Soaring M&A Activity is a Recession Indicator

Daniel Shainberg

September 24, 2018

A flurry of mega-deals were announced recently including the love affair in the health insurance and pharmacy benefits management sectors, the media tie ups and the continued trend of no-growth consumer staples businesses acquiring each other with cheap debt financing to extract synergies given the absence of organic growth opportunities.

But soaring M&A activity is a strong recession indicator. It is a classic sign hinting at the lack of organic sales growth options. When interest rates are too low for too long corporate executives expect their special "access to credit" pass to always remain available. But unlike the debt they assume to finance deal activity, refinancing markets can change in an instant, the cash flows of the acquired companies can evaporate, and the capacity to fund the interest expense associated with the newly assumed debt grows impossibly burdensome. And that spells the end of the credit boom. This story has played out like clockwork over the past few decades. Rinse... Wash... Repeat. 

In the 1980's we saw record deal activity signal the end of the "greed is good" era with the excessively leveraged $25 billion buyout of RJR Nabisco. 

In the dot-com boom you saw real companies like Yahoo acquire Mark Cuban's web idea Broadcast.com despite not having any realistic possibility of generating cash flows in a reasonable time frame. Don't forget the blockbuster mega-deal tie-up between AOL and Time Warner which closed with champagne popping in the board room, but the party ended only a few months later with a 70% evaporation of equity value.

And now we have seen over a dozen mega-deals, many at extraordinary valuations, but justified by the acquiring management teams as their financial wizards model projected synergies and perpetually stable growth to justify the potential for deal accretion to their shareholders. We even saw the audacity of an $80 billion leveraged management buyout of a company that never generated any cash flow as Elon Musk's laughable tweet did nothing more than give some government regulators something to do. 

In the real world economic cycles occur and punish the follies of aggressive buyouts at market peaks. Cash flows decline, maturing debt fails to rollover in a stressed financing environment and targeted synergies disintegrate. 

It is human nature to expect trends to continue forever. That's why we wrote this article on last decade's recession. No two recessions are exactly alike but history does have a rhythm and certainly repeats itself with regards to economic cycles.

Dan Shainberg
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#RecessionResister
@DanShainberg