Analysis: M&A/credit binge versus double-dip fear

By Jeremy Gaunt, European Investment Correspondent

LONDON (BestGrowthStock) – A new conundrum faces financial markets — why, if the global economy is heading back into trouble, are companies on an M&A binge and big investors snapping up so much corporate debt?

At one level, the answer would seem to point to a world of short-term worries that are not seen likely to come to pass or, even if they do, will not derail longer-term growth prospects.

But there are also specific reasons for the moves that paint a less stable picture. It may be another case of there being just so much money around that it has to go somewhere.

Data from Thomson Reuters Proprietary Research shows worldwide M&A deals coming in at $267 billion in August, the biggest monthly activity since June last year and the most active August since 1999, at the height of the internet boom.

Deals include BHP Billiton’s (BLT.L: ) hostile takeover offer for fertilizer company Potash (POT.TO: ), GDF Suez Energy’s (GSZ.PA: ) deal with International Power (IPR.L: ), and Genzyme’s (GENZ.O: ) likely merger with Sanofi-Aventis (SASY.PA: )

At the same time, investors have been buying investment grade corporate bonds with no apparent concern that a U.S. slowdown and contagion elsewhere could hurt companies’ finances (in much the same way that earnings projections remain robust).

Reuters asset allocation polls for August showed mild moves away from equities and into bonds in general. But moves within bonds were decidedly in favor of high-quality corporate credit.

Within bond allocations in a typical mixed fund, 27.4 percent was in investment grade at the end of August compared with 19.9 percent three months ago.

Meanwhile, the costs of insuring U.S. and European investment grade debt against default has come down over summer, according to Markit, despite some increases in August.

LOOKING BEYOND U.S. TO EMERGING WORLD

The M&A spree certainly suggests corporate treasurers are confident that whatever the near term may bring, now is the time to expand.

A survey by law firm Eversheds found one in five senior executives said their business would be looking at potential acquisitions during the next year.

Mike Lenhoff, chief strategist at wealth manager Brewin Dolphin, reckons many companies are taking advantage of relatively good valuations to position themselves for the new world economy being led by Asia and Latin America.

While the U.S. economy struggles, investors hopes are pinned on new, vibrant, emerging competitors to pick up the slack over the short term. Over the long term, these economies are seen as the new leaders, with domestic markets primed to explode.

“These guys are around for the long term,” Lenhoff said of the corporate buyers. “They are going for the emerging world.”

He cited BHP Billiton’s bid for Potash. China’s need for fertilizer is so large the country is trying to find ways to hamper the deal over worries about market concentration.

But other corporate activity has involved companies that may simply have found themselves loaded with cash and/or able to get hold of as much as they need cheaply.

“Obviously they think things are going to pan out, otherwise they would not do it,” Lothar Mentel, chief investment officer of Octopus Investments, said.

But he added: “There is so much money at the upper end of the financial system, we are almost concerned that they might be tempted to buy something silly.”

So while the M&A surge implies belief that the global economy will not fall back too far, it may be just as much a reaction to the very wave of money unleashed by governments to pull the world out of recession.

And, as Goldman Sachs points out, overall M&A activity this year “remains well below the heady days of 2008.”

RELATIVE RISK

The picture is similar when it comes to corporate debt. On one level, buying investment grade bonds is a sign of faith in the future — look at the sell-off in such debt during the subprime/Lehman crisis for what happens when it is not there.

But it is only a mild form of risk appetite.

“Buying corporate debt is still a risk asset, but it is a more defensive way of playing it,” Brewin Dolphin’s Lenhoff said.

Some money has moved from lower grade, higher yielding “junk” to investment grade. The high-yield allocation in the Reuters polls dropped from 10.3 percent in June to 8.5 in August.

And the investment grade rally may be being driven less by risk appetite than a fear government bonds are now so overbought that corporates present a better alternative.

“They are getting out (of governments) and they have to put their money somewhere,” said Octopus’s Mentel.

It all leaves investors pretty much where they were at the beginning of summer — trying to work out whether the signals they see are telling them all is well or whether they merely reflect the money that has been put to work, not fundamental economic improvement.

If they get it wrong bond investors could end up nursing big losses and some company executives will find they’ve overpaid for acquisitions.

(Additional reporting by Quentin Webb, editing by Mike Peacock)

Analysis: M&A/credit binge versus double-dip fear