Much has been written about the recent acceleration in global M&A (Mergers & Acquisitions) activity. The $1.4trn worth of deals announced globally year to date is 75% higher than 2017 and the strongest first four months of any year on record according to Dealogic.
Accelerating M&A is often cited as a late cycle indicator although Citigroup argue this year’s pace is not yet a sell signal for equities, given it is well below previous cycle peaks when considered as a percentage of equity market capitalisation.
Nonetheless, as credit investors increased M&A gives us considerable pause for thought. Despite the recent increase in global rates, companies can still take advantage of historically cheap debt funding to help finance acquisitions through increased corporate leverage. Indeed, the frequency of large, M&A-related debt issuance has increased in recent years (see chart 1).
Chart 1: Large debt issuance deals ($5bn or higher) which includes acquisitions among the use of proceeds
Source: Dealogic, Goldman Sachs Global Investment Research
Such issuance can create headwinds for performance at both the issuer and sector level. However, it can also create opportunity. Empirical analysis by Goldman Sachs suggests the evidence supports a “sell the rumour, buy the news” pattern.
Here at Kames we adopt a similar strategy in trying to avoid issuers and sectors, such as pharmaceuticals, where we see the risk of leverage increasing via M&A as high, and where current valuations do not compensate for the risk. Instead we seek to invest “post-transaction” in newly issued bonds used to help finance an acquisition, when management are able to provide clarity around the trajectory of balance sheet metrics. It is our approach to bottom-up analysis and active investing that helps us navigate the idiosyncrasies of M&A and increase returns for our clients.