There’s nothing quite like Mergers and Aquisitions to raise the animal spirits of the markets. There’s something primal and prurient about watching them.
It’s like seeing one of those really huge snakes open its jaws impossibly wide as it slowly wriggles forward, engulfing some still breathing animal that’s as big or bigger than it is. You are transifxed as the obscene just refuses to stop happening.
M&A’s are the same. The loser disappears. The winner lies there bloated and obscene. The Markets love them. Thus the present frenzy of M&A’s has rallied the markets. Or at least held them back from diving straight into another week of losses.
Of more interest to me however, is how they are funded. What concerns me is that the really huge M&A’s, the epic ones, are often also suicidal convulsions of debt and leverage. Which brings me to BHP Billiton.
At the end of ’09, the degree to which Billiton was funded by debt, its leverage, was 15.6%. But if it goes ahead and swollows Potash Corp. whole , for cash (no shares), then it’s debt will bloat to 50%. SAB Miller is also looking to ingest a rival. In their case Fosters, the Aussie brewer. The effort would swell SAB’s debt by 50% from the present level, to three times the company’s earning capacity. H-P is also eyeing a victim.
Generally the markets love predators. Herbivores are dull and slow. Carnivors are agressive and entertaining. M&A’s give markets the horn. Sadly they are quite often disasters of greed and avarice. Think of RBS and ABN Ambro. No one ever seems to learn. The temptations are just too great. If you need growth and can’t generate it yourself you just swallow someone and presto you are bigger and fairly oozing with profitability. That’s the idea at least.
Anyway, what gets less attention is the debt required to lubricate it all. Here we are in a banking crisis caused by leverage and debt watching both increasing. Of course the predators will say, the merger will provide growth. Buy Potash and strike some sweet bulk deal with China. Great as long as there is no contraction of growth and demand. No constriction in funding while you are still trying to digest what you swallowed.
Here ‘s what I see in this sudden interest in M&A’s. At the moment billions are flowing out of stocks. A lot of that money is flowing into Bonds and funds which trade bonds. This has caused bonds to become cheap. It is making it easier and cheaper to issue corporate debt. Some debt is being bought up at rates that barely give any return at all – but it’s still selling.
So although the total corporate bond market is still smaller than it was during the bubble years – corporations have sold about $1.9 trillion in bonds this year in comparison to about $2.6 trillion in ’09 – there is a window of opportunity. While stocks seem too risky and their returns too low corporations will find buyers for their debt and be able to fund grand aquisitions.
More interesting and worrying is the kind of debt which is being most sought after. While total corporate bond sales are down sales of Junk Bonds – those which are rated as highly risky but therefore offering high returns – those bonds are selling at record levels. $14 billion just last week breaking the all time record which was itself set in March this year. For the year so far $170 billion have been issued and bought up. The record was set in ’06 at $185 billion.
It seems to me we have an unfortunate and possibly disastrous confluence of desires and needs. Corporations are desperate for growth. A company like Billiton sees a window of oportunity to strike while China is still growing and sucking up bulk commodities. H-P just wants to be a predator to save it from becoming prey.
At the same time investors and fund managers are equally desperate for growth. Both are increasingly willing to run greater risks in order to achieve it. Sound familiar?
The first bond sellers who jump in, which means the first to consumate their aquisition and issue the debt to fund it, will get a flood of buyers for low priced debt. Those who come later will have to offer higher returns. The junk end will get junkier and the promised returns less sustainable.
The impetus is to get in quick. Those who dither or consider will miss out. The danger will come from those who have missed but refuse to accept that they have and plough on unwisely even as things turn sour.
All debt binges start well, fortunes are made, heros are feted and then the stragglers get slaughtered.
As I see it debt is on the move again. In its many guises because growth, the vanilla kind, has failed to materialize. The markets are like junkies waiting for a fix. That kind of waiting doesn’t last long.
That’s the corporate world. The sovereign world and its debts have gone quiet over the summer. But as summer darkens to autumn the pain and the sense of panic will return.
Consider this. Spain has been ‘helping’ its bond sales by buying them with its own social security funds. The Spanish Social Security fund is now stuffed almost full with Spanish governemtn debt. The S.S. fund sold its holdings of other debt and went all in on Spanish bonds. Risk management? Or doing anything at all, no matter how unwise just to keep Spain’s debt sales from failing and its borrowing costs from spiralling up up and away?
Spain is heading where Japan has been for a decade. Which you might think is a sustainable plan then. I mean look at Japan. They may have had a moribund decade but dead they are not. But wait…I always have a bit of doom to spare for these end paragraphs. It woudn’t be fun if I didn’t now would it?
Japan has always relied on selling its sovereign debt to its own banks and people. They were able to do this because, post war, the japanese were savers. Trouble now is those savings have been used already to buy up Japanese debt. And the people have stopped saving. Because two decadse of stagnant or declining wages mean they aren’t flush with savings any more.
