What the Pickup in Mergers Means for Investors

When companies start disappearing, it's usually not a sign of economic recovery—except when they’re getting snapped up in mergers. That's what's happening now, and it’s a positive development for investors, even if their portfolios don't include the latest dancers in the M&A waltz.

In the last days of summer, more than $24 billion worth of merger deals have been announced or proposed, including Kraft Foods' (KFT) rejected $16.7 billion takeover bid for U.K. candymaker Cadbury (CBY), Walt Disney's (DIS) $4 billion pickup of Marvel Entertainment (MVL) and Procter & Gamble's (PG) $3.1 billion sale of its prescription drugs unit to Warner Chilcott (WCRX).

The pickup in deal-making is music to Howard Lanser's ears, particularly after the discordant screech of the capital markets grinding to a halt after the collapse of Lehman Brothers a year ago Sept 15. Lanser, the director of mergers and acquisitions at investment firm R.W. Baird & Co., called the period from November through March "the worst we've ever seen" for M&A activity.

The near-meltdown of the financial system not only froze the channels of capital that financed a frenzy of buyouts in 2007, but made future deals all but impossible as many companies stopped forecasting their own financial results on the brink of the economic abyss.

"We couldn't even forecast in 2009," Lanser said. "To do valuations, you need to have reasonable confidence in what you're buying, and this was a very big black cloud hanging over the market."

While deal volume is still well short of where it was a year ago, LPL Financial's chief market strategist Jeffrey Kleintop sees the resurgence as a sign the economy is well past its most dire point. The capital markets are lending again – albeit at a higher price – but the benefits won't just line the pockets of discredited investment bankers, Kleintop is telling clients.

"We believe the recent upturn in merger and acquisition activity may be a sign that the improvement in the economy and credit markets has been sufficient to restore enough confidence to lift business spending," he wrote in a Monday note to clients. "In the past, a revival in M&A deals was a sign that businesses were ready to prepare for growth by hiring workers. During the last cycle, job growth finally turned positive in the fourth quarter of 2003 – the same time M&A activity revived."

Carsten Stendevad, head of the financial strategy group at Citigroup, said the time is ripe for a wave of hostile takeovers undertaken by the cash-rich survivors of a harrowing time for many companies. The value of hostile takeover bids world-wide hit $81 billion in the second quarter, more than six times that of the first three months of 2009.

"Corporate valuations remain low for many firms and takeover defenses have weakened considerably over the past few years in response to pressure from corporate governance reformists and activist investors," he wrote in a Thursday note. "At the same time, the reopening of credit markets has allowed buyers to raise substantial liquidity."