6/9/19: Small Cap Stocks EPS: racing to the bottom of the MAGA barrel

Everything is going just plain swimmingly in the Land of MAGA, where American companies are now expected to do their duty by President Trump's agenda for investment in the U.S. because, you know, this:

As 'share' part of the EPS ratio has shrunk (thanks to buybacks and M&As tsunami of recent vintage), earnings per share should have gone up... and up... and up. Instead, small cap stocks' EPS has collapsed. To the lowest levels since the 2007-2008 crisis.

But never mind, more money printing by the Fed will surely cure it all.

Source for the above chart: @soberlook and WSJ.

6/3/19: Expectations Sand Castles and Investors

As raging buybacks of shares and M&As have dropped the free float available in the markets over the recent years, Earnings per Share (EPS) continued to tank. Yet, S&P 500 valuations kept climbing:

Source: Factset 

As noted by the Factset: 1Q 2019 "marked the largest percentage decline in the bottom-up EPS estimate over the first two months of a quarter since Q1 2016 (-8.4%). At the sector level, all 11 sectors recorded a decline in their bottom-up EPS estimate during the first two months of the quarter... Overall, nine sectors recorded a larger decrease in their bottom-up EPS estimate relative to their five-year average, eight sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 10-year average, and seven sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 15-year average."

Bad stuff. Yet, "as the bottom-up EPS estimate for the index declined during the first two months of the quarter, the value of the S&P 500 increased during this same period. From December 31 through February 28, the value of the index increased by 11.1% (to 2784.49 from 2506.85). The first quarter marked the 15th time in the past 20 quarters in which the bottom-up EPS estimate decreased while the value of the index increased during the first two months of the quarter."

The disconnect between investors' valuations and risk pricing, and the reality of tangible estimations for current conditions is getting progressively worse. The markets remain a spring, loaded with the deadweight of expectations sand castles.

2/8/18: M&A Activity: More Concentration Risk Signals

In recent media analysis of the markets, less attention that the rise in shares buybacks has been given to the M&A markets. And there are some interesting observations to be made from the most recent data on these.

Top level (see https://insight.factset.com/mega-deals-dominate-even-as-the-u.s.-ma-market-remains-in-a-slump for details) analysis is that the overall M&A markets activity is remaining at cyclical lows:

As the chart above shows both values and volumes of M&A activities are shrinking. But the numbers of mega deals are rising:

Per chart above, overall transactions in excess of $1 billion are at an all-time historical high. Per FactSet: "the first half of 2018 has reported the second-highest level of deals valued over $1 billion with 200 deals; the highest level was attained in the first half of 2007 with 210 deals. It is also worth noting that the streak of billion-dollar deals started in 2013, and since then there have been over 100 billion-dollar deals in each half-year. Even in the run-up to the financial crisis the streak was only three years (2005 to 2007). And to help complete the pattern, the dot-com boom had a similar three-year streak of 100 billion-dollar deals in each half-year from 1998 to 2000."

In other words, markets reward concentration risk taking. Mega deals generally add value through increased valuation of the acquiring firm, and through synergies on costs side. But they do not generally add value in terms of future growth capacity. Smaller deals usually add the latter value. Divergence between overall M&A activity and the mega-deals activity is consistent with the secular stagnation theses.

16/5/17: M&As and Investment Climate: 1Q data

As an illustration to the point made a few weeks ago (see http://trueeconomics.blogspot.com/2017/04/28417-vuca-markets.html)  here is the latest data on aggregate deals volumes and deal values for M&As

8/1/17: Corporate Cash: Organic Capex Still Sluggish

In 2016, based on data from Goldman Sachs, 26 percent of aggregate S&P500 company cash went to fund shares buybacks, matching 2013 ratio of buyback to cash for the highest in 9 years. At the same time, Dividends rose to 19 percent of cash compared to 18 percent in 2015, and M&As contracted to 14 percent of cash from 18 percent in 2015.

