In the last week, some additional positive data points on the state of the US economy have emerged. US business spending on non defense capital goods recorded the largest gain since end 2011 and the pending home sales index jumped by the largest margin since April 2010.The former is a gauge of the willingness by US firms to invest in core capital items and is usually a leading indicator of an upturn.
The caveat in making inferences from these early gains, however, is that one must avoid jumping to conclusions until sustained, across the board movements in macroeconomic indicators emerge.Nevertheless, as I highlighted in my piece last week, the fact remains that several large, globally diversified US companies with rock solid balance sheets and sound cash balances are beginning to now look for opportunities to consolidate.
The Fed has this week again reasserted its willingness to provide prolonged liquidity support (read: low interest rates) to the US economy and there are no immediate persistent signs that inflation may rear its ugly head. So, cost of carry remains attractive for quality balance sheets, private equity and LBO (leveraged buy-out) funds. Reportedly, there is liquidity sloshing about with some of these funds as large investors have begun to signal a greater (than 2011-12) appetite to take risks and invest in strategic opportunities.
This is likely being driven by the ebbing of “gloom and doom” scenarios that were being played out in the global media back in 2011 and early 2012 about an impending Euro zone collapse coupled with the downgrade in US sovereign debt rating and the uncertainty over how the US fiscal situation would be resolved. Two out of these three factors have not yet been resolved and remain a source of long term worry to global markets – however it appears that there may now be a greater willingness to reconcile with these risks.
Two factors however pose strong headwinds to the possibility that 2013 may yet emerge as a record year for mergers, acquisitions and business consolidations in the US markets. First, while sound US corporations may be cash rich, a lot of the cash on their balance sheets are stashed on the books of their subsidiaries overseas. Repatriating these cash balances back to the US is costly as it would suffer a 35% tax rate in the US – effectively ‘dual’ taxation since the subsidiaries have already been taxed once at the point of profits in the foreign jurisdiction.
So analysts making simplistic conclusions about the depth and potential for globally diversified US corporations to make acquisitions at will, need to bear in mind that there is a cost to moving this cash back to the United States, which is what the acquirer company will need to do to be able to pay target company shareholders. This effectively increases the cost of acquisition for US companies and potentially impedes investment opportunities. The alternative is to raise debt from US markets while rates are low – however, raising debt for long term acquisitions has long term implications and leverage is never a preferred alternative even in the best of times.
The other factor emerges from the behavior of leveraged funds this time round – the scars from 2008 are yet fresh and such funds would want to be circumspect in extending themselves to fund acquisitions – by corollary this means they would only want to fund very attractive opportunities that present genuine avenues for the target company to make large efficiency gains through business restructuring, post LBO.