With Heinz, American Airlines, and Dell, Big Deals Are Back

Warren Buffett isn't the only investor with a loaded elephant gun.

The Oracle of Omaha has spread some cheer among investors with his plan to buy food company H.J. Heinz for $28 billion. The deal, on which Buffett's holding company Berkshire Hathaway will partner with Brazilian private-equity firm 3G Capital Management, has the typical hallmarks of a Buffett acquisition: It involves a stable company with top brands and plenty of upside earning potential.

It also comes at a time when corporate deal activity is heating up, a sign that many investors are becoming optimistic about the future and more comfortable risking their money. So far this year, Michael Dell has teamed up with a group of investors hoping to take his troubled computer company private, and American Airlines and U.S. Airways have announced plans to merge and form the largest U.S. carrier. "I'd be amazed if there weren't more of these types of deals," says Colin Claydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth University's Tuck School of Business.

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Deal activity is being fueled by a combination of low interest rates, easing credit conditions and a growing belief that the risk of another economic downturn is fading. Low rates are prompting investors to look for ways to earn a higher return on their money--which is precisely what the Federal Reserve hopes to accomplish with its controversial "quantitative easing" policy. Improving credit conditions are allowing banks and other lenders that got burned by the 2008 financial meltdown to get involved in deals once again. And the declining risk of a crisis caused by the European debt spiral, poor fiscal policymaking in Washington or some other time bomb is reviving investors' animal spirits.

Buffett famously hinted in his 2011 letter to Berkshire shareholders that he was eager to make more acquisitions. "Our elephant gun has been reloaded," he wrote, "and my trigger finger is itchy." Berkshire will spend roughly $13 billion of its $47 billion in cash on the Heinz deal, with the rest coming from 3G Capital, and from newly issued debt. That leaves more money for other Berkshire deals. "I'm ready for another elephant," he said on CNBC while discussing the Heinz purchase. "If you see any walking by, just call me."

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Dealmakers have been hoping for just this sort of high-profile acquisition to get the ball rolling on others. Merger and acquisition activity plummeted in 2009, as investors everywhere hunkered down to wait out the financial crisis. There was a pickup in M&A activity in 2011, according to data compiled by consulting firm PwC, as many deals that had been delayed finally got consummated. But activity dropped off after that, as dealmakers shied away from all but the safest opportunities, with a high probability of success.

Deal activity picked up again during the last few months of 2012, mostly involving mid-sized companies. Now, mega-deals like the Heinz buyout and the American-U.S. Airways merger may signal a brisker pace of deals ahead. "The fundamentals for sustained M&A activity in 2013 are solid," PwC wrote in its annual outlook for mergers and acquisitions.

Big companies are one potential driver of new deals, since they've got more than $1 trillion in cash and they're under increasing pressure to use it. During the recession and its aftermath, corporate cash was a comforting cushion in case there was a relapse of the financial crisis. With the odds of that seemingly in decline, shareholders have been clamoring for companies to generate higher returns on their holdings and boost value for shareholders. Using cash to purchase other firms is one way to do it.

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Hedge funds and private-equity firms are another source of dealmaking activity, since they're in the business of promising big spenders higher returns than they can get through traditional investments. If a few pension funds or university endowments decide it's safe enough to commit money to buyouts, others are likely to follow, fueling even more activity.

Another key element of a healthy dealmaking environment is a stable stock market--neither undervalued nor too bubbly. Of course, it's impossible to predict where stocks will go, but in general they follow the direction of the economy. So if the smart money is betting on a rising stock market, it's also betting on a sustainable economic recovery. Even if your elephant gun is a pea-shooter, it may be a good time to follow Warren Buffett's lead and reload.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.



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