As the result, CAPEX and R&D spending by S&P500 companies managed to rise to 41 percent of cash in 2016 from 40 percent in 2015, making this the third (after 2015) lowest CAPEX & R&D spend year (as a share of total cash) since 1999.

CAPEX & R&D represent organic investments by the firms and are jobs additive. M&As and Buybacks are forms of financial allocations and are not supportive of jobs creation. In 2016, based on the data, the split between financial and organic investment was 40:41, which is slightly better than in 2015 (42:40), but still represents the fourth worst year on record (since 1999).

Charts below illustrate:

Controlling for volatility, on trend, share of cash diverted to organic investment continues to trend down and is forecast to fall below 40 percent in 2017. Meanwhile, share of cash going to financial allocations is trending up and is forecast to reach 43 percent of total cash in 2017.

And, financial markets are once again starting to reward buybacks relative to organic growth:

All in, the trends suggest that CAPEX improvements are unlikely to materialise any time soon and the secular decline in investment, consistent with supply and demand sides of secular stagnation thesis is here to stay. Which is bad news for the  S&P500 constituents - lack of organic investment spells lack of value added growth and market potential in the long run. Glut of M&As and Buybacks spells rising risks from misallocation of cash (M&As) and superficial priming up of equity valuations (buybacks-sustained asset bubble). Neither are good.

30/12/16: Corporate Debt Grows Faster than Cash Reserves

Based on the data from FactSet, U.S. corporate performance metrics remain weak.

On the positive side, corporate cash balances were up 7.6% to USD1.54 trillion in 3Q 2016 y/y, for S&P500 (ex-financials) companies. This includes short term investments, as well as cash reserves. Cash balances are now at their highest since the data records started in 2007.

But, there’s been some bad news too:

1. Top 20 companies now account for 52.5% of the total S&P500 cash holdings, up on 50.8% in 3Q 2015.
2. Heaviest cash reserves are held by companies that favour off-shore holdings over repatriation of funds into the U.S., like Microsoft (USD136.9 billion, +37.8% y/y), Alphabet (USD83.1 billion, +14.1% y/y), Cisco (USD71 billion, +20.1% y/y), Oracle (USD68.4 billion, +22.3%) and Apple (USD67.2 billion, +61.4%). Per FactSet, “the Information Technology sector maintained the largest cash balance ($672.7 billion) at the end of the third quarter. The sector’s cash total made up 43.6% of the aggregate amount for the index, which was a jump from the 39.3% in Q3 2015”
3. Despite hefty cash reserves, net debt to EBITDA ratio has reached a new high (see green line in the first chart below), busting records for the sixth consecutive quarter - up 9.9% y/y. Again, per FactSet, “at the end of Q3, net debt to EBITDA for the S&P 500 (Ex-Financials) increased to 1.88.” So growth in debt has once again outpaced growth in cash. “At the end of the third quarter, aggregate debt for the S&P 500 (Ex-Financials) index reached its highest total in at least ten years, at $4.57 trillion. This marked a 7.8% increase from the debt amount in Q3 2015.” which is nothing new, as in the last 12 quarters, growth in debt exceeded growth in cash in all but one quarter (an outlier of 4Q 2013). 3Q 2016 cash to debt ratio for the S&P 500 (Ex-Financials) was 33.7%, on par with 3Q 2015 and 5.2% below the average ratio over the past 12 quarters.

Net debt issuance is also a problem: 3Q 2016 posted 10th highest quarter in net debt issuance in 10 years, despite a steep rise in debt costs.

While investment picked up (ex-energy sector), a large share of investment activity remains within the M&As. “The amount of cash spent on assets acquired from acquisitions amounted to $85.7 billion in Q3, which was the fifth largest quarterly total in the past ten years. Looking at mergers and acquisitions for the United States, M&A volume slowed in the third quarter (August - October) compared to the same period a year ago, but deal value rose. The number of transactions fell 7.3% year-over-year to 3078, while the aggregate deal value of these transactions increased 23% to $564.2 billion.”

