US Economy

More Mergers!

By, 02/01/2008

Story Highlights:

  • Blockbuster mergers returned to headlines today with Microsoft's $45 billion offer to buy Yahoo!
  • Mergers and share buyback activity are bullish for stock prices and continue at a fast clip, contrary to popular conception.
  • Conditions for big companies to carry on with acquisitions and share buybacks today are even better than a year ago.


There were two big stories making headlines today:

Job Shock: U.S. Lost 17,000 in January
Chris Isidore,

We quote: "There was a net loss of 17,000 jobs in the month, according to the Labor Department reading. That was partly balanced by a sharp revision higher for the December reading to a gain of 82,000 jobs from the original reading of only an 18,000 increase."

Put another way, this isn't a big deal. A net loss of 17K relative to a job force in the hundreds of millions just doesn't matter much. Also, the unemployment rate actually dropped to 4.9%. We've discussed the media's often apoplectic analysis of unemployment numbers in the past:

US Economy: Employment Drizzle (1/4/2008){5835DB25-E289-4367-B772-E5BBCD256E9E}&sectionID=%5ccommentary%5cdaily

The second dominant financial headline today was far more interesting:

(Editor's Note: MarketMinder does NOT recommend individual securities; the below are simply examples of broader themes we wish to highlight.)

Microsoft Offers to Buy Yahoo for $44.6 Billion
By Ari Levy and Dina Bass

Whoa! Where did this come from? Isn't this the time of financial dire straits, where companies batten down the hatches and weather the economic storm? Apparently not.

Merger and share buyback activity posted another record year in 2007—and buybacks actually accelerated in the second half of the year. Media commentary and conventional wisdom center largely on the notion acquisitions and share buybacks are somehow evil and perilous. This is measurably and demonstrably false throughout market history. Just the opposite is true.

Mergers and share buybacks are a bullish driver for stocks because they decrease overall equity supply. Holding demand constant, shrinking equity supply should bolster prices. This highly bullish phenomenon began a few years ago, and is likely to continue into 2008.

Earnings yields (the inverse of the P/E ratio, or E/P) remain well above comparable bond yields. This historically rare environment is highly advantageous for companies wishing to borrow cheaply and execute share buybacks or acquisitions—both of which can boost corporate earnings and bolster stock prices.

While 2008's acquisition and share buyback activity may or may not exceed 2007, fundamentals remain intact for another big year. As yields on riskier forms of debt such as junk bonds rose in the second half of 2007, many declared an end to the wave of big private equity deals (which largely finance their transactions with this type of debt). That is true. It's certainly more difficult for the private equity shops to borrow and acquire companies today.

But this view misses the larger picture. For one thing, private equity and high yield debt is a relatively small component of overall corporate borrowing. Additionally, hordes of large cap companies have corporate balance sheets flush with cash waiting to be deployed. Even better, the biggest companies by market cap (the ones most likely to make big acquisitions) have the best credit ratings. That's important because the cost of investment grade debt today is plentiful and cheaper now than a year ago. The sum of plentiful liquidity and overflowing cash coffers creates a highly fertile environment for strategic acquisitions and share buybacks. Hence:

Here Comes Merger Mania!
By Paul R. La Monica,

Maybe there will be more headline-making blockbuster mergers in the months ahead, maybe not. But expect the overall level of equity supply destruction to continue robustly through 2008. That's bullish.

Have a great weekend.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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