September 23, 2009
Never before have US companies piled up cash faster compared with interest costs than they are now, setting the stage for a surge in mergers and acquisitions.
As the economy emerges from the worst recession in 70 years, cash flow may rise from the $1.5 trillion reported by the Commerce Department for the year ended in June, according to data compiled by Credit Suisse Group AG and Bloomberg.
The amount reached a record in the past 12 months amid the biggest wave of firings since World War II and central bank interest rates near zero percent.
Cash relative to share prices will climb to the highest in at least two decades next year compared with yields on corporate bonds, the data show. The previous high in 2005 preceded the two busiest years ever for takeovers.
"You'll see a steady return to growth in the M&A market," said Michael Boublik, the chairman of mergers and acquisitions for the Americas at New York-based Morgan Stanley.
"Investors are wanting and demanding that companies start thinking about M&A to fuel growth, so therefore deals are being well accepted."
Takeover bids by companies from Walt Disney Co to Kraft Foods Inc signal increasing confidence among executives that may extend the 58 percent rally in the Standard & Poor's 500 Index from a 12-year low on March 9. A record amount of mergers helped send the benchmark gauge to its October 2007 high.
Selling bonds
US companies posted annualized cash flow of more than $1.5 trillion in each of the last three quarters, the most on record, Commerce Department data starting in 1947 show.
With expenses shrinking, the money makes US corporations more attractive to buyers who plan to sell bonds to pay for takeovers, Credit Suisse strategists led by London-based Andrew Garthwaite wrote in a report on Sept 11. Pay to non-government workers has fallen for three straight quarters, dropping 6.6 percent to $5 trillion in the April-to-June period from a year earlier, Commerce Department data show.
Yields on corporate bonds are 0.8 percentage point more than the estimated free-cash-flow yield, or income left over after capital expenses, divided by stock-market value, for US companies in MSCI indexes, data compiled by Zurich-based Credit Suisse and Bloomberg show.
Mergers climbed at least 13 percent in the four years from 1990 until the credit crisis when the gap between rates on corporate bonds and free cash flow was less than 2 percentage points.
Biggest years
Rising cash levels in 2005 preceded the two biggest years in US deals, Bloomberg data show. Takeovers jumped 32 percent in 2006 to $1.74 trillion and 13 percent in 2007 to $1.97 trillion, the data show.
"People are going to realize how resilient cash flows have been in a bad recession," said Russell Napier, Edinburgh-based strategist at CLSA. "Buyers usually have to finance some kind of debt and cash flow is king. We are not going back to the silly days where anyone could raise billion-dollar deals but we are going to see M&A. For businesses with strong balance sheets, this is a great time to buy."
The cash levels also provide a margin of safety for companies should the highest unemployment rate in 26 years and lower consumer spending drag the economy back into a recession, said Richard Weiss, who oversees about $50 billion as chief investment officer at City National Bank in Beverly Hills, California.
US consumer credit plunged by a record $21.6 billion in July, according to a Federal Reserve report released this month, as banks restricted lending and job losses made Americans reluctant to borrow.
Futures on the S&P 500 lost 0.2 percent to 1,059.10 as of 12:36 am in New York. The measure has rallied in the past two weeks to close at 1,068.30 on Sept 18.
Companies in the gauge have hoarded cash to weather a two- year slump in earnings, the longest since the Great Depression. Share buybacks by US corporations fell to the lowest level in the second quarter since at least 1998, New York-based S&P said last week, as the recession reduced earnings.
Profits for companies in the index will probably fall 22 percent in the current quarter before growing 62 percent in the final three months of the year, according to the average estimate of analysts surveyed by Bloomberg.
"Making acquisitions now makes more sense than it would have done six months ago," said Bo Nordberg, a merger analyst at GFI in London. "But a big caveat is if this rally is not a fundamentally driven rally and we see a pullback, then CEOs don't want to be seen as having offered too high a price."
Executives will have to rely less on cutting costs to make acquisitions work. The US unemployment rate climbed to 9.7 percent last month, bringing the number of Americans thrown out of work since the recession began in December 2007 to 6.9 million, the most in any post-World War II contraction, data compiled by Bloomberg show.
From the start of the decade until the onset of the contraction, the jobless rate averaged 5 percent.