When a company throws around $19-billion (U.S.) to acquire a start-up with limited revenues and just 55 employees – as Facebook Inc. did when it made a jaw-dropping deal for WhatsApp Inc. several days ago – skeptics see red: Surely, this is a sign that the stock market is overheating.
In some anecdotal ways, the WhatsApp deal does appear to push the limits of deal-making to the extremes. According to Bloomberg News, it marked the biggest deal for an Internet company in more than a decade. It also values a company with an unproven business model above more than half of the companies in the S&P 500, drawing comparisons to the dot-com bubble.
Perhaps most worrisome, supporters of the deal have been forced to reverse-engineer the final price to come up with vague justifications: "If anything, this exercise made me re-appreciate the most obvious and powerful of Web dynamics: Massive global reach at nearly zero marginal cost. Up close, it can be majestic," wrote a Wall Street Journal columnist.
So, if you are looking for evidence of froth, you can definitely find it.
However, many market watchers prefer to look at broader measures of deal-making activity for signs of overheating – and from an historical perspective, things look far from bubbly.
Strategists at Pavilion Global Markets looked at the global value of announced mergers and acquisitions on a quarterly basis, going back to 1999. They have been rising steadily since the bull market in stocks began in 2009, from about $400-billion to the current estimated $639-billion for the first quarter of 2014 – but they are at less than half the levels seen at the peak in 2007, prior to the financial crisis.
The number of announced deals is also well off the peak in 2007, and is at the low end of post-recession periods.
As for prices paid, the Pavilion strategists don't see excesses. In 2014, acquirers have been paying an average premium of 18.9 per cent over pre-announcement values. The average since 1999 is 21.1 per cent.
Their conclusion: "We are always looking for signs of excess in financial markets as they usually herald sharp downturns. However, M&A activity is still far from peak levels and shouldn't be a concern to investors."