Why investors should be wary of ‘mergers of equals’

DESPITE a modest increase in deal announcements recently and some increasing chatter about deals in the works, total mergers and acquisition activity has been muted for much of the past two years.

We attribute slowing activity to a decelerating US economy and uncertainty about the Federal Reserve’s stance on interest rates. Moreover, the regulatory environment remains a burden. In such uncertain macroeconomic regimes, management teams can be tempted to instigate change by doing deals with companies that are similar in size, the so-called merger of equals.

We define these deals as those between two companies within 20 per cent of the market capitalisation or enterprise value (including net debt) of each other. As these tend to be agreed deals, they might be seen by management as less risky to pull off.