- Deal activity in 2014 has already topped $1 trillion worldwide, surpassing levels only seen three times before since 1980. This high level of merger and acquisition activity is a sign that CEOs are confident in the economy. - Companies have large cash balances but cash provides little return, so CEOs are choosing to spend the cash on mergers and acquisitions rather than capital expenditures in order to quickly boost revenues and profits. - Low interest rates are also encouraging companies to take on debt to fund large acquisitions that can provide faster growth than developing new products internally.

1. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
Thought for the Week (298):
Deal Activity Is On Fire
Synopsis
 Companies tend to grow organically by building new products/services internally, or they can grow by buying existing companies that already have proven products/services.
 The value of deal activity in 2014 has already topped $1 trillion worldwide, which is only the third time since 1980 that this level has been surpassed so early in the year.
 The Investment Committee strongly believes that this level of deal activity is a sign of confidence from CEOs and supports our bullish view on the economy.
Buy vs. Build
Since the financial crisis of 2008, companies have repaired their balance sheets and right-sized their businesses to achieve some of the highest levels of efficiency in modern history. In fact, Thomson Reuters recently reported that firms worldwide are sitting on $7.5 trillion in cash.
Cash has accumulated to such high levels because CEOs have been overly cautious when it comes to spending money. Those who survived the “Great Recession” learned their lesson and have hoarded cash to protect from the next downturn in our economy (few people rarely touch a hot stove twice).
A high cash balance certainly reduces the risk that a company will fall into financial difficulties. However, cash earns next to no interest, thanks to the Fed’s zero interest rate policy, so excessive cash balances frustrate investors because cash creates a drag on growth.
Companies that are forced to answer to shareholders will generally return this cash in the form of dividends and share buybacks when they see little prospects for growth. Although when CEOs do see opportunity for growth, they tend to spend this cash in two primary ways:
1. Capital Expenditures (Capex): A company will buy new machines, supplies, and talented labor to build new products and services to sell for a profit.
2. Mergers & Acquisitions (M&A): Instead of building new products/services from scratch, companies will often buy competitors or those that complement their businesses.
The decision to “buy vs. build” is a decision that CEOs face in every industry. For example, consider a large pharmaceutical company trying to decide whether to create a new drug or to buy a small start-up that has a proven drug. Purchasing this smaller firm may appear attractive for several reasons including:
 Time to Market: On average, a new drug will cost over $1 billion and take almost seven years from the time it is conceived to the time it goes on sale. Management teams typically do not have that long to prove to shareholders that they are providing value so it often makes more sense to simply buy a competitor in order to realize that potential growth much sooner.
 Operational Risk: Not only does a new drug take several years to bring to market, the risk of failure is very high. Creating a new drug from scratch faces scientific hurdles and regulatory risks, and management teams often prefer to buy a proven drug instead to avoid such risks.

2. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
 Synergies: Imagine if two pharmaceutical companies with completely different product lines joined together. The buyer could eliminate duplicate sales personnel, land and equipment, and other expenses, yet increase the amount of products to sell on their existing infrastructure.
Simply put, companies often prefer to buy rather than build because the risk-adjusted returns often appear far more attractive, particularly when the cash is sitting in the bank and the economy continues to improve.
Deal Activity is on Fire
Several market pundits began 2014 with talks of a looming surge in business spending that would lift equity markets higher. Instead, the largest companies in the world appear to be far more interested in buying vs. building. The chart below shows just how much deal activity we have seen already in 2014:
The blue bars indicate that value of deals announced this year has already topped $1 trillion. That number is 35% higher than the same period in 2013 and only the third time since 1980 that the $1 trillion mark has been surpassed so early in the year.
The green line’s importance is subtler but still adds to the story. Comparing Q4 in 2013 to Q1 in 2014 shows that roughly the same number of deals was announced (green dots), however, the total value of the deals was quite different (blue bars). Therefore, the average deal size (total value divided by number of deals) has been higher in 2014 compared to 2013 and years prior.
The backdrop for these “mega-deals” is quite attractive for CEOs and company boards. Companies are sitting on big cash balances, and record low interest rates entice borrowers to pursue cheap money.
Additionally, companies like Pfizer have most of their cash in bank accounts that reside outside the U.S., and they would rather spend the money acquiring firms in Europe and Asia than paying the hefty tax imposed by the U.S. government if they were to repatriate that cash back to the U.S.
Lastly, the economic recovery has boosted business confidence, and management teams are rewarded faster when using M&A to boost competitive positioning instead of waiting years for capital expenditures to yield rewards.
NOTE: It’s important to also remember than many CEOs are compensated based on short-term results. Therefore, they are often incentivized to raise their stock price quickly, and M&A can be a highly effective way to boost earnings and sales in a relatively short amount of time.

3. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
The bottom line is that recent deal activity is a direct result of trillions of dollars burning holes in the pockets of CEOs. The fact that they are finally spending tells the Investment Committee that confidence has returned to boardrooms. The Investment Committee is encouraged to see this competitive spirit back, and we expect this M&A surge to continue to fuel equities higher over the long run.