The wordwide M&A boom has caused many a funds manager and many a client fund to wonder what will happen when the bubble bursts. Legg Mason Capital Management, for one, argues: ‘this time it’s different’.

In his latest letter to clients, Michael Mauboussin, chief investment strategist for Legg Mason, notes that equity returns are usually poor following crests in M&A activity. “The recent M&A boom has led some investors to fear a repeat of the historical cycle,” he says. “The perceived causal link, however, focuses solely on common attributes and ignores today’s circumstances. “Legg Mason believes that ‘this time may be different’, as the circumstances surrounding the current M&A wave do not us to think that what has been true in the past will necessarily be true this time.” He says, for example, recent research by McKinsey & Company, based on two market-derived indexes, shows current M&A activity is creating much more value than it did at the prior peak earlier in the decade. “Given the different set of circumstances existing today, Legg Mason believes that, until conditions change, ongoing M&A activity and healthy market returns can coexist.” Mauboussin argues that, given his firm’s views on relative values across equity and fixed interest markets, private equity firms are acting “very sensibly”. “They are buying an undervalued asset (stocks), selling an overvalued asset (bonds) and taking direct steps to allocate capital intelligently within the business. Until the relative valuations of stocks and bonds change – which can certainly happen – the private equity train is likely to keep rolling.” He says that there are two fundamental differences between the current buoyant M&A conditions and the previous peak in 1999-2000. They are: there is a much higher percentage of cash used in the average deal this time; and companies today are paying lower premiums to acquire their targets than in the prior peak. “The inescapable conclusion from the McKinsey data is the economics of deal making today are markedly better than the prior M&A peak (albeit not as good as they can be). Combine these healthy metrics with a stock market that has an overall valuation that appears reasonable, and the case for anticipating poor equity returns going forward is substantially weakened.”

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