Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Economic Dark Darkside of the M&A Boom

Economics / Mergers & Acquisitions Aug 31, 2010 - 05:20 AM GMT

By: Money_Morning

Economics

Best Financial Markets Analysis ArticleMartin Hutchinson writes: With its $39 billion hostile bid for Canada's Potash Corp. (NYSE: POT), mining giant BHP Billiton Ltd. (NYSE ADR: BHP) capped an active August in the mergers-and-acquisitions market.

With the moribund growth prospects of the U.S. economy, there would seem to be no great urgency for companies to go on an M&A spree, yet the total value of announced buyout deals for August alone has topped $175 billion.


Cynics are reaching only one conclusion: With interest rates so low and corporations so cash-rich, it seems that company management teams would rather do anything with that cash than to give it back to shareholders via stock buybacks or boosted dividends.

And those deals signal additional trouble ahead for the U.S. economy.

Corporate America: The New Cash Cow

There's certainly plenty of cash available to keep fueling this deal boom. According to Moody's Investors Service (NYSE: MCO) U.S. non-financial corporations are currently sitting on $1.84 trillion in cash. When measured as a percentage of total corporate assets, that's Corporate America's biggest cash hoard in 50 years.

And that cache of cash doesn"t end there: Hedge funds hold an additional $450 billion in cash, which can also be brought to bear in M&A deals. With bond-market conditions also currently favorable and interest rates at 50-year lows, it's thus not surprising that top Corporate America execs are indulging their wildest empire-building fantasies.

U.S. CEOs could, of course, be paying that money out to shareholders as dividends. As of Aug. 25, the dividend yield on the Standard and Poor's 500 Index was 2.09% -representing a 40% dividend-payout ratio on an S&P index that was trading at 19.38-times earnings.

While that's above the average of 32% payout ratio of the 2000s it's well below historical levels - the payout ratio in the Great Depression was greater than 90% and averaged more than 55% through the 1950s and 1960s. Given the huge amounts of cash that so many companies currently possess - as well as the relatively favorable tax treatment of dividends (individuals currently pay only 15% on dividend income) that's right now in place - U.S. public companies could easily pay out much more of their income in dividends than they presently are.

As shareholders, we should demand higher dividend payouts. Historically, dividends have represented about half the return on the S&P 500 Index. Dividends alone provided U.S. shareholders with a total uncompounded return of 61% in the 1980s and 43% in the 1990s.

The 2000s, by comparison, were pathetic: Dividends provided a total return of only 16%, not enough to make the overall return positive. Given that companies have accumulated record levels of cash (as well as making innumerable fatuous takeovers), we investors should feel shortchanged.

The Dealmaking Payoff

A number of factors have caused this change in management behavior.

First and foremost, monetary policy has been very loose since 1995. So there's always been lots of liquidity sloshing around the global financial system, making mergers easy to finance.

Modern financial theory has held that a company should concern itself mostly with the tax consequences of its balance sheet. This meant that earlier concepts of balance-sheet 'soundness" were irrelevant and that cash dividends should be of less interest to investors than the fluctuations in the company's stock price. Top managers have increasingly been rewarded with stock options, and as a result have come to view dividends as unattractive, since those payouts take cash out of the company - reducing the value of the shares (besides, option-holders themselves don"t reap the benefit of dividends).

These have all been factors. However, the most important factors leading to merger activity have arisen from the shift in the shareholder power base that we"ve seen. It was once true that large individual shareholders exercised direct control over a company's management.

But that's now a relatively rare situation: The top shareholders are now largely institutional in nature. And rather than waste time sparring with a corporate management team whose policies or strategies it doesn"t like or agree with, an institutional investor will be all too willing to simply "dump" its shares.

All of these changes have induced corporate leaders to treat companies as their own private piggy banks, paying themselves ever-larger salaries and bonuses and being relatively unconcerned about shareholder value - except as something to which they pay lip service.

Most important, managers get rewarded based on the size of their empires. This elevates the importance of the M&A deal: Acquisitions, which increase the size of the empire being managed, become all the more alluring to a CEO who is looking to increase the span of the company he controls.

Merger-and-acquisition deals have the additional advantage of allowing frequent restatements of earnings and other financial accounts, meaning it's easier for managers to hide losses or other financial problems without having to actually run them all the way through the income statement.

Some of these same issues make M&A deals attractive to the target ("acquiree") company. For instance, with the "golden-parachute" payouts and other payoffs that management teams receive as compensation when their firm is taken over, it's not surprising that the leaders of a firm that becomes a buyout candidate don"t fight too hard to preserve their company's independence. When Potash CEO Bill Doyle is due to receive a $445 million payoff when his company is sold, he will be less than ferocious in opposing the sale.

Thus, it is not surprising that corporate cash is useful to management primarily for acquisitions. If the shareholders are particularly quiescent, as in the Kraft Foods Inc. (NYSE: KFT) takeover of Cadbury PLC (NYSE ADR: CDSCY), the buying chief executive can be paid off with a $27 million premium for undergoing the nervous stress of arranging the deal, without waiting to see whether it actually provided any benefit to Kraft.

In that case even Warren Buffett, owning 9% of Kraft stock, was unable to prevent the acquisition, as Kraft's financially counterproductive aggression and its oodles of cheap money wiped out a 200-year-old British company.

Management behavior will only change when its incentives change, and that won"t happen until interest rates are much higher than they are today. In the meantime, the damage that foolish acquisitions will inflict on U.S. industry is immeasurable: Corporate America will slash employment, hold back on capital investment and - worst of all for the future - dial down research-and-development activities.

Editor's Note: Martin Hutchinson brings readers the global view that most financial columnists only wish they could provide.

Just look at some of his most recent global predictions. Earlier this year, just a week after Hutchinson recommended Germany, the European keystone reported much stronger-than-expected GDP. He recommended Chile back in December, and three of the stocks he highlighted have posted strong, double-digit returns - and one is up nearly 25%. He again recommended Korea - which analysts were downgrading - only to have the traditionally conservative International Monetary Fund (IMF) come out with an upgraded forecast that projects solid growth for that Asian Tiger for this year and next.

A longtime international merchant banker, Hutchinson has a nose for profits - as evidenced by his unerring ability to paint a picture of what's to come. He's able to show investors the big profit opportunities that are still over the horizon - while also warning us about the potentially ruinous pitfalls hidden just around the corner.

With his "Alpha Bulldog" investing strategy - the crux of his Permanent Wealth Investor advisory service - Hutchinson puts those global-investing instincts to good use. He's managed to combine dividends, gold and growth into a winning, but low-risk formula that has developed eye-popping returns for subscribers.

Take a moment to find out more about "Alpha-Bulldog" stocks and The Permanent Wealth Investor by just clicking here. You'll find the time well spent.]

Source : http://moneymorning.com/2010/08/31/mergers-and-acquisitions-2/

Money Morning/The Money Map Report

©2010 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in