Caution pays off for European investors
Investors have received billions of euros from European companies so cautious about the economic outlook they could find nothing better to do with spare cash, but many now want boards to snap up rivals instead - and are rewarding them when they do.
Years of financial crisis meant companies used any surplus first to pay down debt and then keep shareholders sweet with dividends and share buybacks.
They spent nearly US$3 trillion ($3.7t) on buybacks globally since 2008, Thomson Reuters data shows, a rise of more than US$150 billion from the 2002-2007 period.
Now the pressure is on firms to put excess cash to work.
European M&A is down nearly a quarter on last year to US$511b, according to Thomson Reuters data. But globally, the shares of active buyers have enjoyed their best run since the financial crisis kicked off, beating quiescent peers by 4.7 percentage points, say consultants Towers Watson.
UK engineer Kentz, for example, rose 13 per cent after buying US firm Valerus Field Solutions, and French retailer Carrefour beat its sector, up 1.9 per cent, on the day it announced plans to buy 127 malls from real estate group Kleppiere.
While the share price of the target company usually rises to reflect the attractive premium a suitor typically has to pay to secure a deal, it is less common for the buyer's stock to gain.
"The share prices of buyers have generally reacted positively to the announcement of acquisitions this year.
"That shows that investors want companies to put money to work and not to hoard cash," said Wolfgang Fink, head of investment banking at Goldman Sachs in Germany and Austria.
For companies worth $1b and more, JPMorgan research puts that hoard of cash or cash equivalents at $5.3t globally, up from $5.2t in 2012.
Swedish telecom Ericsson, for example, was carrying net cash of 24.7b Swedish crowns ($4.6b) at the end of the third quarter, while carmaker Volvo had 20.8b crowns.
And in a sign that a broader range of investors expect more deals, hedge funds that bet on the outcome of M&A - and need a healthy stream of deals to make money - have pulled in US$16.4b ($20b) this year after seeing $6.6b take flight last year.
Christer Gardell, co-founder of Cevian Capital, one of Europe's largest activist investors, told Reuters last month he expected rising corporate confidence to spark a burst of deals.
The dilemma for many firms is what to buy.
Executives remain wary after being forced to write down the value of assets bought pre-crisis, and while the economic outlook is improving, it is patchy and slow.
"Assuming the economy is getting better, there are a fair number of companies sitting on cash that should be employed more gainfully," said Nick Williams, head of Baring Asset Management's small and mid-cap equity team, which has £1b ($2b) in assets under management.
Recent earnings suggest buyers will be well served by a sceptical eye when assessing value.
European companies lagged expectations on both revenues and profits in 2013, and many analysts said earnings growth needed to improve in order to see European share indexes add much to the double-digit gains many are sitting on this year.
While some firms will invest in upgrading existing assets, still-weak demand in many sectors means companies have to be careful not to add capacity where it is not needed.
"Investing and adding capacity can be dangerous in times of relative economic uncertainty because you don't really know if there is enough demand to absorb this extra capacity," said Hernan Cristerna, global head of M&A at JPMorgan.
"But if you keep returning cash to shareholders, you then take the risk of compromising the future."
The safest bet for many boards looking to hit the spot for investors would be to focus on smaller deals, said Ed Shing, global equity portfolio manager at BCS Asset Management.
"People are prepared to stump up money for a sensible deal where you're not paying a ridiculous multiple - big taking over smaller, where the valuations are still reasonable, particularly in Europe."
And when pitching the financial logic of the deal, boards had better focus on more than just earnings, said Bertie Thomson, senior fund manager at Aberdeen Asset Management.
Picking a point when the merged company finally contributes to the bottom line is a favoured point of reference for executives looking to justify a deal, but as most deals should boost earnings, investors are more concerned with the return on each pound, euro or crown spent by the company.
Deals should improve your return on capital, Thomson said.
"Some companies do it better than others, but it's still quite amazing how many focus more on earnings accretion than on returns."