You’re not just imagining things if you feel like merger and acquisition activity is one of the few areas of this market providing excitement to investors.
Year-to-date the S&P 500 is up just 1.2%. And the S&P 600 small-cap index, which is typically more exciting to follow, is up just 1.1%.
But nearly every day we’re hearing about some deal that is helping to sustain investor interest in an otherwise choppy market.
There has been a ton of action in the health care industry too, where a trend toward “bigger is better” is driving deals aimed to pool resources and technologies in the new Affordable Care Act world.
There’s been an M&A boom in the small-cap arena too. I’ve talked about U.S. Concrete (NASDAQ: USCR) a number of times, and how this company is accelerating growth by buying up ready-mix concrete companies in the fragmented industry.
WhiteWave Foods (NASDAQ: WWAV) is another small-cap stock that I follow which has been on the prowl. The consumer packaged-food company just purchased Vega, a nutrition food company, for around $550 million. And it recently announced plans to acquire Wallaby Yogurt for around $125 million. I like both of these deals.
The most likely reason behind the M&A trend isn’t all that difficult to understand – companies are under pressure to deliver growth in a mature bull market that persists, despite lackluster economic growth.
It’s also likely that an abundance of cheap capital is helping to fuel what’s likely to be an 11% increase in M&A activity in 2015. That’s the growth rate pinned on the deal market by Intralinks (NYSE: IL) at least, and it’s in a good position to make such a prediction.
Intralinks develops technology that passes financial information along from potential sellers to potential buyers. Just two weeks ago The Wall Street Journal reported that “based on ongoing ‘due diligence’ efforts” Intralinks predicted an 11% increase in activity over last year.
Just over a week ago data provider Dealogic stated that should the current pace of activity continue, takeover-deal activity would hit $4.58 trillion this year. That would be above the record $4.29 trillion in deals inked in 2007.
Unfortunately, 2007 was another year when an abundance of capital was sloshing about the globe. And we all know what happened in the years that followed.
That said, investors can take some comfort in the reality that many recent deals don’t seem ridiculously expensive. I haven’t analyzed the Precision Castparts deal, but I would expect that Buffett and his team would have pretty sharp pencils, even if the deal is the biggest in Berkshire’s 50-year history.
Finding the Right Deals
But there are other deals that I have analyzed more closely. And the most recent one involved a financial services and data-related stock that I recommended to Game Changers subscribers a month ago.
That company is Yodlee (NASDAQ: YDLE), and it’s a pioneer in the financial applications – or FinApps –industry.
Consumers are turning to Web-based financial applications in droves to handle banking, investment management, loan fulfillment and a wide variety of other financial and transactional-related activities. Yodlee has been one of the companies helping to drive this disruptive shift in consumer behavior.
The company services the small business, retail banking and wealth management industries. Its products span money and risk management, mobile solutions, big data and money movement.
Clients purchase a subscription to a variety of Yodlee’s FinApps. In most cases the consumer-facing product has been customized to fit the client’s brand, but the underlying software’s building blocks are common to the Yodlee platform.
Yodlee’s platform connects directly to over 14,000 data sources and 20 billion end users, meaning it is pulling in a massive data set from which to power analytical solutions for clients. This data can be screened, cleaned and packaged into analytics reports that show anonymous spending and behavioral patterns.
This data set is one of the assets I really liked. And it is likely one of the leading reasons Envestnet (NYSE: ENV), a wealth management technology and services company, offered to pay a 50% premium for Yodlee on Aug. 10.
I won’t get into more details on these two companies, since what I really want to focus on is the valuation of the deal, and the erratic market action following the announcement. Because I think it’s an interesting example of what can happen when the market isn’t exactly ecstatic about a proposed deal – even when, by most accounts, it should be.
Envestnet and Yodlee announced a takeover agreement that valued Yodlee at $18.88 per share. That price represented a 50% premium to the stock’s prior day’s close, and it implied an enterprise value of around $588.6 million.
At that price we were looking at a takeout enterprise-value-to-sales ratio (EV/sales) of 4.4, based on estimated 2016 sales.
As a point of reference, prior to the deal, and not including the Yodlee acquisition, shares of Envestnet traded with an EV/sales ratio of 3.0, based on estimated 2016 sales.
The takeover valuation was around the current value of other specialized subscription software companies with 20%-plus annual growth, so the deal wasn’t bad. It wasn’t a huge premium, but it wasn’t bad.
But things haven’t exactly gone smoothly since.
On the day after the deal was announced, shares of Envestnet traded down by 30%. This meant that the resulting rise in Yodlee’s share price wasn’t the 50% bump the takeover price suggested. Instead, the stock only traded up by 29%.
Now, I know if you weren’t watching this all unfold you may not care all that much. I was expecting a bigger gain for my subscribers, so I cared very much (though to be fair, I also wasn’t entirely disappointed that a gain of around 30% was on the table after less than a month).
Whether you had skin in this game or not, I think you should care though. Because here we have what appears to be a very fair takeover deal that the market has somewhat rejected.
And while there are certainly company-specific factors at play, I look at what has happened in the market recently and I wonder if the lack of excitement in this deal is symbolic of waning interest in the M&A boom.
I know that investors are concerned about what’s going on overseas in China, Europe and elsewhere. And I know that we’re all on the edge of our seats waiting for the Federal Reserve’s first interest rate hike. Add to this the increasing number of severe stock price drops in recent weeks, and it all adds up to a very, very challenging market. Despite all that’s good in the market – including near record M&A activity, an extended bull market run, low interest rates, and so on – the stock market itself is feeling increasingly fragile.
Is this the beginning of a new trend? Are we going to move from a sideways market to a downward moving market? I’ll be the first to admit that I don’t know.
But I have recently recommended that subscribers to Game Changers lock in some profits, just in case. These included selling out of Yodlee for a 20.4% gain, as well as selling half of their holdings in three other stocks.
Our average gain on the four sales was 218%, so clearly we had some pretty good profits that we wanted to hold on to.
There are still growth stocks out there that I think you can buy now. But I think the really good opportunities are becoming fewer and farther between.
So my best advice this week is to be careful out there, and try to think about what the market’s big trends are suggesting will happen in the near term – and perhaps focus less on what they say about the past.