Broadly speaking, U.S. large cap companies are sitting on some sizable war chests. That’s a positive for investors because it speaks to balance sheet strength and financial flexibility.
Now, with the global economy showing signs of getting back to normal, many cash-rich companies are mulling plans for that capital. Yes, buybacks, in some industries, are back and dividend growth is soaring, but many companies are looking for other ways to spend, including mergers and acquisitions. In fact, some market observers see increasing consolidation as a looming broader market catalyst.
“The next driver of equity share demand is likely to come from merger and acquisition (M&A) activity. Corporate leaders had a ‘deer in the headlights’ reaction to the pandemic last year, choosing to retain capital and engaging in little acquisition and buyback activity,” says Nationwide’s Mark Hackett. “As the environment has improved, corporate cash balances have elevated. Companies now hold over 6.3% of assets in cash—two-thirds higher than the long-term average of 3.8%—and earning virtually no return. Already, we have seen a wave of acquisition announcements, setting the stage for record completions in coming quarters.”
Hackett doesn’t identify specific industries that could be homes to increasing consolidation activity. However, plenty of analysts are already discussing the prospects for elevated biotechnology takeover activity in the back half of this year.
Likewise, there’s already been a brisk pace of mergers and acquisitions in the banking industry this year as still sluggish deposit and loan growth makes consolidation all the more attractive.
With oil prices rebounding and energy companies on firmer financial footing than they were in 2020, there have also been some inklings of consolidation in that industry as well. Yet regardless of where M&A activity ramps up, investors should remember to see the forest through the trees.
“Substantial M&A activity is often seen in the later stages of a market run, making equities very difficult to short and contributing to outsized returns in certain stock sectors,” adds Hackett. “At the extreme, however, it could indicate that companies are struggling to drive organic growth and are willing to take increased risks to drive profits. If that proves to be the case, it would signal that the market rally has become extended.”
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