A Good Deal of Bad Deals?

MAKE MONEY BLOG$;I'm a worrier by nature. I like to see the glass half-empty and contemplate the next trigger that will make things fall apart.

Do I sound like a perma-bear? I'm not. I know that only seeing the downside has serious limitations. After all, over the very long term, the market has gone up, not down. But that trip upward has been anything but a straight line. Even when the indexes are surging, someone is losing wealth somewhere in the market. I don't want that person to be me--or you, either! So even though my worst-case scenarios rarely come to pass, I'm still compelled to heed those downside risks.

For example, that stock you're eyeing may be able to post explosive revenue growth over the next decade, or it may be betting the farm on an unsustainable business plan. Surely it is a lot more fun to think of all the money you'd make if everything works out rather than worrying about losing your shirt. But accurately assessing the probability and magnitude of the potential downsides is crucial. You can't gauge if a potential reward is adequate without looking at the risks, too.

The point is, the bear shouldn't be the only one in the room when you're assessing investments. But he should always be in the room.

On that front, in this weekly column, I'm going to play the bear--looking at issues that have been bugging me recently and what the impact could be for investors. In turn, I hope you'll share your concerns with me as well in the Comments section below each article. Am I blowing things out of proportion? Or is it even worse than I think? I look forward to hearing from you.

So get ready for a walk on the downside...

More M&A on the Way
The big news this week was AT&T's (NYSE:T - News) jaw-dropping announcement that it was buying T-Mobile from Deutsche Telekom (Other OTC:DTEGY.PK - News) for $39 billion. Aside from the impact on my personal cell phone bill, I'm not overly concerned about this particular merger from an investor's perspective. AT&T is paying a reasonable price, the synergies and cost savings are pretty obvious, and the only real hurdle is getting the federal government to go along with it.

But not all deals look this good. You don't have to look all that far into the past to see big mergers gone horribly wrong. AOL/Time Warner, Sprint/Nextel and Daimler/Chrysler jump to mind. There are plenty more that didn't generate the headlines that these megadeals did, but that ended up with similarly disappointed shareholders.

What I am worried about today is that conditions may be ripe for another string of value-destroying acquisitions. Here are a few factors that could make CEOs a little more trigger happy than usual:

Cheap Money. Financing deals remains incredibly cheap. The Fed's quantitative easing programs and generally loose monetary policy is making borrowing very cheap for big corporations. The market isn't worried about corporate credit risk and many firms can borrow for a nominal spread over Treasuries. It's awfully tempting to use that cheap borrowing to go empire-building

Good Balance Sheets. Plenty of firms won't even have to borrow money to make big deals happen. After the scare of 2008, most corporations made huge efforts to repair their balance sheets and pay off existing debt. Many companies began to build up a good war chest of cash. They could, of course, use that cash to pay out a bigger dividend or even do share buybacks. But big splashy deals are just so much more fun.

Bank Incentives. And the banks certainly aren't going to hold back dealmaking. With traditional banking revenue streams getting pinched by low rates and new regulations, investment banking has become a key area of focus for many institutions. Coupled with the lucrative fees and lending opportunities that come from a big deal, bankers are incentivized to aggressively pitch deals.

Flat Stock Prices. Morningstar believes that the stock market is roughly fairly valued right now. True, it is impossible to know exactly where the market will go, but it seems to be a fairly safe bet that we aren't going to see enormous upside from today's levels. Flat share prices make executives nervous and more likely to try to "do something" to right the ship. A big splashy deal shows that a CEO is trying, but it may not be the best way to build shareholder value.

There are also a few reasons why the deals that do get done are more likely to be value-destroying:

High Prices. A corollary to our belief that stocks are fairly valued is that there aren't as many bargains around. Sure, there are pockets of value here and there, but by and large, there aren't very many screaming buys. That makes it much more likely that a big deal will also have a big price tag. And overpaying is the easiest way to turn any merger bad.

Less Fat to Cut. "Synergy" is firmly enmeshed in the lexicon of corporate buzzwords. The idea is that by combining two firms, you can cut out a lot of corporate overhead and other costs to save money. This is a great idea, but during the recession, most corporations cut overhead to the bone and are still operating at very lean levels. Without as much fat to cut out of purchased firms, a lot of the hoped-for savings may never materialize.

So does this mean every merger is a bad one? Of course not. But history has shown us that many deals end up going south. Given the confluence of these factors, I'm worried we're going to see some bad deals in the months ahead.

What do you think? Is M&A activity going to come back in full swing? What was the worst deal of all time? Best? How do you protect yourself against empire building? Please leave your comments in the section below.

Source: http://finance.yahoo.com

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