While Japan was selling its debt to its own people they could rely on paying a very low rate – 1.3% typically. But very soon now Japan will have to , for the first time in a generation, sell its debt to foreigners – to the bond market where the srongest nations pay 3 – 3.5%. The cost of Japanese debt will double or triple.
We have not heard the last of debt because we have not kicked the addiction of basing our growth upon it.
Hi Golem,
I have recently read a few articles about the bond market bubble and how it may end up bursting. Opinion seems to think that this may lead to hyper-inflation as the first to get out of bonds rush headlong into commodities. There was a recent article on this over at zero hedge.
It then struck me that this bond bubble may perhaps the aim of the powers that be (FED). How can you escape from deflation and also rapidly inflate away debts to such an extent that a whole new currency may ultimately be required? They must surely realise that there is no way out of the current mess – they cannot be stupid.
Any thoughts?
I don't think the FED currently wants to inflate fast. I think they are trying to off-set deflation by printing into a deflationary vortex created by securitized assets losing their value.
I think the FED and other Central Banks are trying to follow a narrow path that off-sets deflation and possibly inflates a little, but does not set off major inflationary forces. What they want is enough to try to devalue their own currency relative to competitors, but not enough to destroy anyone. This is difficult and made more so because each nation and its CB are competing with the others to devalue that competative amount and gain an edge for their exports.
I don't think anyone yet sees any value in fast inflation and devaluation. Because it would lead to a revolt among those who hold the debt. Most important among them being China. If China thinks the buying power of its several trillion in US debt is being infalted away by the US, then China should/would dump its holdings if for no other reason than pure revenge.
All would be mightily impoverished by such a series of events. Better for them all, if they can walk in step. Allow some inflatoin and devaluation in the hope of re-building a trading partnership but not too much that a chain reaction sets in and everyone loses.
Of course the people who lose from the 'success' of walking this narrow path are the Western Tax payers and citizens. As we are all the time required to pay off the debts of the entire financial system.
Of course the bond bubble – which I take as being 90% sovereign and only a small part corporate – could implode. I have argued from the start that the 'bail-out and debt denial' ppolicy is unsustainable in the longer run. Unsustainable not least because it requires that no nation, no people, balk at the sheer injustice of the debts they are being required to pay and the austerity they are required to suffer – all in order to save the banks and the wealthy who profit by them.
I think something, some debt, sovereign most likely – will implode, it will then take out banks who are exposed to that debt. I am sure the ECB are working behind the scenes to ring fence as much of the bad debt as they can in as few places as they can. Not easy. They may not be able to do it. I would be trying to shove it in a couple of Landesbanks and a couple of other sacrificial banks in a few countries that might be able to absorb the shock.
But if it goes and isn't absorbed, then there will be a massive and uncontrolled eruption of debt. The stock markets will plunge for sure. Will a major currency collapse too? Depends on how long before it happens. The longer it is before it happens the worse it will be.
Won't allow me to put it all in one post so continued below…
I think it quite likely that a failure now would plunge us into a much deeper and longer crisis than we have seen thus far. BUT IF, as a result, we abandoned the foolish policies we have followed up till now, and instead finally purged the bad debts, then we would at least be on a firm path towards 'real' grwoth, job creation and clawing our way back to democracy which I do not think we currently have.
But this outcome would end the current banking system, wpould swallow whole most of the financial class and their wealth – NOT all but many – And would put an end to the project of globalization. It would have to. There would be no job creation without some form of what we currently call protectinoism. A means of stopping markets being ruled by the lowest levels of enerything – wages, safety, environmental regulations etc. Today it is all labelled as 'protectionsim' so as to cast it out from any discussion. That too would have to end.
For all these reasons there are huge powers ranged against such an outcome. Would those made wealthy and powerful by the present system, faced with a choice between inflation or what I have just described, chose inflation and chance holding on to power after hyper-inflation? I don't know Rob. But I know which I want for my children.
That is what I think, Rob.
As someone has had first hand experience of how globalisation has robbed me of my job (more than once as well!), I welcome the scenario you sketch out. I hope it comes to pass but I think the vested interests will be doing their best to hide the debt and fool all of the people all of the time – much as is being done right now with the welfare reforms blaming the recipient for their own predicament.
IanG,
I think they will too. The question is, can they sustain it or will it blow up in their faces? It happens to bomb disposal experts whose lives are on the line. It could happen to the financial class. There is hope.
I lived in Japan, 3 years ago 1 GBP = 245 JPY
Now 1 GBP = 133 JPY
WOW !!!!
However , 15 years ago the rate was about the same . The carry trade has been a mainstay of the western economy for a many a year. I f I was clever I could predict a future for this scam !
Tom,
I can't help think that the carry trade is part of why Japan has been trapped with low domestic growth and a strong currency. No matter what they do, no matter how much money they print it goes abroad to be invested in other things by other people.