May 2009

Following the sharp upturn in the equity markets that began in early March, analysts have been divided on the issue of whether the advance is the beginning of a sustainable upward development or merely a protracted bear-market rally.

While there remains little indication of the economic downturn reaching bottom, investors’ capacity to quickly absorb and discount negative news has clearly improved. However, although the fortunes of some major banks appear to have taken a significant turn for the better, which has been a prime driver of equity markets latterly, the original catalyst for the ongoing recession, the housing market, remains essentially depressed. Nor has there yet been any really concrete evidence that the myriad of central bank initiatives to stabilise markets, and government spending packages to boost the global economy, are beginning to have the desired impact.

Nevertheless, one recent positive development is the sudden renaissance in merger and acquisition activity. As at the end of the first quarter of 2009, companies had raised $1,500 billion in the bond markets, taking advantage of investor demand for corporate debt and thereby lessening the need to resort to banks for funding. Despite this, M&A volumes for the same period actually fell by 36% year-on-year. Then, quite unexpectedly, M&A activity soared in April. On one day alone, ten deals, with a total value of over $27 billion were announced (Oracle’s $7.4 billion bid for Sun Microsystems being the largest) across a variety of industries. Significantly, more than half of this total will be paid in cash, highlighting corporate wariness of the now relatively expensive cost of borrowing from banks.

Before corporate remuneration packages for senior personnel were directly linked to a company’s share price development, managements would look beyond the smoke and mirrors of the stock market, and were able to distinguish between a company’s share price and its underlying business. Have corporate boardrooms returned to pursuing strategies underpinned by long-term, business-logic considerations rather than the prospect of short-term financial gains? Perhaps.

Do managements see something that investors have overlooked? Probably not. That the spike in M&A activity occurred after a sustained improvement in equity markets is no coincidence. So far in 2009, overall M&A business is a third lower than for the same period last year and less than half of the volume for that period in 2007, suggesting a strong correlation between M&A activity and equity market strength.

Also, closer inspection of the current composition of M&A activity reveals a diversity of deal-type that reflects the present economic and financial backdrop more than the level of stock markets. Many deals are bankruptcyrelated, especially in the US and Japan, and such transactions are expected to rise in number, as the deteriorating economic outlook obliges more companies to dispose of assets to shore up their fragile balance sheets.

While the surge in M&A activity is a welcome development, especially for shareholders of target companies, it does not mean that the investment environment has fundamentally changed for the better: when the deals worth over $27 billion were announced on 21 April, equity markets were singularly unimpressed, falling across the board on persistent economic fears.