The Street Loved "Merger Thursday" (And M&A 2013)

Yesterday was quite the interesting market day, as many traders, including some of us here at SOTM, thought the bears finally had an opportunity for at least a start at chipping away at the relentless “buy any and all minor dips” mentality which has been pervasive in the start of 2013 bullish run.

Very disappointing GDP numbers came out for Europe during the overnight and pre-market session and S&P futures were down at the low point about 7 points and Dow futures about 75 points, not disaster by any stretch, but down more than all but one or two days so far in 2013. And the key German DAX exchange index was trading down well over 1%, leading to expectations of a fairly significant down day here in the U.S.

And then CNBC-TV, Bloomberg, and the wire services lit up with the breaking news of the proposed buyout by Berkshire Hathaway and Brazilian-based investing group 3G Capital of food/consumer goods icon Heinz, at a price tag of $23 billion and at $72.50 per share, a +20% premium to the prior day’s stock price. Certainly great news for holders of Heinz stock (HNZ).

Like a lot of blue chip names, Heinz has had a fairly nice stock run in 2013, and since the 2009 market lows has risen from the $30 area to the $60 range. Last quarter, HNZ broke out of some longer-term resistance near $55.

The Heinz deal news also had the effect of turning futures around from their downward push, and the day on the whole ended up with a modest green for the S&P.

Helping this along also was the news of A) the American Airlines/US Air merger, B) movement on the part of AB InBev in suggesting a revision of their deal to acquire Mexican brewer Grupo Modelo (a story which is a bit complicated, but AB will possibly spin off Corona rights to Constellation Brands), and C) drug wholesaler Cardinal Health Inc.'s $2 billion purchase of rival AssuraMed.

The Wall Street Journal had the following perspective:

Other deal items of note recently include the Dell potential leveraged buyout ($24.4 billion), the $16 billion merger of cable companies Liberty Global Inc. and Virgin Media Inc., and the $18.1 billion to be spent by Comcast Corp. to buy General Electric’s remaining stake in NBCUniversal.

And although not a deal per se, the prospect of Apple perhaps returning some cash to shareholders in some way, shape or form, or putting that cash to work in other ways, has also been in the news. (Although there are many different opinions on this issue.)

Ok, so the premise has been set up and it is estimated that M&A activity is up about +27% versus year ago and it has been one of the healthiest deal periods since before the financial crisis.

Aside from the shareholders of the companies involved, why does The Street care so much about it and why is it taken as such a bullish signal? At the risk of stating some obvious points, let’s quickly review some reasons:

• First and foremost, because a spate of mega-deals lines the pockets of major Wall Street banks, investment houses, and law firms through equally outsized fees
  
• It is a signal that companies are putting that much-discussed hoard of “cash on hand” to work and subtly saying that some smart players think there are “undervalued assets” out there
  
• It is a way of also a way of saying that the FOMC “easy money” policies in terms of low interest rates is having some sort of stimulative effect on the American economy and business activity (although hard to say how that helps the Average Joe)…companies like Berkshire and 3G are potentially reaping huge future payouts on earnings streams versus their cost of capital.
  
• These deals generally lead to higher stock prices for at least one of the involved parties and, often, both. There is also what Jim Cramer likes to refer to as “pin action,” with companies in the same category as a related takeover target often moving up in sympathy (and sometimes other similar companies are viewed as potential future takeover targets themselves).
  
• Related to the last point, P/E multiples for an entire stock market sector can move higher, which in turn can lift to some degree the entire market multiple.
  
• And then the final point, which can cut two ways: “synergies of scale” and “cost efficiencies” can be unlocked, especially through mergers, which unfortunately can also be code for severe cost-cutting and layoffs. Others will argue this is a good thing, leading to improved “best practices” for an industry segment (this was actually much of the debate over Mitt Romney’s LBO background and whether or not “his deals” represented a net plus for the American economy). However, does anyone really think the American Airlines/US Air deal will lead to higher or lower airfares for the general public?

Let’s leave that discussion right there as I want to go back to the Berkshire/3G/Heinz deal, as there are several sidebar stories of some interest:

• One of the winners coming out of the deal will be John Kerry’s wife, Teresa Heinz Kerry, who was estimated to hold about $3 million in Heinz shares as of trust filings in 2010. However, their gain of several hundred thousand dollars is just a drop in the bucket compared to their overall estimated net worth.
  
• Warren Buffett’s Berkshire Hathaway appears to have struck yet another “sweetheart deal” for which he is famous. Some are saying the Heinz stock price offer is too high, but buried a bit in the deal news was a feature that will pay handsomely. According to CNBC:
  In the Heinz deal, Buffett told CNBC that Berkshire is putting up $12 billion to $13 billion in exchange for half the company and $8 billion in preferred stock that will pay 9 percent a year. The investment firm 3G Capital is putting up the rest of the money and will run Heinz. (Ok, do the math…where are interest rates right now compared to a 9% annual return?)
  
  
• Any number of news outlets are picking up on a story regarding unusual call option buying in Heinz the late morning and afternoon before the deal was announced. The good news here, according to the NY Times, is that the SEC is well aware of it and investigating; the bad news is that it is a second instance in the past two years in deals involving 3G Capital.

Always cynical (and usually amusing) website Zero Hedge said the following about the incident, indicting the SEC, Buffett, Morgan Stanley, JPM, and Moody’s all in one deft stroke: