A record year for corporate mergers and acquisitions is nothing to celebrate

Das Capital: The vast majority of mergers will prove expensive: cost reductions will be difficult, synergies elusive

The US drugs giant Pfizer unveiled plans to buy the Botox maker Allergan in November in a $160bn (£106bn) deal (Getty Images)

In Bret Easton Ellis’s American Psycho, banker Patrick Bateman tells a woman that he is into “murders and executions”. She thinks he means mergers and acquisitions. In practice, they are interchangeable.

In 2015, worldwide volumes of mergers and acquisition reached $4.6trn (£3.3bn), higher than the previous record level of $4.3trn of 2007. There were a significant number of mega deals bigger than $10bn such as the drugs groups Pfizer and Allergan, the brewers AB InBev and SABMiller, oil explorers Shell and BG, chemicals giants Dow and DuPont and the technology groups Dell and EMC. It is the continuation of strong recent corporate activity.

The current wave of merger activity is perversely driven by weak rather than strong economic conditions. Transactions reflect the need to adjust to a world of prolonged low growth and disinflation of deflation.

A striking feature of the past five years, following the Great Recession, has been the lacklustre growth in revenues across many industries. This reflects slow economic growth rates, low inflation, weak wage growth, overcapacity and a lack of pricing power. Higher profitability has been driven by cost savings rather than increases in revenue.

Some transactions reflect a strategy of increasing scale. The objective is industry consolidation, removing excess capacity and reducing costs through economies of scale and scope. Other transactions are focused on buying growth.

Pharmaceutical companies are externalising research and development. With new drug development and commercialisation estimated at about $2-3bn for a new treatment, larger, less flexible firms now rely on smaller firms and start-ups for new products. Technology companies have purchased smaller firms to provide add-ons to their existing portfolio or customer base. Retailers and financial services firms have acquired innovations to address changes in client behaviour, delivery platforms and also to participate in the high-growth technology area.

Firms have purchased businesses that give them access to emerging markets where growth is stronger or to link into cheaper supply chains to lower production costs. In Japan, demographic factors which limit growth are behind cross-border acquisitions involving banks, insurance companies, beverages, cigarettes and media.

Other transactions are opportunistic, taking advantage of environmental factors such as low commodity prices. Mergers and acquisitions in resources and oil services by stronger players are motivated by financial weakness of the acquired and low valuations.

Another factor is a change in investment strategy. Sovereign wealth funds are diversifying away from financial assets to real businesses. This reflects concern about highly manipulated and illiquid financial markets as well as a focus on direct access and proximity to underlying cash flows. Emerging market firms are also purchasing operations outside their home country to diversify political risk.

For example, Chinese companies are aggressively investing overseas in areas such as energy, technology, semi-conductors, agro-chemicals and financial services. Key drivers include the slower domestic outlook, weakening yuan and political uncertainty.

Some transactions are tax driven, with companies seeking to invert their jurisdiction or domicile using acquisitions in order to lower effective tax rates as a mechanism for increasing shareholder returns.

Loose monetary policy has facilitated mergers and acquisitions activity. Ample availability of funding at historically low rates and credit margins has helped finance activity. Facing subdued loan demand, banks have been keen lenders. Searching for yield, capital market investors have been eager buyers of debt, both investment and increasingly non-investment quality, originated to finance mergers, acquisition and corporate restructurings. Low policy interest rates and quantitative easing programmes have also lowered equity risk premiums. This has increased share prices, allowing companies, particularly in technology and biotechnology sectors, to use their own stock as currency for acquisitions at elevated valuations.

There is little new in this latest round of corporate activity. As in previous cycles, valuations are now stretched. Average deal multiples (purchase price as a multiple of Ebitda earnings) of about 10.5 are marginally below the 2007 level of about 11. Problems in high-yield markets and rising credit costs also point to shifts in the financing environment which may affect transactions.

History shows that the vast majority of transactions, perhaps more than 80 per cent, will result in destruction of value. Integration of new businesses will prove expensive and problematic. Cost reductions will be difficult. Synergies will be elusive. Unknown liabilities will emerge. Undoubtedly there will be transactions which join the pantheon of disastrous mergers such as AOL-Time Warner, HP-Autonomy. From a broader perspective, mergers may reduce jobs and lower incomes. Given that most developed economies are based on 60-70 per cent consumption, this would dampen an already weak recovery.

It also points to crucial changes in industrial structure. Companies once focused on researching, developing, manufacturing and selling new products and services. Over time, some evolved into brand management, marketing and distribution enterprises. Today, businesses have become increasingly asset traders, with some attached residual operational functions. Mergers and acquisition have underpinned stock prices, generated fees for investment banks and consultants and allowed private equity to prosper. However, its effects on the economy at large may be less positive.

Satyajit Das is a former banker. His latest book, ‘A Banquet of Consequences’, will be published in April