The above, of course, suggests that quality of the deals being done (at least on valuations side) remains relatively weak: larger deals signal higher risks for acquirers. This is confirmed by data from Bloomberg, which shows that 2016 median Ebitda Multiple for M&A deals of > USD 1 Billion has declined to x12.7 in 2016 from an all-time high in 2015 of x14.3. Still, 2016 multiple is the 5th highest on record. In part, this reduction in risk took place at the very top of M&As distribution, as the number of so-called mega-deals (> USD 10 billion) has fallen to 35 in 2016, compared to 51 in 2015 (all time record). However, 2016 was still the sixth highest mega-deal year in 20 years.

Overall, based on Bloomberg data, 2015 was the fourth highest M&A deals year since 1996.

So in summary:

• While cash flow is improving, leading to some positive developments on R&D investment and general capex (ex-energy);
• Debt levels are rising and they are rising faster than cash reserves and earnings;
• Much of investment continues to flow through M&A pipeline, and the quality of this pipeline is improving only marginally.

Source: https://www.bloomberg.com/gadfly/articles/2016-12-30/trump-set-to-refill-m-a-punch-bowl-in-2017

18/4/16: Capital Gains Tax & Investment Distortions: Corporate Data from the U.S.

In our MBAG 8679A: Risk & Resilience:Applications in Risk Management class we have been discussing the links between taxation, optimal corporate capital structuring and investment, including the decisions to pursue M&A as an alternative strategy to disbursing cash to shareholders.

Lars Feld, Martin Ruf, Ulrich Schreiber, Maximilian Todtenhaupt and Johnnes Voget recently published a CESIfo Working paper, titled “Taxing Away M&A: The Effect of Corporate Capital Gains Taxes on Acquisition Activity” (January 26, 2016, CESifo Working Paper Series No. 5738: http://ssrn.com/abstract=2744534). The paper links directly taxation structure to M&A decisions and outcomes.

Per authors, “taxing capital gains is an important obstacle to the efficient allocation of resources because it imposes a transaction cost on the vendor which locks in appreciated assets by raising the vendor’s reservation price in prospective transactions.” Note, this is an argument similar to the effects of limited interest deductions on mortgages and transactions taxes on property in limiting liquidity of real estate.

“For M&As, this effect has been intensively studied with regard to shareholder taxation, whereas empirical evidence on the effect of capital gains taxes paid by corporations is scarce. This paper analyzes how corporate level taxation of capital gains affects inter-corporate M&As.”

Specifically, “studying several substantial tax reforms in a panel of 30 countries for the period of 2002-2013, we identify a significant lock-in effect. Results from estimating a Poisson pseudo-maximumlikelihood (PPML) model suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year. We use this result to estimate an efficiency loss resulting from corporate capital gains taxation of 3.06 bn USD per year in the United States.”

I am slightly sceptical about the numerical estimate as the authors do not appear to control for M&A successes. However, since the lock-in mechanism applies to all types of re-investment projects, one can make a similar argument with respect to other forms of capex and investment. One way or the other, this presents evidence of distortionary nature of U.S. capital gains taxation regime.

9/2/16: We've Had a Record Year in M&As last... next, what?

Dealogic M&A Statshot for the end of December 2015 showed that global M&A volumes have increased for third year running, reaching USD5.03 trillion in 2015 through mid-December. Previous record, set in 2007, was USD4.6 trillion.

• 2015 annual outrun was up 37% from 2014 (USD3.67 trillion) 
• 2015 outrun was the first time in history that M&As volumes reached over USD5 trillion mark.
• 4Q 2015 volume of deals was the highest quarterly outrun on record at USD1.61 trillion, marking acceleration in deals activity for the year
• There is huge concentration of deals in mega-deal category of over USD10 billion, with 69 such deals in 2015, totalling USD1.9 trillion, more than double USD864 billion in such deals over 36 deals in 2014.
• Even larger, USD50 billion and over, transactions accounted for record 16% share of the total M&As with 10 deals totalling in value at USD798.9 billion.
• Pfizer’s USD160.0 billion merger with Allergan, officially an ‘Irish deal’, announced on November 23, is now the second largest M&A deal in history (see more on that here: http://trueeconomics.blogspot.com/2016/01/28116-irish-m-not-too-irish-mostly.html)

