If you look back on the history of mergers and acquisitions, you'll see a lot of notable trends. In the 1950s and 1960s, it was the building of conglomerates. In the 1980s, it was the leveraged-buyout craze (financed by Mike Milken's junk bonds). And in the 1990s, it was strategic deals.
After the bust in the equities markets in 2000, though, the M&A market had its own meltdown. But there has been an M&A revival in the past few years, including a particularly strong 2005. Now, according to a survey from the Association for Corporate Growth, a trade organization that focuses on M&A, it looks as though 2006 will also be a stellar year for M&A, too.
While M&A in 2005 was dominated by private-equity firms -- such as KKR, Blackstone Group, and Bain Capital -- expect to see an increase in strategic deals from big-cap companies in 2006.
It's no easy feat for large caps to grow -- after all, they already dominate their markets -- so growth through M&A makes sense for these companies. Besides, they're flush with cash reserves, and prospective targets are still attractive in terms of earnings multiples, since the equities markets have been lackluster over the years. There are also appealing valuations in other parts of the world, such as Europe and Canada.
Another key factor if big-cap M&A does become a trend is that the economy continues to grow, despite recent shocks to the system such as Hurricane Katrina. In addition, interest rates seem to have peaked. Yes, the rates have increased, but they have been largely confined to short-term rates -- almost creating an inverted yield curve. As a result, credit is still relatively cheap for long-term debt -- the very kind of debt used to finance M&A deals.
This is all good news for investors. But how do you find a potential buyout candidate to invest in? Well, that's the tough part. In fact, it's usually a bad idea to buy a company based on a buyout rumor alone. Focusing on quality companies is always a good approach -- and those companies often make attractive buyout candidates.
But there's also another way to capitalize on the M&A boom: Buy into companies that provide M&A services, such as investment banks Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MWD).
Of course, those banks also engage in other lines of business. If you want a pure-play M&A house that may be more attractive to clients (since it doesn't have any potential conflicts of interest), take a look at Lazard (NYSE:LAZ) or Greenhill (NYSE:GHL). They both have long-standing relationships with their clients, and their deal-making teams are top-notch.
Keep in mind that M&A is cyclical and that, if the economy stumbles, pure plays like Lazard and Greenhill will probably not be spared. Going into 2006, though, it looks like more of the same for M&A, which is good news for investors.
Fool contributor Tom Taulli does not own shares of companies mentioned in this article.
