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M&A frenzy should scare investors

As markets digest the news that AB InBev has agreed a deal to buy SABMiller for some £68bn, investors would be wise to consider what these kind of blockbuster deals may signify for markets.

The deal to buy SAB Miller is being done at a premium to the undisturbed share price of 50%. Even for a beer producing company that looks frothy, and there are plenty of similar cases in the past year.

This scale of deal-making is not a quirk of the drinks industry by any means, with many sectors seeing high levels of activity in both in terms of number of deals and transaction size. Another very recent example is Dell’s planned $67bn acquisition of cloud computing company EMC in the IT sector.

One of the most striking graphs I have seen of late is the one featured below from Reuters, which shows an almost eerie similarity between the last two M&A booms in how equities markets reacted at the peak.

Looking at this, it could easily set some alarms bells off over where markets are heading.

The counter argument to this is a solid and easily made one. Since the financial crisis, many weak companies have been swept out of business in Darwinian fashion, with the strong surviving, and chastened by the events of 2008 have been building up their balance sheets to allow for tough times.

The problem with this line of thought is that it assumes investors, and markets act rationally. Often, shares are driven down by wider sentiment which can be partially or totally unrelated to the balance sheet strength of most of the companies effected.

Looking at the chart again, a notable difference appears to be steeper rise in the Dow Jones Industrial during the current M&A boom than was the case in previous cycles.

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