The hype of M&As as the form of ‘investment’ in a sales-less world (see here http://trueeconomics.blogspot.com/2016/02/9216-sales-and-capex-weaknesses-are-bad.html) is raging on and the big boys are all out with big wads of cash. Problem is:

• M&As are not that successful as a strategy for corporate growth (http://trueeconomics.blogspot.ie/2015/05/21515-global-m-and-economic-fundamentals.html), 
• They are pretty terrible deal for organic capital investment (http://trueeconomics.blogspot.com/2015/11/141115-more-evidence-us-capex-cycle-is.html), and
• They are usually jobs subtractive, rather than jobs additive. 

The former, however, is trouble for investors, not management. The latter two are trouble for us, mere mortals, who want well-paying jobs. which brings us about to 'What's next?' question.

Given lack of organic revenue growth and profitability margins improvements, and given tightening of the corporate credit markets, one might assume that M&As craze will abate in 2016. Indeed, that would be rational. But I would not start banking on M&A slowdown returning companies to real capital spending. All surplus cash available for investment ex-amortisation and depreciation and ex-investment immediately anchored to demand growth (not opportunity-creating investment) will still go to M&As and share support schemes. And larger corporates, still able to tap credit markets, will continue racing to the top of the big deals. So moderation in M&As will likely be not as sharp as moderation in corporate lending, unless, of course, all the hell breaks loose in the risk markets.

28/1/16: Irish M&As: Not Too Irish & Mostly Inversions

Experian latest figures for *Irish* M&A activities for 2015 show some astronomical number: Per release: “The number of deals on the Irish mergers and acquisitions (M&A) market increased by 10 per cent last year, its strongest performance since 2008…” Which is not what is impressive. Although the overall number of actual transactions hit 458 in 2015, up from 416 the previous year, it is the value of transactions that is beyond any belief.

Again, per Experian: “The total value of transactions reached €312 billion – up from €154 billion in 2014 and by some way the most valuable year for corporate deal making in the country’s history. Activity continues to be driven by the pharmaceuticals and biotech sector.” This number is a third higher than the value of exports of good and services from Ireland over the period of 12 months through 3Q 2015 and it is almost 60 percent higher than Irish GDP. In other words, using normal valuations multiples, you should be able to buy anywhere between 1/4 and 2/5 of entire Ireland on this money. In one go, and forever… And that’s one year worth.

Per Experian: “Irish deals accounted for around 3.6% of the total volume of European transactions in 2015, but 20.5% of their total value. In 2014, the Republic of Ireland again featured in 3.6% of European deals but contributed just 12.7% to their overall value.”

So conservatively, let’s say 1/3 of Ireland bought last year and, say 1/5 in 2014… that’s half the country economy in two years.

But how on Earth can a little country like Ireland attract such a level of financial activity? Why, remember that magic word… ‘inversions’ - yes, that same word that out Government denies applies to Ireland.

Well, Experian provides a small insight (they wouldn’t tell us the full story, but they can’t quite escape from telling us some. Enjoy the following: per Experian, Top 5 “Irish” deals announced in 2015 includedd:

• Pfizer-Allergan at EUR143.564 billion
• Teva Pharma - Generic drug business of Allergan at EUR35.454 billion
• Shire - Baxalta at EUR29.533 billion
• Willis Group Holdings - Towers Watson deal at EUR15.566 billion, and
• CRH - Holcim & Lafarge deal at EUR7.671 billion

So, yep: tax inversion at the top, related to tax inversion at No.2, tax inversion at No.3… and none (repeat - none, including CRH deal) related in any way to Ireland, except for tax domicile of the companies involved.

Repeat with me… “There are no tax inversions into Ireland”… now, with zombie like intonation, please… “There are no…”

10/12/15: Europe's M&A activity lowest in 17 years

While the U.S. companies are gorging themselves on M&As (see post here: http://trueeconomics.blogspot.ie/2015/12/71215-another-nothing-to-see-here-chart.html), while shying real organic investment (see post here: http://trueeconomics.blogspot.ie/2015/11/141115-more-evidence-us-capex-cycle-is.html), Europe's 'repaired' economy is shying away from both.

