MorningWord 10/13/15: The Urge to Merge

by Dan October 13, 2015 9:31 am • Commentary

Yesterday, I touched on the Dell/EMC mega deal that spans across computer hardware, services & software (A Shell Game of Declining Levered Assets).  To sum up, the combination of these two companies in such a complicated structure, involving tracking stocks, soon to be ipo’d divisions and a mountains of debt, seems odd at this stage of the tech, economic and credit cycle.

Yesterday in the NYT’s DealBook column, editor Andrew Ross Sorkin poses the question, In a Flurry of Deals, the Beginning of the End?.  Sorkin points out that “Mergers and acquisitions are on track for a record year. So far in 2015, there have been nearly $3.5 trillion worth of transactions, according to Thomson Reuters.”  He goes on to suggest that the two deals announced yesterday, including Imbev for SabMiller, are “are far more logical than pie-in-the-sky deals driven by illusory goals or fantastical synergy claims, such as the infamous AOL-Time Warner merger in 1999, widely considered the worst deal ever. We haven’t seen anything that silly — yet.”

A fear of toppy m&a has been on most investor’s minds, as it was when Facebook  agreed to pay $22 billion for WhatsApp, a text messaging app with NO revenues in February 2014, or in may 2014 when AT&T agreed to pay $49 billion for Directv, or when Heniz agreed to buy Kraft for $45 billion in March, or in April when Teva agreed to pay $51 billion for Mypan, or when Charter agreed to pay $80 billion for Time Warner Cable or also in May when Avago agreed to pay $37 billion for Broadcom.   You get the point.  Mega deals have become a thing. And they will likely remain as such until borrowing costs make them unsustainable.

The most important takeaway from Sorkin’s article was a quote from the CEO of DELL/EMC arch rival, Meg Whitman of HPQ. From an email to employees yesterday:

“To pay back the interest on the $50 billion of debt that the new combined company will have on their balance sheet, Dell will need to pay roughly $2.5 billion a year in interest alone…….That’s $2.5 billion that they will allocate away from R.&D. and other business-critical activities, which will keep them from better serving their customers.”

That’s an interesting comment from a CEO who has presided over most of the earnings and sales decline of about 20% from their peaks in 2010. Whitman has given into investor pressure the other way and has split up hardware and services into two separate companies.

Mega deals are going to continue to be a thing, until one of the proposed deals, possibly the DELL deal can’t close due to “market conditions”. That’s likely to mean a higher rate environment, or one with weakening global economy.

Switching gears away from the massive to the meager. I could see a newly focused but split HPQ look for growth engines for their slower growing hardware group.  If 3-D printing is still a thing, then a manufacturing company like Stratasys (SSYS), with an enterprise value of $1.25 billion, and $745 million in expected sales this year (this could end up being below $700) seems like one way for HPQ to speed their entry to the market. At  their recent analyst meeting on Sept 15th, HPQ placed specific emphasis on this as a growth area.

The recent rally in beaten up stocks made one thing apparent, there is investor appetite at a price.  Shares of SSYS have risen about 25% from their 52 week and multi-year lows on Oct 2nd, and while that seems like a lot, remember that the stock is down 75% from its all time highs made in early 2014. And it has 27% short interest. These types of stocks will be interesting to keep an eye on. We would be more inclined to pick spots in beaten up, small, potential targets, than try to figure out which two large pieces of crap are gonna try to combine. Just saying.

Oh and one other name, given all the m&a in semiconductors this year. Ambarella (AMBA), maker of video compression chips that go into GoPros and other industrial uses has an enterprise value of $1.6 billion (41% short interest) and could also be a very easy tuck in for a larger cash rich company like Qualcomm or Texas Instruments.