Industrial giants Johnson Controls and Tyco are hoping to tie the knot, financially speaking. It’s the latest example of inversion, a type of merger-plus-relocation overseas.
It's also a big merger after a huge year for mergers and acquisitions in 2015. And that makes it a bit of an outlier. Historically, mergers and acquisitions follow a familiar pattern.
“There’s documented waves of M&A’s,” said David King, assistant professor of supply chain management at Iowa State. They surge and break records one year, the stock market crashes the next.
“It’s almost one to one,” he said, pointing out that 2000 was a record M&A year before the 2001 dot com boom. And 2007 was another record year before the economic catastrophe that unfolded in 2008. And 2015 was another boom year, and 2016 has for now gotten off to a dismal start in terms of markets.
After each bust in the markets, M&A’s retreat. In one sense it’s a peculiar trend. If beef is on sale at the grocery store, that beef should sell.
“One would think that sensible, smart M&A activity should be countercyclical to the market,” said the Tuck School’s Anant Sundaram. “You want to buy something low, not when it’s high!”
Not so, and there are several explanations.
“A lot of companies use company stock to buy companies, so their stock is also depressed,” said King. The company you want to buy might be cheap, but you might be poorer. If you need to borrow cash from a bank, in a bad market the bank will be skittish too.
There are a number of psychological reasons for dropoffs in mergers and acquisitions during bearish markets.
"How do you convince shareholders?” said Donna Hitscherich, senior lecturer at Columbia business school. Just because you see a bargain does not mean it is easy or even possible to extract a deal from reluctant shareholders; it’s difficult for anyone, shareholders included, to admit that their baby is now a bargain.
“It’s very hard to convince shareholders of a public company that in a short space of time the true intrinsic value of their stock has gone down as much as its gone down,” Hitscherich said.
One final reason to expect M&A’s to drop is that, it turns out, that in one way companies are like beef. Well, cows, really.
“There’s a lot of herd behavior,” said Sundaram. When nobody else is doing something, it’s scarier to do.
“Being wrong in a crowd is far less onerous than the cost of being wrong when you’re all by yourself,” he said. “So people seek out the comfort in a crowd.”
Now if history is a guide, companies will realize there are good deals to be made eventually.
“I think a weak economy is actually good news for M&A prospects,” said David Nelson, chief strategist at Belpointe Asset Management. There’s significant political pressure to make certain types of mergers, such as inversions, more difficult in the future, he added.
“A lot of large companies have lagging sales growth, and the easiest way to get around that hurdle is to buy another company — company A takes company B over and overnight your revenues go up, your synergies go up," he said.
After a time, the best deals will get snatched up, and the herd will move on to the next feeding frenzy.