Europe's M&A cycle is weak - second weakest for the period of 1998-2015:

Which makes for some interesting reading, especially when one realises that most recent quarterly growth in Europe was underpinned by domestic demand and inventories build up... Time for ECB to start buying companies outright...

7/12/15: Another "Nothing to See Here" Chart for M&As

I have written over the recent months about the over-heating present in the global (and especially N. American) M&A markets (see posts here,  here and here) so it is only reasonable from continuity perspective to post some more data on the subject. Here it is :

Source: @Jim_Edwards

Looking at the volumes of M&A deals since around the start of 2Q 2014 through today, one cannot escape a simple conclusion: absent organic growth in revenues, and with shares buy-backs now being discounted in the markets (belatedly awakening to the reality of unsustainable valuations in the equity markets), current levels of M&A (over at least 18-21 months period) are simply, certifiably, clearly bonkers.

14/11/15: More Evidence U.S. Capex Cycle is Still Lagging

In a recent post (link here), I covered the issue of shares buy-backs and the lack of capex at the S&P500 constituents level. A recent report by Credit Suisse titled "The Capital Deployment Challenge" takes a look at the same problem.

Per report: "Companies in the US market are currently in great health as corporate profitability is approaching historical highs. This high level of profitability has produced record levels of corporate cash, and thereby has created a challenge for managers: how to allocate all of this excess cash. Companies may choose to reinvest in their businesses – organically or through M&A – or they may return the cash to capital providers, through dividends, share buybacks or by paying down debt..."

"Historically, companies have deployed an average of 60% of cash flows in capital investment (28% in organic growth and 32% in M&A) and have returned  26% to shareholders (12% dividends and 14% share buybacks). In the past several years, the capital allocation balance has swung away from growth towards buybacks and dividends: capital invested has dropped to 53% (27% organic growth and 26% M&A), while cash returned to shareholders has increased to 36% (15% dividends and 21%
buybacks)."

A handy chart to illustrate the switching:

So Credit Suisse divide the S&P500 universe into two sets of companies: reinvestors and returners. The former represents companies which predominantly direct their cash balances to organic reinvestment and/or M&A, whilst the latter are companies that prefer, on balance, to use cash surpluses for dividends and/or shares buybacks.

The report looks at three metrics across each type of company: underperformers within each group - companies that underperformed their peers average in terms of total shareholder returns, outperformers - companies that outperform their peers average, and average across all companies.

Chart below shows the extent of differences across two types of companies and three categories in terms of cash flow return on investment (CFROI):

The chart above "shows that the initial level of returns on capital is generally lower for reinvestors than for returners, with an average of 9% and 11%, respectively. The reinvestors and returners who outperformed their peers both improved their CFROI. However, the outperforming reinvestors generated a greater operating improvement (180bps vs 150bps for returners)."

Which is all pretty much in line with what I said on numerous occasions before: no matter how you twist the data, average returns to not re-investing outpace returns from investing. Meaning that: either companies are getting worse at identifying and capturing investment opportunities or investment opportunities are thin on the ground. Or both...

11/11/15: Take a Buyback Pill: U.S. Corporates Shy Away from Capex

As buy-backs of shares inch down as the drivers of U.S. stocks valuations (chart below), things are not going much smoother for the hopes of a capex cycle restart in the U.S. corporate sector.

As the following chart from Goldman Sachs research shows, 2015 has been shaping up as yet another year of decline in investment pipeline for U.S. companies. Capex and R&D investment share of aggregate cash holdings by S&P 500 companies is expected to hit 41% this year, down from 47% in 2014 and 2013 and marking the lowest reading since 2007. Worse, Goldman expects 2016 figure to be even lower at 40%.

Goldman figures relating to ‘Investment for Growth’ indicator include M&As, which in my opinion should not be considered in this context, as success rate of M&As is extremely low (historically at around 30%) and current M&A valuations are frankly bonkers. 

