Hey, There’s M&A!

- The investment community seems enthralled by a pickup in deal activity. "A few
friendly and hostile transaction announcements have energized investors, who are
almost desperately seeking some reason of late to be enthusiastic about stocks,
given macroeconomic uncertainties. Indeed, fund managers are seeking possible
takeout candidates even as the business outlook remains unclear and corporate
leaders may be unwilling to make such commitments en masse yet based on
preliminary work given out to law firms."
- Funding costs are down sharply and high yield issuance is soaring. "With money
flowing heavily into bond funds, the cost of doing a deal is fairly attractive given
the spread to cash flow yields, such that it may be challenging to not do accretive
transactions unless the prices paid get exorbitant. Moreover, there appears to be
a very willing buyer of new junk bonds being issued given poor yields elsewhere."
- M&A trends often lead stock prices, but more linked to big cap gains. "While
investors may perceive them to be coincident, there does seem to be respectable
correlation between M&A volume and future stock price direction. However, the
analysis shows that this is far more accurate for large cap indices rather than for
small cap stocks, despite arguments to the contrary. Should more deals transpire,
the S&P 500 is likely to be higher a year from now."
- Energy and Telecom Services have the widest cash flow yield to high yield spreads.
"When studying cash flow yields to high yield financing cost, it becomes evident
that both the Telecommunications Services and Energy sectors look the most
intriguing in terms of their acquisition potential given their widest spreads.
Regulatory issues and recurring capex requirements could explain the
differentials."
- Industrials, Technology and Financials have the lowest spreads. "Several sectors
have the tightest spreads, making successful acquisitions harder as business plan
execution could make or break a deal’s potential for success. The IT, Industrials
and Financials sectors have the tightest spreads between cash flow yield and junk
bond yield, thereby providing much less margin for error. From a purely
fundamental approach, select industrials are preferred to technology names, from
our perspective."

Citigroup_Equity_Strategy_20100823