M&A deals, corporate spending to boost equities

Reuters

By Natsuko Waki

LONDON (Reuters) - Growing M&A activity and increasing investment suggest that firms are finally putting their massive cash piles to work, a trend which is likely to give equity markets another leg-up towards the end of the year.

Deals such as Verizon's $130 billion swoop for the rest of its U.S. wireless business have pushed this year's global M&A volume to $1.56 trillion, up 1 percent from the same period last year, according to Thomson Reuters data.

Combined with an uptick in capital spending by U.S. and Japanese firms, they reflect improving corporate confidence which is encouraging companies to spend some of their dormant cash.

That may help give a fresh impetus to world stocks. After hitting a five-year high in May and recovering from a June sell-off, the MSCI world equity index has been trading sideways.

"With an improved economy companies get more confident. And their willingness to spend money increases. It's very positive for equity markets," said Gabriel Bartholdi, strategist at Swiss private bank J. Safra Sarasin in Zurich.

"When companies start to reinvest it shows their confidence for growth. It shows demand is coming back, which will boost earnings."

Since the crisis, corporates have deleveraged and built up a huge savings pile. Companies worldwide now hold $6.7 trillion of cash and equivalents on their balance sheets, more than double the amount a decade ago, according to Thomson Reuters data.

But there are signs companies are starting to spend some of the savings to grow their businesses via acquisitions and also capital investment.

The Verizon (VZ) deal and Microsoft's (MSFT) move to buy Nokia's (HEX:NOK1V) phone business for 5.4 billion euros ($7.1 billion) are high profile examples of the M&A surge.

The benefit of capital expenditure - building new factories or upgrading equipment - often takes years to come through in revenues. Hiring new staff also doesn't offer immediate rewards. But by re-investing in their businesses, companies show they are confident about their outlook and that attitude can also boost stocks in the short term.

In order to fund product development and invest overseas - classic examples of capital spending - social network company LinkedIn (LNKD.N) is raising $1.2 billion by selling shares.

Equity issuance is usually negative for a stock because it dilutes the stock. But LinkedIn shares have actually risen since the announcement, hitting an all-time high on Friday.

JP Morgan estimates nominal capital expenditure of U.S. and Japanese companies rose slightly to $1.2 trillion and 37.39 trillion yen ($374 billion) respectively at end-March from the fourth quarter.

Capex in the United States, Japan, Britain and the euro zone (G4) stood at $2.9 trillion at end-March, slightly lower than late 2012.

"We had been expecting a capex increase in Q1 which did not materialize, which was a disappointment. But there may be a better picture in Q2 or later this year," said Nikolaos Panigirtzoglou, managing director at JP Morgan.

"We should see an increase from Q2 onwards across the G4. M&A and buybacks represent a background support for equity markets."

According to an annual survey by the Association for Financial Professionals, around a third of companies who reduced cash balances cited an acquisition of a company, launch of new operations and increased capex as reasons.

This could prove popular, with a net 64 percent of investors polled by Bank of America Merrill Lynch last month saying companies should be investing more in their business to enhance future growth.

CYCLE MATURING

So far the overwhelming trend for companies shrinking their balance sheets has been to buy back shares and return cash to the shareholders.

Buybacks are an easy choice for corporates and they certainly please investors looking for income in the environment of low interest rates depressed by money printing by major central banks.

Companies worldwide bought back $342.6 billion of shares in the first six months of the year, up 24 percent from the same period in 2012. And JP Morgan's model points to the full-year volume of $535 billion.

However, delaying investment will in the long term slow productivity and limit the capacity for future growth.

Therefore, moving forward in the corporate spending cycle to M&A and investment is a welcome development for equities.

For corporate bonds, however, re-gearing of balance sheets may generate some downside risks, especially in the United States.

"Leverage in the U.S. is likely to keep rising," Chris Iggo, CIO of fixed income at AXA Investment Management, said in a note to clients.

"It is ok to borrow money when the government is borrowing at very low yields. When those yields rise it puts upward pressure on borrowing costs and raises the net interest cost for companies. These are credit negative trends." ($1 = 0.7623 euros) ($1 = 100.0350 Japanese yen)

(Reporting by Natsuko Waki; Editing by Toby Chopra)

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