MARKET SNAPSHOT: Corporate Cash Reserves, Cheap Stocks Could Trigger More M&A

By Nick Godt

As a spree in mergers and acquisitions in the health-care industry showed last week, many companies have cautiously built up cash reserves over the past year, and with many stocks at 12-year lows, some are now ready to use it.

"The market is offering a lot of opportunities in terms of M&A," said Peter Cardillo, chief market economist at Avalon Partners. "We could see M&A pick up, just because a lot of market [capitalizations] have been shaved."

And with some in the market now expecting that stocks have hit or are near their bear-market lows, an M&A resurgence could go a long way to help fuel a rebound.

Taking protective measures amid the crisis and the recession, U.S. firms took "dramatic" action through 2008 to preserve cash, according to Moody's Analytics. Not only did dividends after years of explosive growth turn negative, but also share buybacks fell by more than half, to $395 billion in 2008 from $831 billion in 2007.

Those firms with the strongest cash positions are in the health-care and technology sectors, where borrowing and spending have been curbed back for a while. Out of a total of $628 billion in cash positions for S&P 500 firms, more than a third, or $224 billion, is in the information-technology sector, according to Standard & Poor's. Next up is health care, with $143 billion.

Those two sectors are the best performers on the S&P 500 so far this year, with tech down 3% year-to-date and health care down 9.5%. Overall, the S&P remains down 14.5% year-to-date.

"My sense is that in good times, investors like strong income statements and during bad times, investors gravitate towards strong balance sheets," said Jack Ablin, market strategist at Harris Private Bank.

On Monday, stocks interrupted a four-day winning streak, with losses in the tech sector weighing on the market. The Dow Jones Industrial Average fell 7 points, or 0.1%, to 7,216. The S&P 500 index fell 2.6 points, or 0.3%, to 753, and the Nasdaq Composite (RIXF) lost 27 points, or 2%, to 1,404.

"We saw techs rally over the last couple of weeks because of their strong balance sheets, so there may be some sector shift as people shift into the more speculative financials [sector]," Ablin said.

Last week, a flurry of mergers in health care was highlighted by Merck & Co.'s (MRK) plans to acquire Schering-Plough Corp. (SGP) for $41 billion. Also, Genentech Inc. (DNA) agreed to be acquired by Roche Holding AG for $46.8 billion a share, and Gilead Sciences agreed to buy biotech group CV Therapeutics (CVTX) for $1.4 billion.

A large chunk of these deals will be financed with corporate bonds. Although these companies still need to access credit markets for sizeable deals, it's likely more will be on the way in the sector, according to Kevin Ellich, a health-care services analyst at RBC Capital.

"On a case by case basis, it does make sense. A lot of companies generate good free cash flow and their balance sheets are fairly clean. And they can get deals at pretty good discounts."

Defensive M&A

But several analysts, including Harris Private Bank's Ablin, were quick to warn that investors shouldn't make too much of the health-care M&A deals, which were seen mostly as defensive moves.

"In health care, deals in normal times is a balance between opportunity and threat, and these last ones were mostly defensive deals, with firms defending their product pipelines," Ablin said. "Any merger in tech would be more opportunistic."

For tech companies, which do tend to be more in tune with economic cycles, more visibility might be required before an M&A watershed is unleashed.

"With all this cash, including a lot of cash in the sidelines from private equity, it will eventually offer an opportunity for M&A to expand across the board," said Avalon's Cardillo. "But we first need to get confirmation that the economy is on a recovery path and that we have financial stability."

Other market analysts, such as Alec Young at S&P, warned that M&A tends to be a lagging indicator of a market recovery, and that opportunistic or defensive deals in today's market shouldn't be read as a sign of a growing trend.