come when business is booming, usually leading to higher stock prices.
Debt can be had at any point. However, companies tend to have less debt when they generate more cash.
As far as acquisitions, the cash discussion still holds true. However, when companies acquire another, they tend to do so to boost their growth prospects.
So, the companies they buy likely demonstrate exceptional growth and consequently cost more.
That might seem topsy turvy. But think about the other side of the coin.
If a company held onto cash to possibly buy back shares at lower prices at a future date, that wouldn’t give investors much confidence since management is signaling lower prices in the future.
Plus, wouldn’t it be prudent for management to acquire a company that proves itself rather than on the hopes that it might?
Mergers & Acquistions
The Era of M&A Continues
2021 was the year of acquisitions coming in at $945 billion by late November.
That breakneck pace is expected to continue in 2022.
A Record Year
At 2.5x the volume of deals in 2020, last year’s private equity purchases came in at more than double the peak of 2007.
Global mergers and acquisitions (M&A) smashed records with $5.8 trillion, up 64% from a year earlier and well above the previous record of $4.55 trillion set in 2007.
This comes as Special Purpose Acquisition Companies (SPACs) outpaced initial public offerings (IPOs), the more traditional way to go public, with $162 billion raised during 2021.
As 2021 trudged along, SPAC deals slowed down considerably. In fact, nearly half of the +600 SPAC deals occurred in Q1 of 2021 at 298 followed by 60, 89, and 166 listings in Q2, Q3, and Q4 respectively.
2022 isn’t looking friendly for SPACs. With heavy outflows from growth and speculative investments, investors are rotating money towards value plays.
Signs emerged in the last month of trouble in SPAC markets with 20 SPAC listing withdrawals in January, a jump from single digits in the prior two quarters.
The IPOX SPAC Index (SPAC), which tracks the aftermarket performance of US SPACs wilted over the last several months to its lowest levels since October, 2022.
On the flip side, M&A deals are heating up, especially in the IT world, where 340,000 openings remain unfilled as of last month.
Short on staff and struggling to acquire workers, companies are instead choosing to scoop up IT shops to fill the gap.
That said, two headwinds are likely to push more M&A deals to the front-half of the year in an effort to get ahead of the game.
First, regulators are ramping up scrutiny of deals. Washington policymakers have been signaling plans to apply more scrutiny, though nothing definitive has come out yet.
More importantly, we’ve seen antitrust has become the word of the day, with agencies focusing on big-tech, digital platforms, as well as the burgeoning crypto markets.
Second, higher interest rates increase the cost to borrow capital to pay for transactions. That won’t stop companies with large warchests, but it will hamper some of those massive buyouts we’ve seen proposed.
The Bottom Line: We expect M&A activity to remain above historical averages but well below last year’s levels, tapering off as time marches forward.
That may hurt the bottom line of companies like Goldman Sachs (GS) and JP Morgan (JPM) who thrive on M&A activity.
SPAC stocks like SoFi (SOFI), BarkBox (BARK), and the like aren’t great stocks to bottom fish while rates continue to rise.
Eventually, they may be worth a look, but it will be years down the road.
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