The median YTD premium for U.S. mergers dropped to 26% from the 44% peak achieved in 2009, and the bid premiums in general are likely to be narrow as U.S. stock market is expected to maintain its upward momentum, notes Goldman Sachs.

David J. Kostin and team at Goldman Sachs in their report dated June 27, 2014, titled “US Weekly Kickstart”, notes U.S. mergers are on pace for a 50% growth relative to last year.

Falling bid premium

The Goldman Sachs analysts point out that the valuation of the equity market has implications for bid premiums. They note one approach to decipher the relationship could be to measure the control premium paid relative to the unaffected share price for transactions where over 50% of a company was acquired.

By using this approach, the analysts point out that the median YTD bid premium equals 26% and reflects a steady decline from the 44% peak in 2009, as can be seen in the following graph:

Decline in M&A premium

The analysts note the falling bid premium makes intuitive sense given the dramatic stock market rally. The analysts anticipate the U.S. stock market will continue its upward trajectory and hence bid premiums in general are likely to narrow. However, the analysts note premiums could potentially rise in select sectors where competition has increased among strategic buyers.

M&A volume on pace

The Goldman Sachs analysts highlight that so far in 2014, nearly $750 billion in U.S. mergers have been announced. This marks a surge of nearly 50% in US merger announcements during 1H 2014, as set forth in the following graph:

Surge in M&A volume

The analysts point out that if deal-making maintains the current trend, full-year 2014 domestic M&A announcements would clock in at $1.5 trillion, the second-highest level ever, trailing only the LBO-fueled peak achieved in 2007.

Digging deep into premiums, the analysts note one trend that could enhance premiums paid is the currency used in mergers. As can be deduced from the following graph, the analysts point out that the cash component of deals announced YTD has plunged to 60%, the lowest percentage since 2001:

Drop in cash component

Bond markets fueled LBO bids

The analysts note considering the high P/E ratio of the market, the enhanced use of stock as a currency in acquisitions makes sense. Though cash accounted for 79% of consideration in mergers in 2007, the analysts note such a high percentage reflects a bond market that fueled LBO bids. However, during the past 15 years, cash has accounted for an average of 67% of deals, while stock accounted for 19%.

The analysts also anticipate that the Goldman Sachs Strategic M&A candidate basket will continue to outperform. They highlight that the basket has outperformed S&P 500 by 450 bp YTD. The following table captures the Goldman Sachs Strategic M&A candidate complete basket:

GS M&A Candidate basket