Will a Superabundance of Capital Lead to an M&A Boom?

Posted by John Slater on February 17, 2013

Authored by John Mason

“Bain & Company, the consultancy, forecasts a ‘superabundance of capital’ between now and 2020. In a recent report it argued that markets would be distorted by surpluses in Asian and Middle Eastern countries and private investment funds.

“It estimates that the world’s financial assets will outbalance its domestic product by ten to one – it will have $900 trillion of financial assets compared with $90 trillion of GDP – by 2020. The result will be a ‘world that is structurally awash in capital’ chasing few opportunities.

“‘Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles. The propensity for bubbles to form will be magnified as yield-hungry investors race to put capital into assets that show the potential to generate superior returns,’ the report concludes.”

These words from John Gapper appeared over the weekend in the Financial Times of London.

The signs of this possibility, according to Gapper, are two: first, the presence of lots and lots of cash on the balance sheets of corporations, hedge funds, and other financial interests; and second, the apparent movement in the buyout and acquisition market that reflects a growing belief among international investors that the US economy is stabilizing, the eurozone crisis has reached its final stages, and that elsewhere in the world economic recovery continues and capital flows are increasing. Apparently with these events, the desire to take on more risk has risen.

I have written for three years or so about the build up of cash on the balance sheets of corporations. Companies that never had issued long-term debt before took advantage of exceedingly low interest rates to increase their cache of money. The basic reasoning behind this buildup was that these financially sound firms would “make a killing” as the United States economy began to grow faster and government regulatory policy came together.

The targets of these companies? The answer was … companies that were not so financially sound; companies that needed restructuring; and companies that needed new life and new capital.

The merger and acquisition binge never took place. The reasons given for why a massive boom in M&A never took was also two-fold: first, economic growth remained tepid, and uncertainty seemed to blanket the world as the regulatory stance of the Obama administration never became clear, as the European crisis worsened and grew longer and the economic health of the rest of the world, especially in China, India, and others, was unclear.

Corporate leaders were just not willing to commit. Better safe than sorry.

But, now this seems to have changed. The Federal Reserve System has pumped billions of dollars into the United States economy and is continuing to do so as we go to work each day. The Fed has promised that this will continue for an extended period of time and short-term interest rates will remain low for another year or more. We believe them.

The American economy is not growing robustly, but there seems to be sufficient confidence that the economy will not fall apart to warrant some belief that investors can extend themselves into riskier investments. European financial markets have been relatively stable now since early December as European officials seem to be working to knit something together, even though the pace of accomplishment remains extraordinarily slow. And, the rest of the world seems to have stabilized and seems to be heading in the right direction.

The confidence of international investors seems to be building as money has moved out of United States Treasury securities and German Bunds.

Furthermore, it finally appears as if money is finally flowing into the “deal” market. Of course, the eye catcher here was the $24.4 billion buyout deal struck by Michael Dell for Dell (DELL). This was followed by John Malone, of Liberty Global (LBTYA), who stated that he was buying Virgin Media (VMED). Then a group of private equity funds in England announced a deal with EE, the United Kingdom’s largest mobile phone operator. And, there is also the deal announced a little earlier to less press coverage of Dish Network (DISH) buying Clearwire (CLWR).

The year started off slowly, but now near the middle of February, the numbers are starting to look really good. Finance is good!

But, what about economic activity? Will all this financial activity help the real economy grow and help to reduce the unemployment rate?

Three years ago when I was writing about the corporate build up of cash and the possible “boom” in mergers and acquisitions that might follow as the confidence picked up and the uncertainty surrounding government regulation dropped away, I wrote that there was still one problem to consider. All this money going into “deals” was not immediately going into new innovation or into the purchase of new capital equipment. This money was going to be swirling around and around with little or no immediate impact on achieving faster economic growth.

Buyout deals, like the Dell deal and mergers and acquisitions usually result in company consolidations, corporate restructurings, downsizing and reductions in employment.

The immediate impact of these transactions is to “rationalize” the economy and make it more efficient. This “rationalization” and increase in efficiency does not immediately add to economic growth or to lower unemployment rates. If anything it can move things in the opposite way.

Yes, eventually these restructurings and so forth will be good for the economy. They will lead to greater worker productivity, more capital expenditures, and more innovation. But, these latter things will not take place immediately.

Gapper, in his Financial Times piece, closes with similar sentiments. He states that “such investors are not risking money on entrepreneurs through venture capital funds or buying stakes in untested companies in initial public offerings. They are choosing well-known enterprises on a firm footing and using their earnings to gain better returns than cash or government bonds.”

These activities may lead to better times, he states, but “at the moment, the wave of deal making contrasts oddly with sluggish economies and risk-averse banks.”

The scary part of this scenario is the possibility presented us by Bain Capital: “Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles.”

I have written a great deal about credit inflation in my posts. It seems to me that the Bain 2020 picture of a $900 trillion in financial assets compared with $90 trillion of GDP is the height of credit inflation. Even if we don’t get all the way to this result, a credit inflation of this degree makes the credit inflation of the 1961 to 2007 period look like an insignificant “bump in the road.”

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