Will Current M&A Activity Benefit Small-Caps?

Will Current M&A Activity Benefit Small-Caps? by Royce Funds

With M&A total deal volumes running at their highest pace since 2007, what has spurred increased activity? Portfolio Manager Lauren Romeo and Director of Consultant Relations & Client Service Jeff Smith discuss the correlation between improving economic conditions and increased corporate spending.

See the video here.

Jeff Smith: Lauren, many thought 2014 would be the year for M&A. Has it been?

Lauren Romeo: It actually has in the sense that M&A total deal volumes are actually running at their highest pace since 2007. But what’s been interesting is that more of the activity has been in the large-cap and mega-cap part of the spectrum and less so in the smaller-cap area.

So far, through the first half of the year, 35% of the M&A deals in the U.S. were in the mega-cap arena, whereas historically small-cap deals have dominated, representing 70% or higher of the deals that are done in any given year.

Jeff: So are the conditions in place for continued M&A?

Lauren: Yes. First, cash levels on corporate balance sheets remain at all-time highs, interest rates are very low, access to financing—debt financing—has improved for companies, and valuations continue to remain attractive.

The big thing that I think has spurred activity this year, and is something that we hear from companies themselves, is that confidence in the economy and the political situation in the U.S. has finally improved, and companies are now willing to take those steps. Instead of returning cash to shareholders like they’ve done in the past couple of years, they’re now turning towards redeploying that cash into productive growth investments for their businesses.

Jeff: Will this benefit some of the companies we own in our portfolios?

Lauren: Yes. We own some M&A advisory companies such as Lazard, which is one of the top independent advisory companies.

But I think the bigger impact we’re also seeing is that our small-cap companies are making acquisitions at a pretty rapid pace themselves, and the reaction that companies have gotten, they’ve seen their stock prices rise anywhere from 5-10% on the announcement of the deal.

I think it’s a reflection that investors are happy that the companies are finally putting the excess cash that they’ve had on their balance sheet that was not earning very much money—putting it to use so that it will earn a greater return and will help the business grow going forward, as well as improve the company’s competitive situation.

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