The Case for an M&A Binge as Companies Blow Through Tax Windfall

(Bloomberg) -- Buybacks are nice but the real winner in corporate America’s tax windfall will probably be takeovers, Bank of America Corp. says.

Unlike the 2004 repatriation holiday when 80 percent of proceeds were used to repurchase stocks, this year will probably see considerably less sent to shareholders -- and considerably more used on acquisitions, according to Savita Subramanian, the head of U.S. equities and quantitative strategy at Bank of America Merrill Lynch.

Using an analysis that matches the industries getting the most money with what they’ve spent it on in the past, the bank sees prospects for a buyout binge that pushes this year’s deal count to a record. Sure, capital spending and debt repayment will also get a boost, but a combination of things, including the strengthening economy and rising confidence, could give M&A a particularly large slice of the pie.

The Case for an M&A Binge as Companies Blow Through Tax Windfall

At stake is $1.2 trillion that U.S. firms, excluding financials, had amassed overseas, a pool of money whose size was dramatized this week when Apple Inc. said it will repatriate hundreds of billions of dollars to the U.S. Three-fourths of the cash stashed outside the U.S. belongs to tech and healthcare companies, industries that have historically preferred to spend on mergers rather than use it for capital investments and buybacks.

“The fact that M&A has been twice as popular as capex among companies with the most cash suggests that multinationals bringing home cash may spend it on acquisitions rather than capex,” strategists including Subramanian said in a note dated Wednesday. “2018 could be the record year for M&A.”

Foreign cash repatriation may push the number of deals in the U.S. to more than 350 in 2018, the most on record, the bank estimates. Not that shareholders will go wanting. Stock repurchase may take up half of whatever freed cash companies decide to spend. But rising corporate leverage and rich valuations may rein in the total.

Unlike buybacks, the pace of capital spending will pick up, but it won’t result in a material boost. Tight capacity combined with cheap borrowing costs have historically been more important for capex than tax policy, according to Subramanian.

There’s a catch, namely the weaker dollar. The greenback lost the most since 2003 last year, giving the U.S. firms who have been looking overseas for an expansion a reason to pause. Tax cuts boosted cash but decreased the relative appeal of foreign transactions, Bloomberg Intelligence strategist Gina Martin Adams said in a note.

“Large-cap U.S. companies might find their best deals among smaller domestic targets in the year ahead,” she said.

It’s unlikely to stop a titan like Apple should it decide to make an acquisition overseas. The firm’s plan to bring money home and pay $38 billion in taxes on its overseas holding, a move that triggered a personal thank-you call from Donald Trump, helped the stock rise as much as 0.6 percent on Thursday. If Apple returns all of its cash, it will have about $139 billion net of debt to spend.

“The time might be right to make a big deal,” said Bloomberg Intelligence’s senior analyst John Butler, who said the acquisition of streaming services Netflix Inc. or Hulu LLC would advance Apple’s strides to expand beyond the smartphone market. “The company is striving to expand its services and content revenue in a bid to preserve growth as sales of its core iPhone slow in a mature market.”

©2018 Bloomberg L.P.