Wednesday, April 30th, 2014

Premium Valuation

We make no secret of the fact that we have been concerned about the possibility of a general correction in equity markets for at least the last two months. Many of our clients have not shared these concerns, or have found them too exaggerated. Their arguments can be summarised along the lines of (1) sustained and sustainable economic recovery, (2) accommodative monetary policy, (3) reasonable valuations and (4) no obvious crisis. Recently we have noticed a tendency to add in a fifth reason for markets to go higher: a surge in M&A activity.

Like everyone else we see the headlines that announced global M&A deals are already past the $1 trillion mark, the earliest this has happened in a year since 2007. Investment bankers are busy again. The hostile bid by Pfizer for AstraZeneca is the biggest, but by no means the only large deal announced this year. So will the surge in M&A activity be enough to prevent equity markets from suffering a significant correction?

In the end this is a question of numbers. A month ago, before news of the bid approach leaked out, AstraZeneca was the 11th largest company in the FTSE100. As of Monday it is now 7th having gone up by 18% as the approach was confirmed. This obviously good news for their shareholders and it had a positive effect on the index, accounting for 32% of the net increase over the last month. The trouble is that the net increase is only 1.5% and without the approach the index would have been up 1.0% instead. As it stands, the bid for AstraZeneca is simply not enough to move the dial for the market as a whole. We expect Pfizer will be forced to increase its offer at least once, but even if they double the premium on offer, this will only add 1% to the value of the FTSE100. To make a material difference to the outlook for the UK market we would need at least two or three more deals of this size and premium i.e. bids for Vodafone, Barclays and BG Group all at the same time. Not many people would commit to that story.

So far we have concentrated on the UK market, because that it where the headlines have been generated. If we look at the US, the biggest gainer in the S&P100 over the last month is Andarko Petroleum, up 17% following the settlement of environmental litigation for less than the most pessimistic estimates. The biggest contributor to the performance of the index is Apple which announced a $30bn share buyback scheme. Both of these events are significant and good news for investors, but they cannot be characterised as part of a surge in M&A activity. In the Eurozone, the situation regarding M&A activity is more complicated. The big deal, Lafarge / Holcim, is structured as a share-swap, not a cash deal, and will not complete in 2014. The hot news is the approach for Alstom, which has a big reputation but which isn’t actually in the Eurostoxx 50. In other words it simply isn’t big enough.

So yes, there is an increase in M&A, but so far there are enough large cash offers to stop the markets from falling, if that is how they are inclined.

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