What does the boom in mergers & acquisitions tell us? A conversation

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Houlihan Lokey, one of the biggest Los Angeles-based investment banks, is heavily involved in advising companies on mergers and acquisitions. Money & Company sat down with the company’s co-CEO, Jeff Werbalowsky, to talk about the recent surge in activity in the M&A market. Some of the action has clearly been motivated by the possible increase in the capital gains tax on Jan. 1, which means that people who sell their company after Dec. 31 will be hit with a higher tax rate -- 20% -- if Congress doesn’t extend the current 15% rate. But is that all that’s behind the activity? Here is an edited transcript of the discussion.

Money & Company: We’ve seen a mini-boom in mergers and acquisitions of companies -- do you think that is just ramping up or about to peter out?

Jeff Werbalowsky: I would say that there’s an artificially induced component because of the probable expiration of the capital gains tax rate. Our deal flow really has got a flavor of, “‘Let’s get it done by the end of the year, because who knows what the tax law will be next year.’”

But in addition to that, there is such a desperate hunger for yield that money is fairly abundant.

A year ago people were whining and moaning that banks weren’t lending. Now, people in a scramble for yield are trying desperately to get money out. Ask any finance company and they will say, “We are getting more money in than we are able to get out.”

The first issue -- the tax issue -- that’s going to stop December 31.

Because of that I think you’re going to really have a peak between now and December 31. But I used to think it was going to be a very slow first quarter next year. I’m not so sure now because there is a lot of money out there looking to finance deals.

MC: If a family owned company wanted to sell itself before December 31, is it too late?

JW: If you came to us right now and said, ‘I want to sell my company before year end,’ it’s going to be a real scramble, because even if it’s a great company, you have to find a buyer and you need to find financing.

I predict that the financing companies will be overwhelmed in the last 60 days of this year.

MC: What does the activity in the mergers and acquisition market tell us about the broader economy right now? Is this the sign of financial recovery?

JW: An M&A boom in and of itself is indicative and I believe supportive of a positive economic recovery. By many indices the underlying economy is far from robust, however -- it’s more an indicator that people don’t think the world is coming to an end financially, and an artifact more of monetary policy than economic activity.

It’s amazing what has happened. We were sitting here just two years ago and we weren’t sure whether we were going to be able to maintain the banking system. Now we’re seeing this weird recovery that I’ve never experienced before, where confidence in the financial system has returned in spades, fears have all but vanished and there is an unimaginable volume of nearly free money that is on a yield-hunting mission.

Whatever gripe you have with the powers that be, we are not bartering canned goods and ammo, so they did something right in dealing with what was a scary crisis. But of course in today’s world, not only is hindsight 20/20 but memory extends only to about last week in the financial markets.

MC: When does all the financial activity happening right now translate into progress for the consumer?

JW: I’m not sure it does. The basic problem is that although many corporations have deleveraged, or will, we’ve overspent our resources and have become materially overleveraged at every meaningful level. The consumer level, the municipal level, the state level and the national level. Our drive for instant gratification over the years will soon require sacrifice and underconsumption over an extended period of time -- something that our society appears wholly unable to embrace voluntarily.

What’s going to happen? I’m not smart enough to tell you how, but over the next decade we’re going to have to save and invest more money than the goods and services we get -- and that’s going to create sacrifice and some disappointment given current expectation levels for social goods and services. People hate to hear or experience that.

There’s of course an optimal approach that would minimize the pain, but the fact that we have failed to address a large but relatively simple problem like Social Security is not a good harbinger of things to come. Over the next 10 years, we have some real work to do to get ourselves fiscally and socially healthy.

-- Nathaniel Popper