Susan Easton: Companies dig deep to fund new deals

Opinion

The recent flurry of merger and acquisition (M&A) activity suggests that the global economy and financial markets are continuing to get back on to a more normal footing.

So far this year global M&A transactions are about US$1 trillion ($1.3 trillion) to US$1.5 trillion.

That's well short of the heady period of 2006 and 2007 when transactions were a whopping US$3.5 trillion to $4 trillion a year, but they are well above the doldrum levels we've seen in the past 18 to 24 months.

The vast majority of deals announced so far have been of the smaller bolt-on variety.

That's when a smaller acquisition is made which can easily fit into the acquiring company's existing business.

These tend to be more easily digested and less problematic and it's logical that this emerging M&A flurry should be centred on transactions of this sort.

Just in the last week we've seen US based on-line retailer Amazon.com spend US$500 million to take out privately owned Quidsi.

Quidsi is a speciality e-commerce operator dominant in baby items (diapers.com) and household products (soap.com) and is shortly to launch a beauty product business.

Quidsi's offspring can compete on price with the likes of the bricks and mortar retailers such as Wal-Mart and Target but its critical point of difference is that they can deliver overnight.

Crikey, you'll even get that delivery for free if you fill up your on-line trolley with more than US$50 worth of goodies.

It's not the first bolt-on acquisition that Amazon.com has recently made.

Several months ago it bought woot.com which is the US version of our very own 1-day.

Despite being the largest US retailer of its type Amazon.com hasn't been able to work its magic in every sphere, hence the drive to pounce on those niche players when the "for sale" sign goes up.

You'd imagine for its money that Amazon.com might learn a thing or two, that ultimately the growth in the newly acquired businesses would be enough to compensate shareholders for the price management had paid, and that there might be some additional sales benefits with cross-traffic opportunities between the various sites. Whether that occurs remains to be seen.

Companies these days are venturing out of their own sandpits; there are an increasing number of inter-country deals taking place in the scramble to gain a global footprint.

Again, Amazon.com recently purchased fashion-site BuyVip specifically so it could broaden its geographical reach into Europe.

It's often a hell of a lot easier doing these types of transactions than it is starting a business from scratch where you may have to wait for ages before the cash starts flowing and investors see a decent return.

The challenge, though, is to make sure the purchasing company doesn't get carried away with the deal and pay more than it's worth.

There is simply no point in acquiring if the financial performance of the enlarged business suffers.

The M&A trail is littered with some high-profile disasters.

If management is over-confident and pays too much and the deal is large enough then the house can come tumbling down.

UK insurance provider Prudential failed in its recent attempt to buy AIG's Asian operations after investors baulked at the price.

M&A activity waxes and wanes, much like a lot that happens in financial markets.

No one likes uncertainty, least of all investors faced with putting down hard-won cash to buy growth.

The steady trickle of smaller transactions such as HP's purchase of McAfee has been gathering more steam following the "resolution" of the sovereign debt crisis in Europe earlier this year.

M&A activity is sensitive to the availability and cost of finance.

With interest rates historically low many big businesses can borrow at ridiculously cheap rates.

Furthermore, as noted in last week's column, there are a lot of big companies with very sound balance sheets; a number are sitting on too much cash.

With equities priced well relative to bonds, it looks like there is plenty of scope for more M&A activity ahead.

Just what companies get up to on the deal front will depend a lot on how confident company management feels about prospects ahead, the opportunities available, what competitors are getting up to, and how pressured the chief executive feels to join the game.

But now we are no longer facing financial Armageddon expect more companies to be getting out their chequebooks and going on a shopping spree.

* Susan Easton is the manager of investment strategy at Gareth Morgan Investments.