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By Soyoung Kim and Olivia Oran
NEW YORK, April 14 After years of responding to
shareholder calls for stock buybacks and dividends, major
American companies are hearing a different demand from
investors: buy growth.
In a low-growth economy in which earnings gains have trailed
a run-up in share prices, investors are ready to endorse big
deals if that's what it takes to boost revenue and profits.
While stock price gains in the past year have made it
tougher to find cheap targets, it also means buying back shares
has become much more costly for companies. Using their own
expensive stock for deal making may reap companies more benefits
than repurchasing shares at what might be the top of the market,
some investors say.
About 72 percent of announcements of acquisitions worth $1
billion or more in value in the first quarter were followed by
gains in the stock prices of the buyers, up from 60 percent in
the previous quarter and compared with a seven-year average of
50 percent, Thomson Reuters data shows.
The trend has emboldened CEOs into striking large deals this
year and has contributed to a 52 percent jump in global deal
volumes to $756 billion in the first quarter, the best start for
deal making since 2007. While the recent pullback in prices of
some of the biggest gainers of 2013 may delay some deals, that
is largely seen as a temporary blip.
Buying growth through acquisitions - which often come with
job cuts and other cost reductions - may not be entirely good
news for a U.S. economy that is desperate for increased capital
spending to boost a low growth rate and employment. Many
companies are opting to buy an established entity with a proven
track record rather than investing in developing their existing
businesses at a time when demand from consumers and businesses
is still stuttering.
"We've had a long period after the recession where companies
were afraid to invest their capital, and money was going into
buybacks and dividends," said Lew Piantedosi, portfolio manager
at Boston asset management firm Eaton Vance Corp.
"That's all good, but ultimately you want to see companies
invest in their business," Piantedosi said.
Shareholders have historically pushed stocks lower when
companies announce a takeover, because buyers have to offer a
substantial premium to make a deal worthwhile for sellers and
can easily be tempted to overpay. Taking on additional debt to
fund a purchase can weigh on credit ratings, and some of the
largest deals in the past 20 years have failed, leaving plenty
of wreckage and hurting shareholders.
Some investors say they're prepared to swallow deal risks,
though, provided that an acquisition has clear strategic
benefits, such as consolidating a fragmented industry and
generating significant cost savings.
"Companies cut down costs and tried to become more
profitable, yet revenue growth rates haven't really changed so
companies should be doing more than just stock buybacks, which
don't change revenue," said Mike Obuchowski, chief investment
officer at Boston-based Merlin Asset Management. "One of the
ways to do this is through acquisitions," he said.
STOCK DEALS RISE
Among examples of buyers' stocks gaining after deals,
drugmaker Actavis PLC saw its shares jump 8 percent in
February when it announced a $25 billion acquisition of Forest
Laboratories Inc, while shares of construction materials
producer Martin Marietta Materials rose 6 percent after
announcing in January its $2 billion takeover of rival Texas
To be sure, shareholders are not endorsing all deals at any
Facebook Inc shares came under pressure after the
social network giant announced two deals in a span of just a few
weeks, both of which raised eyebrows for their lofty price tags
- the $19 billion takeover of messaging service WhatsApp and the
$2 billion deal for virtual-reality startup Oculus VR.
Facebook stock is down 14 percent since Feb. 19 when the
WhatsApp deal was announced, as tech and biotech investors have
been hammering down the shares of companies whose valuations had
soared to levels that may not be supported by their earnings
Another to suffer a share price reversal was specialty
drugmaker Mallinckrodt Plc, which dropped as much as 10
percent on April 7 when it announced a $5.6 billion deal for
Questcor Pharmaceuticals Inc, a rival hit by regulatory
inquiries into its marketing practices.
Analysts said much of the deal's allure is in financial
engineering - it is the latest in a series of transactions
structured to take advantage of Ireland's low corporate tax
rate, and the problems Mallinckrodt is taking on may outweigh
any tax savings.
"Companies have to prove to the investors they are growing
their business as opposed to making accounting changes that make
them look better," Obuchowski said.
Not only does the company being acquired need to be the
right target, but the price paid can't be too heady, investors
say. Bidding wars are not encouraged.
So far this year, acquirers have remained relatively
disciplined, with premiums paid to target companies averaging
25.8 percent over their average share prices in the four weeks
before the deal became public, down from premiums of 27.7
percent last year and more than 30 percent in the prior two
years, according to Thomson Reuters data.
In addition, investors say they are comfortable with recent
deals because companies are either deploying a portion of their
huge cash piles or using their own appreciated stock as
currency, rather than relying largely on borrowing.
In the United States, 45 percent of all deals have had a
stock component so far this year, including Comcast Corp's
all-stock acquisition of Time Warner Cable Inc
for $45 billion, the year's largest deal. That is up from 17.7
percent for all of 2013 and the highest since 2001.
"Using stock as a currency for M&A, I think that's the right
way to do it right now. What is a danger sign is when they're
using balance sheet leverage," said James Swanson, chief
investment strategist at Boston-based MFS Investment Management.
"I think this cycle could go longer because corporate America is
not on a borrowing binge," he added.
DEBATE OVER BUYBACKS
In the years after the 2008-2009 financial crisis, many
companies used excess cash first to pay down debt and then keep
shareholders sweet with dividends and share buybacks. U.S.
companies spent $463 billion on buybacks last year, the most
since 2007 and compared with $131 billion in 2009 when companies
were focused on hoarding cash, Thomson Reuters data shows.
The rising payout to shareholders at the expense of capital
investment recently caught the attention of Larry Fink, chairman
and CEO of BlackRock Inc, the world's largest asset
"We certainly believe that returning cash to shareholders
should be part of a balanced capital strategy; however, when
done for the wrong reasons... it can jeopardize a company's
ability to generate sustainable long-term returns," Fink said in
a March 21 letter to S&P 500 companies.
Fink's letter was widely seen as a shot back at activist
investors, who have pressured companies to use cash or
borrowings to buy back shares or pay dividends to shareholders.
But it also underscores a growing consensus among investors
that companies may have done enough to clean up their balance
sheets, and now is the time to use the cash stockpiles for
"I think you're going to see more M&A activity because the
market is rewarding it," said Swanson at MFS Investment. "Now if
you ask me what they should do, I think they should invest in
capex, M&A activity isn't always the best way to go."
(Reporting by Soyoung Kim and Olivia Oran in New York,
additional reporting by Ross Kerber in Boston; Editing by Martin