Mega-deals like the latest bank merger might look good for business - but they're also flashing a major recessionary warning sign

Business Insider | Feb 8, 2019, 06.53PM IST

CEOs of BB&T and SunTrust fist bump


SunTrust CEO Bill Rogers and BB&T CEO Kelly King fist bump to end a video announcement of the merger of their banks.

  • Two big regional banks and two large drug companies have already announced plans to combine in 2019, but experts say that might mean trouble ahead.
  • Mergers and acquisitions have historically become more common when companies need to boost their growth as the broader economy slows down and nears a recession.
  • It can also be a sign that companies have worries about the stock market and doubt they will be able to get a better sale price in the future.
  • There were 723 deals worth at least $1 billion in 2018, according to Dealogic. That was the most since 2007.

A splashy deal between two big companies might excite investors, but some experts think it means corporate America sees trouble ahead.

About a month after one of the largest pharmaceutical deals in history, two banks are combining in the biggest merger in that sector since the financial crisis. Deals like BB&T combining with SunTrust and Bristol-Myers Squibb snapping up Celgene can get stocks rallying.

But the motivation behind the deals can hint at more sinister forces at work.

"They tend to happen when companies run out of opportunities for organic growth," said Brad McMillan, chief investment officer for Commonwealth Financial Network, which oversees $161 billion.

He added that companies have been buying back large amounts of stock since 2009 and might be reluctant to increase their dividends - if they have them - any further.

"If we're looking at a slowing economic environment, pretty much the only lever left is acquiring another firm," McMillan said.

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According to Dealogic, there were 723 deals valued at $1 billion or more last year, the most since 2007. The largest chunks of M&A spending were in technology and health care.

Wheeling and dealing picked up in early 2018 after the passage of the Republican-backed Tax Cuts and Jobs Act led to massive windfalls of capital for companies. But experts often consider an increase in M&A to be a sign the sun is setting on the economic cycle - and that a recession may be looming. That's because companies can turn to dealmaking as a way to perk up decreased revenue growth.

"It's easier to buy a company, buy the talent, buy the technology, particularly when the economic backdrop indicates a slowing economy," said Quincy Krosby, chief market strategist for Prudential Financial, which has $1.4 trillion in assets under management.

The SunTrust-BB&T deal is the largest in finance since 2008, when Bank of America snapped up Merrill Lynch as the financial crisis deepened. According to Refinitiv, the deal is worth almost 50% more than all of the banking industry mergers from 2018.

In the pharmaceutical industry, executives more big deals might follow the Celgene-Bristol Myers combination. Krosby noted that there's a very long history of traditional drugmakers buying biotech companies to perk up their revenues and expand their pipelines of experimental drugs in development.

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However, she's not sure if the recent deals spell trouble for the economy, as there have been previous waves of M&A during the current expansion. Extremely low interest rates and a gradually recovering economy have given companies reason to take on debt and make deals.

McMillan said companies might be willing to sell now because they don't think the market is going to get any better.

"Valuations got quite high and for firms who are looking to sell, that makes a lot of sense to sell at the peak," he said.

There are questions around the deals themselves, too. Brad Golding, a fund manager at Christofferson Robb & Co., wonders what will happen in a year or two, once the credit cycle has turned. He also wonders if SunTrust and BB&T lose customers during the time they integrate systems and cultures and come up with a new name.

"Can a bank that has had very high ROEs at a nice point in the cycle buy another bank and then dramatically outperform other banks?" asked Golding, who runs a fund that invests in bank convertible bonds, preferreds and other hybrid instruments. "How are they so much better than anyone else? What's the secret sauce in Winston-Salem? I'm skeptical."

But even if it's relatively late in the economic cycle, investors want to see action and they want returns, according to Ted Smith, president of technology-focused investment bank Union Square Advisors.

"All of the investors in these large public companies who are paying for growth or want to see growth are demanding of their public company investments, 'You do one of two things. You need to give that cash back to me or you invest it in real growth," he said.

Dakin Campbell contributed reporting.

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