Why the M&A Boom May Continue

WSJ Deal Journal, July 19, 2007, 11:31 am
Posted by Dana Cimilluca
M&A partiers may get their curfews extended.
Deal Journal popped over to the downtown Manhattan offices of Thomson Financial this morning to hear presentations from a couple of its analysts, Matthew Toole and Robert Keiser, on the state of the red hot mergers-and-acquisitions and private-equity markets. We heard some strong evidence for why all may not be doom and gloom for deal makers.

Exhibit A is the relationship between M&A activity and GDP growth. According to Keiser, a vice president in Thomson’s Proprietary Research group, there is a 67% correlation between the two going back to 1990. Though the economy may be slowing a bit, it’s still growing at a healthy clip of roughly 3%. Additionally, M&A accounts for just 4% of GDP now, down from 7% in 1999, at the height of the Internet bubble, Thomson says. That suggests there might be further room for growth.

Exhibit B is cash. Fourteen straight quarters of earnings increases “has put a tremendous amount of cash on the balance sheets of S&P 500 companies,” says Keiser. Companies have nearly $3 trillion of cash, even after all the increased spending on share buybacks and the like, up from just $500 billion in 1994. Even if tighter credit markets slow down private-equity takeovers, corporations, which still account for most M&A activity, could pick up the slack using all that coin.

Exhibit C is stock prices. Although stocks have been on a tear the past few years, the average expected earnings multiple on the S&P 500 is still just about 15 times, in line with the 20-year average. Since M&A tends to move in lockstep with stock prices, the idea that stocks aren’t overvalued may mean that M&A volume isn’t on the verge of falling off a cliff either.