H/T to @prchovanec

Take a look at stripped out mix of real investment against buybacks in ratio terms, per Goldman’s reported data:

As shown above, relative weight of shares buybacks in terms of cash allocations by U.S. carpets has been on the rising trend now in comparison to Capes & R&D spending since 2009 and it has been flat since 2010 on for the ratio of buybacks to dividends. In fact, combined weight of M&As and buybacks ratio to Capex & R&D is now at 0.98, the highest since 2007.

In simple terms, there is little indication in the Goldman (and other) numbers of any restart of Capex cycle and all indication, major U.S. corporates are living in a world of surplus liquidity and shortages of investable strategies and opportunities. 

21/5/15: Global M&A and Economic Fundamentals

Here are some select slides from my presentation at this week's Alltech's Rebelation conference in Lexington, KY.

14/1/2014: Irish M&A activity in 2013

Irish M&A values rose strongly in 2013, according to the Experian data.

• "Total number of Irish Mergers and Acquisitions and Equity Captial Market deals in 2013 was 254 - a decline of 15.1% from the 299 deals announced in 2012". 
• "The total value of deals for the year, however, increased significantly led by a spike in the number of mega (€1bn plus) deals. Transactions worth €38.590bn were announced in 2013, up by 39.1% from 2012’s €27.734bn worth of deals."
• Core mega-deals were split between pharma manufacturing and financial services
• "The Republic of Ireland represented approximately 2.4% of the total volume of all European transactions in 2013, and accounted for 4.9% of their total value. In 2012, the Republic of Ireland featured in 2.9% of European deals and contributed 3.6% to their total value."
• There were 37 large deals (over €120mln) announced in 2013, up by 32.1% on 2012’s total of 28 transactions; the twelve large deals announced in Q4 represented the busiest quarter in the large deals value segment since Q4 2006. Large deal values were up from €24.687bn in 2012 to €35.846bn in YTD 2013, a rise of 45.2%. The largest announced deal in 2013 was Perrigo Corp’s acquisition of Elan Corporation Plc for US$8.6bn.
• Mid-market (€12-€120mln) deal activity declined; 43 transactions were announced, down by 35.8% from the 67 deals announced in 2012. The aggregate value of mid-market deals fell by 34.4%, from €2.803bn to €1.840bn. Notable mid-market deals in 2013 included Dublin electronic payments business Payzone sell Cardpoint Ltd, to Houston-based Cardtronics Inc. for €119mln.
• The number of small deals (under €12mln fell by 11.1% on 2012’s figures; down from 54 to 48 transactions. The aggregate value of small transactions also fell - by 26.3%, from €243mln to €179mln.
• Largest by sector was - manufacturing. In 2013 accounted for 43.3% of deals; however, deal volumes here were down by 27.1% (from 150 in 2012 to 110 in 2013). 
• Second most active sector: wholesale, retail & repair, activity declined by 41.6%.
• Post and telecommunications sector saw 114% upturn in activity. 
• Social and personal services sector activity rose 76.5%. 
• Research and development sector activity was up 53.3%.  

Internationally:
"Europe saw a slight reduction in transaction volume in 2013 (from 10,500 to 10,476 deals), but an upturn in deal value, from €754.7bn in 2012 to €786bn, an increase of 4.1%."

"North American deal volumes were down by 28.7% (from 8,283 deals in 2012 to 5,908 in 2013), but the aggregate value of transactions was up by 1.3% year-on-year, to €939.7bn. North America returned strong activity in its manufacturing and information technology sectors in 2013."

"Asia-Pacific region ...volume was down 25.2% (from 8,822 deals in 2012 to 6,602 in 2013), without the associated increase in value recorded in the US and Europe (total deal value slumped from €616.9bn in 2012 to €385.6bn in 2013)."

See more on the subject here: http://www.experian.co.uk/assets/consumer-information/white-papers/corpfin/cf-monthly-review-dec-2013.pdf

A chart to illustrate: