This New Trend Has Me Worried

Everywhere you turn, merger and acquisition activity is kicking into high gear. Dell (NASDAQ: DELL  ) , a personal holding of mine, agreed earlier this month to the largest leveraged buyout since the recession at $24.4 billion. This was followed a week later with a merger announcement between US Airways (NYSE: LCC  ) and the currently bankrupt American Airlines. Yesterday, following a three-day weekend, we learned that office supply retailers Office Depot (NYSE: ODP  ) and OfficeMax (NYSE: OMX  ) are in advanced merger discussions with a deal that could be expected as early as this week.  

Many investors have praised the return of M&A activity, as it's often a sign that businesses see both a return to growth and economic clarity. As for me, I'm scared to death!

Outside of quipping to friends that these latest two combinations are going to create two horrendously bad companies -- I encourage you to check out my analysis of the US Airways-American Airlines merger -- the only assumption I can draw from the latest round of M&A is that it's being done entirely out of weakness. And mergers out of weakness aren't anything to be excited about!

Starting with Dell, its two largest shareholders behind Michael Dell, including Southeastern Asset Management with an 8.5% stake, and T. Rowe Price with a 4.4% stake, have both publicly denounced the deal as too low. Dell, which is in the midst of a multiyear turnaround that will see it transition from a PC maker to an information technology company, is valued at a mere seven times forward earnings and less than six times cash flow – a pretty inexpensive mark, historically, for a company with plenty of cash on hand. Although I'm up handily on my own purchase, I feel slighted by the perceived "cheapness" of the deal as well.

Next up is the US Airways-American Airlines merger, which can't be construed as anything but a merger out of weakness. US Airways has declared bankruptcy twice since 2002 and AMR once, so how putting these two airlines together makes sense seems to have gone over my head. My Fool colleague Tim Beyers offered his perspective last week on the merger, but I continue to stick with my assessment that a transition is occurring in the airline industry whereby regional airlines, which are logistically and financially more nimble, are going to once again drive national carriers into bankruptcy if they don't downsize. This deal is exactly the opposite of the solution that I see as necessary to resolve their woes.

Finally, yesterday brought us news that perpetual underperformers Office Depot and OfficeMax might soon be joined at the hip. What happened on the release of this news? Both stocks shot up, as expected; but a more interesting tidbit was that Staples (NASDAQ: SPLS  ) shares rocketed higher as well, by 13%. It might seem rather odd that the main rival of an Office Depot-OfficeMax merger would head higher, but consider that merger-related integration troubles and store closures associated with their synergy would work in Staples' favor by allowing it to acquire more customers and, dare I say, take even more market share from this less-than-dynamic duo.

Make no mistake about it, this M&A activity being orchestrated out of weakness is a scary sign and not one to be excited about. Consider yourself warned!

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  • Report this Comment On February 20, 2013, at 2:39 PM, TMFMorgan wrote:

    Sean, shouldn't M&A based off of "strength" be more worrying? (AOL/TW in 2000, LBOs of 2007)

  • Report this Comment On February 20, 2013, at 3:40 PM, coolbreeze92 wrote:

    "US Airways has declared bankruptcy twice since 2002 and AMR once, so how putting these two airlines together makes sense seems to have gone over my head."

    Sean, US Airways reported the most profitable year in the company's history in 2012 AND the 2 bankruptcies you refer to were under COMPLETELY different executive management teams than now. How can you make such statements when ignoring the details? Such reporting seems very irresponsible. I welcome your response.

  • Report this Comment On February 20, 2013, at 6:19 PM, TMFUltraLong wrote:

    Morgan,

    M&A of strength doesn't concern me nearly as much as mergers of weakness. There will always be failed mergers in good times, and successful mergers in weak markets.. but to be excited over the M&A activity at companies struggling to survive as a positive doesn't seem right.

    To have 3 occur so close to each other signals to me that business conditions are tougher than anyone realizes and causes me to worry about growth in the interim.

    Sean

  • Report this Comment On February 20, 2013, at 6:24 PM, TMFUltraLong wrote:

    coolbreeze92,

    I could just expound on that statement and point out that every national carrier has gone bankrupt since 2002? Would that make you happier?

    I get the point that you're trying to show that new management will take US Air in a different direction, and clearly 2012's performance was better than anything we've seen, but that doesn't derail my opinion one bit that national carriers should be downsizing not merging.

    Specifically, US Air's net debt, combined with the fact that it doesn't hedge its fuel costs, puts the company in significant jeopardy if fuel prices rise for any extended period of time. I'm not suggesting these other national carriers are any good at hedging, either, because they seem to lose just as much that way as well.

    What I am suggesting is that every national carrier will wind up bankrupt again in 10 years or less if they don't downsize and become more nimble and able to compete with regional and start-up airline services.

    TMFUltraLong

  • Report this Comment On February 20, 2013, at 7:50 PM, coolbreeze92 wrote:

    Sean, I appreciate your response but again it seems you skirt some of the facts. In your response to Morgan you mention the m&a activity between companies struggling to survive ... US Airways is not struggling to survive. Regarding your point about US Airways position on fuel hedging, while the strategy is indeed risky the fact is US Airways has had the lowest fuel costs of the big 4 over the past several quarters if not the past couple years. So in fact those carriers are not "losing just as much that way", they are losing more. Finally, you mention every national carrier has gone bankrupt since 2002 ........ my point is Doug Parker has never led a carrier into bankruptcy and that's why your point is misleading as he and his team will lead the new American. Just a few points to consider.

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