Investors are always chasing opportunities, but the recent stock market rally has them going to extremes.
With corporations and private equity firms on a buying spree this year, investors seem reluctant to sell shares of companies they think might be purchased next. That has put a floor under share prices and helped ignite a record-setting surge for stocks this year.
It’s hard to miss all the merger and acquisition news. Almost every week there is a fresh batch of super-sized deals that are bigger than the last. Big companies are buying smaller companies, buyout firms are taking public companies private and companies are uniting to expand the reach of their businesses.
Driving the activity is the surplus of cash held by private equity firms and public companies. At the same time, interest rates remain close to historic lows and banks are eager to provide generous financing.
The total value of announced acquisitions worldwide has reached a record $3.52 trillion for the year, exceeding the previous record $3.33 trillion for announced deals set in 2000, according to Dealogic.
Just last week, one of the biggest leveraged buyout deals ever came when The Blackstone Group, a private-equity firm, agreed to buy Equity Office Properties Trust, the nation’s largest publicly traded office-building owner and manager, for $19 billion.
Other notable recent deals include US Airways Group Inc.’s $8.8 billion hostile bid to take over Delta Air Lines Inc., Freeport-McMoRan Copper & Gold Inc.’s acquisition of Phelps Dodge Corp. for $25.9 billion that would create the largest publicly traded copper company, and brokerage and financial services firm Charles Schwab Corp.’s sale of its wealth-management subsidiary U.S. Trust to Bank of America Corp. for $3.3 billion.
As the dealmaking has ramped up, the stock market has risen to levels not anticipated by most market-watchers earlier this year. The Dow Jones industrial average has soared above 12,000 to record highs in recent months, while the Standard & Poor’s 500 index has vaulted to levels not seen in six years.
The surge is due in part to investors counting on more dealmaking to come — and hoping that their company might be the next target. The average premium paid over market prices for shares of companies being bought this year is 17 percent, according to Thomson Financial.
“If you are not invested, you can’t get part of the action,” said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors in Albany, N.Y. “When you see all this merger activity going on, it increases your confidence in stocks.”
Even hedge funds are playing this market differently, which is helping boost stocks overall. One of their often-used trading strategies is to “short” stocks, meaning they borrow securities and sell them with the hope that prices will then fall in value so they can profitably buy back shares at the lower prices.
But that strategy doesn’t work when stocks are rising. As a result, many investors have scaled back their short positions, which is evident by the steep decline in short S&P 500 contracts from around 78,000 in July to about 34,300 now, according to Merrill Lynch.
All over Wall Street, analysts are screening for stocks that could be potential acquisition targets and trotting them out to clients. Often cited attributes include big cash balances, low growth potential and an older executive team with big equity stakes who might be willing to cash out.
The worry, of course, is whether the pace of such dealmaking can go on — and what a slowdown could do to the stock market.
S&P’s chief investment strategist Sam Stovall thinks all the cash on corporate books — $615 billion for S&P 500 companies alone, more than double what was seen 1999 — and cheap financing will prop up the buyout bonanza for a while.
He also thinks the acquisitions are a sign that corporate managers see their stock prices as undervalued, despite the recent run-up in the market. Typically, when companies use cash and debt to finance deals — as they are doing now — that implies executives don’t want to use their stock to fund deals because they see bigger price gains ahead.
Of course, this party won’t last forever, and when it ends, a rough hangover will follow. That’s just what happened after the 1990s dot-com boom and the late 1980s company-buyout binge.
For now, worries of a shakeout seem a world away to many investors.