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Betting on the return of M&A

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Last month, I wrote a piece in Institutional Investor making the case that M&A, which has been moribund since 2008, would rebound to levels at, or above, 2007. I'm no prognosticator. (Few are.) That piece was really a bet on two developments that seemed likely: First, that companies would eventually run out of the ability to boost share prices with stock buybacks and dividend increases and increase profits with cost-cutting and productivity gains; and second, when that happened, the major players in M&A - shareholders, boards, executives - would have to embrace counter-arguments to two pillars of M&A's current conventional wisdom: that the world was too uncertain to shoulder the risk of a big deal, and that most mergers - some say foolishly, all -- fail.

When would revival occur? I'm not dumb enough to pick a date. There are too many variables in something as complex, psychologically and economically, as M&A. And while I accept that M&A is a cyclical phenomenon - it feeds off market and economic cycles - the notion that you can fix their lengths seems more faith than fact-based.

Still, as 2013 ended, both trends showed signs of life. The stock market set records in December, and interest rates and inflation were so low fears of deflation again emerged, particularly in Europe. Profit growth was not keeping up with share prices; as a result, multiples were expanding, which couldn't last forever. The world, through the prism of a stock market goosed by quantitative easing, seemed more, well, normal, stable, even as the Fed announced plans to taper. And some of the fiercest foes of M&A began to soften: not just activist investors like Carl Icahn, but analysts and consultants. You heard less and less about how most deals fail. Life was risk. M&A began to loom as the only viable option to growth. And it was the end of the year: Time for many of the service providers of M&A - bankers, accountants, law firms, deal PR firms, the deal media - to do what they always do, which is to predict, hand over heart, that the bust was totally last year and a boom was lurking around the corner.

And in fact, despite a choppy stock market, January saw a surge in deals, many of them sizable (Suntory's $16 billion deal for Beam, Google's $3.2 billion purchase of Nest Labs and Charter's $61 billion offer for Time Warner Cable). The problem with that is that a similar spasm occurred in early 2013 (Dell, Heinz, US Airways), triggering a story on the front page of the New York Times declaring the slump over, only to see the M&A market fizzle and fade. This year, the Financial Times reacted to a rush of deals on Jan. 14 -- $100 billion in deals announced the Monday before - to declare that "Animal Spirits Had Returned to M&A," with appropriate testimony from an M&A lawyer. And it only took two weeks!

No one would like to declare my own prescience more than me, but allow me to offer a dose of skepticism. A busy Monday, particularly a busy Monday in January, means little. It takes a year of busy Mondays to return M&A to a higher level, particularly at this phase in the cycle. Certainly, some conditions do seem right for increased M&A, but others do not. Consider QE, which many in M&A viewed as a deterrent to dealmakers, because it left the impression that stock-market prices had been artificially inflated. The Fed was getting out of the stimulus racket, but at the rate of only $10 billion a month. So if deals were taking off in January, it raised the question, why now? Why not wait until valuations were more solid, like next fall? Why not see what the effects of the taper would be on stock prices and interest rates and on the rest of the world? My thesis that a psychology resistant to risk and M&A would be undermined and reconstituted under steady pressures to grow was unlikely to take place over a single chilly weekend.

Not surprisingly, as the animal spirits were summoned back to the banquet, chaos ensued again, just in time for that funfest in Davos. China reported lower manufacturing numbers, sending currencies from a variety of current account and politically challenged emerging markets - India, Turkey, Argentina, Brazil, South Africa - plummeting. Fears of the taper re-emerged. The currency crisis rebounded into global stock markets, even in the U.S. where stock prices began to slide. Now at this point this market retreat threatens no one in the U.S., particularly after the big run-up late in the year; and slightly lower prices, in theory, might induce a bidder or two to act. But suddenly, global political and economic uncertainty is rising again, certainly for cross-border deals. And now we get to look forward to the Sochi Olympics, a little fever blister of geopolitical uncertainties and anxieties.

Perhaps this is all a test of market resilience, like the government shutdown last year. If animal spirits have truly been freed, they have the ability to ignore all but the most serious and systemic of problems. When animal spirits are depressed, on the other hand, mere rumors and feverish (if distant) possibilities suffice to send many into passive, cost-cutting, share-buyback mode. That could easily happen again. One of the problems with the emerging-market debacle is the sheer amount of hot air that's been expended upon them over the past decade: argument after argument hyping their newfound stability and fiscal rectitude. This time was definitely different. This time it was blue skies all the way. Once again, yesterday's wisdom blows away on the first stiff breeze, replaced by counter-arguments that were always there, if hidden: the path to developed status is winding, rocky and marked by crises. (And by the way, neither these arguments nor counter-arguments are necessarily true, or at least their truth is profoundly relative, one reason operating in markets is so slippery and dizzying. The truth changes as prices rise and fall. The game, in one sense, is to know when to leap from one set of ideas to another.)

M&A is the emerging markets of corporate life. It's not an inherently black and white, good or bad, venture; it's risky, particularly as markets overheat. Its cycles are both high and deep. The time frames that really matter are far longer than a stock trader or even a market cycle can encompass. It's complex, unpredictable, destabilizing.

If you're an M&A lawyer or banker, particularly one who's not a rainmaker, this post-2008 slump has been a struggle; the banks and law firms, floundering in a post-crisis world, would certainly welcome the profits an M&A boom might bring. You can also argue that the unwillingness to seek out merger partners has created some of the economic malaise that bedevils us, with suppressed job creation and expanding pools of corporate cash. There is no doubt that many M&A transactions, particularly much-hyped transformative deals or all-stock deals at the top of markets, turn out very badly. Time-Warner and AOL did occur. But the Ciscos, IBMs and General Electric's have also ceaselessly recreated themselves over time with M&A. Besides, all business comes down to risk and reward. So once again it's argument, counter-argument, spy versus spy. Pick your truth. Pick your poison.