Cultural incompatibility, poor due diligence, overestimating synergies, and paying too much are just some of the reasons why throwing two businesses together may not be in the best interest of shareholders.

Market participants should always react cautiously when they see the latest merger announcement. The many cautionary tales – America Online and Time Warner, Microsoft and Nokia, Google and Motorola, Rio Tinto and Alcan – serve as stark reminders of the potential pitfalls of M&A activity.

That said, equity investors can enjoy a short-term windfall if a cash bid comes at an attractive premium to the market price. The share price often rises to close the gap with the offer price, helping drive markets higher.

M&A expectations…

Last year, pressure on financial markets, fragile macroeconomic confidence, and rising interest rates contributed to a subdued year for dealmaking. While things improved throughout the year, 2023 still saw the lowest deal volume since 2013 [1].

But the prospects for M&A brightened at the start of this year amid renewed expectations of lower interest rates and generally stronger markets. Lower rates provide cheaper financing for takeovers, helping to fuel activity.

Major announcements – including Endeavor Energy and Diamondback Energy, Ansys and Synopsys, and the failed BHP and Anglo American talks during the first few months of this year – seemed to support the view for a marked rise in corporate activity.

…a work in progress

At the half-year mark, interest rates had not come down as quickly as expected, and the stronger M&A trend didn't continue into the second quarter.

Merger announcements trailed those from the first quarter amid fewer big deals and completions. However, this is unlikely to be the end of the story, and we need not necessarily view this as a negative even if it was.

Lower interest rates are just around the corner, even though the timing and cadence of this much anticipated monetary easing remain unclear.

Meanwhile, given our uncertain world, corporate leaders may be more disciplined and more focused on shareholder value.

Many companies around the world are in a sound financial state – so increasing dividends and share buybacks can be a less risky way for management teams to enhance shareholder value.

Buybacks strike back

Share buybacks – when companies buy their own shares to reduce the number of shares in the market – were once considered a form of market manipulation. In fact, they were illegal in the US until 1982.

Whether you hold that view or believe they are a force for good, what’s clear is that they have become a common capital allocation tool and a significant source of demand for US stocks.

Last year, companies in the US spent US$795.2 billion buying back their own stock [2]. If we include dividends, total shareholder returns in the US totalled some US$1.4 trillion in 2023 [3]. Over the past several years, we have seen the US shareholder value ethos, and the use of buybacks, spread to other parts of the world.

For example, the UK market has been one of the more enthusiastic adopters of buybacks outside the US. Two big UK energy companies, BP and Shell, have reduced their share counts by 18% and 16% respectively over the last few years [4].

Big in Japan

On the other side of the world, a significant driver of the Japan stock market’s dramatic resurgence has been a renewed corporate focus on enhancing shareholder value through increased dividends and share buybacks.

In the first six months of this year, buyback announcements by Tokyo Stock Exchange Prime Market index constituents reached a new high of 7.7 trillion yen (US$47.7 billion) – more than 50% higher than the amount announced over the same period a year earlier [5].

Elsewhere, emerging markets are coming from a significantly lower base in the use of buybacks. That’s why they could see even more significant growth in this area. Buyback activity in Mexico increased by 156% in the 12 months to June this year [6].

Final thoughts

I asked whether M&A and buybacks would drive the performance of equity markets. It’s probably fair to say that a more likely outcome at this point is that they would help fuel them, but alongside other factors.

Ultimately, solid fundamentals, structural tailwinds and transformational technological opportunities should be far more significant drivers.

That said, an increased focus on shareholder returns will provide support, particularly in markets outside of the US. 

M&A will undoubtedly rise again in the future. However, when mergers become a significant performance driver, it may be a cause for concern – as memories of past missteps return to haunt us.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.