Market Direction and Stock Trends

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How the AT&T-Time Warner deal will be bad for the stock market
By Mark Hulbert

* October 25, 2016

Big waves of M&A tend to lead to a large decline in equities

CHAPEL HILL, N.C. (MarketWatch) — Is the proposed merger of AT&T and Time Warner more of a Halloween trick or a treat?

Wall Street, at least initially, considered it to be the latter. Viewing the deal as the beginning of a renewed wave of mergers and acquisitions, the Dow Jones Industrial Average posted a triple-digit gain at Monday’s opening.

But history suggests the deal is more of a trick than a real treat.

For starters, consider this really scary factoid: Counting the AT&T T, +0.19% and Time Warner TWX, +0.62% deal, M&A activity this year is running higher than at the top of the internet bubble. As you can see from the accompanying chart, total M&A deals this year are only slightly behind 2015’s total, which at least so far is the record.


There’s little evidence to suggest that the current M&A wave will end any better than did the internet bubble. In fact, according to Matthew Rhodes-Kropf, an MIT finance professor and expert in the M&A field: “Each of the last six great merger waves on record” — going back more than 125 years — “ended with a precipitous decline in equity prices.”

That doesn’t mean, of course, that a bear market must begin right away. Rhodes-Kropf emphasized in an interview that M&A waves can last a long time before they end badly.

Yet that’s hardly a basis on which to become exuberant. To celebrate the recent M&A wave, you in effect have to argue that the current bubble will expand even further before it bursts.

Good luck with that.

I do want to address one counter-argument that has at least superficial plausibility: the low percentage of M&A deals that are being paid for with the acquiring company’s shares. That’s potentially bullish because corporate officers historically have shown an uncanny ability to know when their shares are overpriced. In 1998, for example, the percentage of shares-only deals rose to more than 80%.

So far this year, in contrast, it’s just 15%.



Rhodes-Kropf, however, cautions against making too much of this argument. The low percentage of this year’s deals financed solely by shares is more a reflection of the “crazily overvalued” bond market than it is about the stock market’s prospects. Acquiring companies that otherwise would be inclined to pay for deals with shares are instead borrowing the money at rock-bottom interest rates.

Therefore, according to Rhodes-Kropf: “Stock market bulls won’t be able to get very far by arguing that this M&A wave won’t end badly because of the high percentage of deals being financed by cash. It’s hard to imagine that the equity market won’t be hurt if the bond market bubble pops; both markets will go down together.”

To be sure, those who closely track M&A activity have been worried about these and related considerations for several years now. And, yet, the stock market has kept on chugging along.

But it would be a mistake to extrapolate recent years’ experience into the indefinite future, Rhodes-Kropf said. He said it’s hard to shake the sense that we’re “nearing the moment when the music stops, even though we don’t know when that might be.”

http://www.marketwatch.com/story/how-the-att-time-warner-deal-will-be-bad-for-the-stock-market-2016-10-24?siteid=rss&utm_source=tf

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