There has been a flurry of major merger and acquisition announcements, signaling that dealmaking is kicking into high gear in 2024 after a relatively slow start to the year. With interest rates declining, bullish stock markets, and healthy corporate balance sheets, conditions seem ripe for an M&A boom.
The blockbuster deals came fast and furious over the past several days. Capital One made waves by agreeing to acquire credit card rival Discover Financial in a $35.3 billion al stock transaction. The merger will create a credit card giant to rival the likes of Visa and Mastercard. Meanwhile, Walmart sent shockwaves through the consumer electronics industry with its $2.3 billion offer to buy TV maker Vizio. For Walmart, bulking up in electronics helps the retailer defend against Amazon. Truist Financial plans to sell the remaining stake in its insurance brokerage business to an investor group, Stone Point Capital and Clayton, Dubilier & Rice, in a deal valued at $15.5 billion. With this sale, Truist looks to strengthen its core banking business to cope with potentially tougher capital rules. After a spate of large bank mergers in recent years, smaller divestitures like this may become more commonplace.
Head of Morgan Stanley Investment Management Daniel Simkowitz said the firm is “some real data points in the market” on M&A, building on the improved sentiment and backlog of deals the investment bank saw several months ago. “That leads us to believe that 2024 should be meaningfully improved versus last year and that we’re in the midst of a sustainable recovery,” he said. Several industries are seeing particularly fertile M&A conditions, including technology, health care, financial services and consumer markets. Industries undergoing disruption are prime areas for consolidation maneuvers. For example, as banks face pressures from fintech disruptors, they may seek mergers to cut costs and access innovative technologies. Meanwhile, retailers are racing to bulk up to keep pace with the likes of Amazon and Walmart.
Cheap Money Fuels Deals
In addition to lofty stock values, cheap and abundant credit is adding fuel to the takeover fire. The Federal Reserve’s benchmark interest rate is expected to decline to 3.5% by year-end 2024 from 4.5% currently, making it relatively inexpensive for corporations to issue bonds to finance acquisitions. Moreover, banks have been easing lending standards, which helps finance big-ticket M&A deals.
The U.S. economy heads into 2024 with expectations that the Federal Reserve will lower interest rates as inflation appears tamed. This could lead to a bull market frenzy. Wharton Professor Jeremy Segal shared recently, “The Fed has to realize that all its tightness is in the pipeline and will continue to press on the economy in 2024. They must start thinking about lowering rates.” 2023 saw the economy more resilient than many experts had predicted — productivity surged, and so did the stock market. “But we do have a slowing economy now, so we do have to watch out for 2024,” Siegel warns. Six months ago, there was growing chatter about the possibility of a downturn or significant cool-off in 2023-2024. These concerns led to a lull in mergers and acquisitions for much of 2023. However, expectations for a soft landing for the economy have calmed jitters. Continuous Fed rate cuts are expected to elongate the expansion cycle, which is entering its twelfth year.
How to Play the M&A Game – Merger Arbitrage in Discover Stock
For investors interested in merger arbitrage, the Capital One (COF) and Discover Financial (DFS) deal presents a straightforward opportunity. DFS traded around $125.50 at time of the announcement, while the merger values the shares at $139.50 – allowing for potential gains of approximately 11% over the estimated 12 months until the acquisition closes. An investor could buy DFS now to pocket that 11% upside when the deal concludes. Existing COF shareholders could also swap into DFS and exchange back into COF in a year at the higher valuation. Of course, risks exist should regulatory issues arise jeopardizing closure, but market indicators signal confidence in smooth completion.
Unlike a typical cash acquisition, this all-stock merger splits risks across both shareholder bases. If markets broadly crash, DFS holders would face losses despite the nominal premium. But Capital One has exhibited stellar performance recently – Warren Buffett accumulated shares over the past year as the stock doubled the S&P 500’s return. Playing the arbitrage through the deal process allows DFS shareholders like Buffett to benefit.