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M&A Report: Cash reserves aren’t prompting M&A activity

By Tim Curtis

With companies holding billions of dollars in cash reserves, 2017 was supposed to be the year of the deal. And a new president touting tax reform was also expected to serve as a catalyst for merger and acquisition activity.

But so far, it has not played out that way. As a matter of fact, merger and acquisition activity was down in May, with 404 fewer deals than the year before, according to FactSet, a research and analytics company that tracks mergers and acquisitions.

No single factor seems to explain the lull in deal-making. Instead, a confluence of events has companies holding off on buying and selling, for now.

“This is as much an economics question as anything,” said Stuart Smith, a managing director of the M&T Investment Banking Group, where he co-heads the mergers and acquisitions group. He pointed to several different factors on both the supply and demand sides of the equation that have limited activity.

“There’s so many moving parts in the whole discussion that I think people are trying to have some of those things nailed down before they weigh in vigorously,” he said.

Supply-side factors

One of the bigger components on the supply side has been a decrease in the number of new businesses. Last year, U.S. census data showed that just 452,000 new businesses were created in 2014, one of the lowest amounts in the last 40 years, according to a CNN Money report.

Smith likened the impact on merger and acquisition activity to a conveyor belt. Investors and companies can buy new businesses coming off of the factory line, but something has to be produced to replenish the supply. That has not been happening.

The expiration of some of former President George W. Bush’s tax cuts at the end of 2012 exacerbated the problem. The tax increase from 15 percent to 20 percent helped trigger a run on merger and acquisition activity.

“That, in my view, led to a sort of artificial rush,” Smith said. “It’s hard to quantify it, but how many transactions did that pull into 2012 (from 2013 through 2016)?”

But while that created a vacuum in the area for several years, Smith believes companies acquired during that period could be on the move again, given the cyclical nature of private equity investment.

Another supply-side component for Smith has been that business owners who made it through the recession have greater belief in their ability to survive.

“For people that lived through the financial crisis and the aftermath … their view may be that, ‘I lived through the worst possible thing that’s happened in this economy in three generations, and nothing that bad happened so I may as well hang on for a little while,’” Smith said.

Demand side

On the other side, potential buyers could be looking for new companies more judiciously, trying to find the right fit for what they do.

“Strategic buyers probably look pretty carefully these days,” Smith said. Organizations ask themselves, “Is this going to make a difference to my organization?”

Companies also want some room for error on the transaction. They do not want to make the move to buy a company that will ultimately set them back.

Taxes have also played a role in why companies appear to be holding onto their cash instead of spending it.

Last year, Moody’s Investors Services reported that U.S. non-financial companies rated by the company would increase their cash holdings to $1.77 trillion by the end of the year, from $1.68 trillion at the end of 2015. Most of that has been generated and is being held overseas, Moody’s said.

“The tax incentives of generating the income in a low-tax jurisdiction are pretty strong,” said Michael Faulkender, an associate dean and professor of finance at the University of Maryland’s Smith School of Business. “It’s ‘trapped’ because if it comes back to us it goes through the repatriation tax.”

But even if that money came back stateside, Faulkender doubts it would have an effect on the economy because it has already been recorded as American money.

“The notion that there’s $2 trillion that’s going to come into the U.S. and jump-start it is a fantasy,” he said. “There’s no new money.”

Investors could also be wary that the economy’s growth period is coming to an end. The economy has been growing for around eight years, and Smith said that growth is getting “long in the tooth.”

“The question you ask yourself is, are they cautious right now?” he asked. “I want to be holding onto my cash for that rainy day that might be coming.”

But that rainy day could also provide companies more opportunities than the current market.

“During downturns, that’s oftentimes when growth opportunities are peak and having a bunch of cash in reserve to grab them can be valuable,” Faulkender said.

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