Mergers and acquisitions (M&A) activity continues to thrive in the small-cap space, and it’s not hard to see why. For most companies, it’s a matter of needing a place to put excess cash to work. After the onset of the financial crisis, many companies focused on cleaning up their balance sheets by cutting costs, hiring fewer employees, increasing savings and paying down debt. Today, companies that made significant efforts to shore up their balance sheets still have restrained capital expenditures. At the same time, they possess a significant amount of cash waiting to be put towards new investments. The persistent low interest rate environment has made cash a lackluster investment opportunity.
Shareholder activism is spurring additional interest in M&A deals. These activist investors, who have significant ownership in certain companies, often see these deals as a way that company management can boost shareholder value and returns over the long term. They may use their clout to demand that a company invest its cash in a potential acquisition or pay out the cash to shareholders so that they can reinvest it as they see fit.
Many activist investors have pressed company management to look for attractive M&A deals. M&A can help companies generate economies of scale, gain access to avenues of growth at a much faster pace than growing organically and put some of its cash to work for a higher return. All of these outcomes can contribute to a higher stock price for the company.
Activists’ efforts are paying off. Currently, M&A activity is on its way to having a record year. Already in the first half of the year, M&A activity increased 11.6% compared to the same period the year before, and marked its highest six-month period since 2007, according to Mergermarket.
Besides shareholder activism, changes in the macro environment can also be a catalyst for M&A activity. For instance, in the banking sector, regulatory changes from the Basel III accords and the Dodd-Frank Act have dramatically increased the costs of doing business for smaller regional banks. Without sufficient scale to comply with these requirements, these banks will likely become less competitive with lower long-term returns. As a result, many of them are putting themselves on the market in hopes that merging with a larger bank would provide a way to stay in business and to continue to be profitable.
Changes in industry trends can also make M&A more appealing. In the retail sector, the massive shift from brick-and-mortar stores to online shopping has left many store chains with a glut of underperforming real estate that they must continue to maintain. Due to the significant change in the business model, these retailers must rethink their strategy by investing quickly and heavily in IT to drive e-commerce. Joining forces with other smaller retail businesses can help defray some of these costs and help make some smaller companies more competitive among their peers. Companies are also acquiring competitors that are failing to win business because of aggressive pricing, which increasingly consolidates the industry and provides more buying and selling power.
It is important to note, however, that there are many factors that could put a damper on M&A activity. Currently, the slowdown in global growth has made central banks either more likely to reduce interest rates or, in the case of the Federal Reserve (Fed), more cautious to begin raising interest rates from ultra-low levels. If, however, the Fed begins to embark on a path to raise interest rates gradually over a few rate hikes, M&A could undergo a significant increase as companies decide to take the plunge before the cost of borrowing becomes too much to justify a new acquisition. Further changes in the regulatory environment could also create costly barriers as well.
For now, though, the active investment lifestyle (as carried forth by activist investors) is encouraging M&A activity as a way to drive higher investment returns, as cash on the sidelines and cheap loans are making acquisitions very attractive. In the same way that having an active lifestyle can help people lose weight, stay mentally sharp and live longer lives, having an active lifestyle as it pertains to investing can also boost the health of a portfolio.
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