At the end of every great investment trend there is a mega deal that rings the bell at the top of the cycle.
Vodafone buying Mannesmann signalled the top of the TMT boom; BHP bidding for Rio Tinto the beginning of the end for the commodity supercycle; and RBS buying ABN Amro virtually guaranteed the bursting of the credit bubble.
Paying a high price for equity that has already done well and gearing up the balance sheet to try to make the numbers stack up all sounds very sensible to management, their investment bankers and ‘independent’ analysts at the time but invariably history has shown these mega deals to reflect over-confidence at the end of the cycle.
The AB InBev mega bid for SABMiller will be one of those bell ringing deals. The bubble this deal represents is the BPAP `bond proxy at any price` bubble. The investment theory is that all you have to do is find an industry that very reliably grows at a rate ahead of inflation. Once this is done you can pay almost any price for it because it’s cheaper than government bonds.
The problem with this investment concept is that it is priced off bond yields that are at a 200-year low and provide no value to anyone who stops to think about whether they really are happy with a 1 per cent per annum return.
The other problem with this BPAP thinking is that – just like the TMT bubble, commodity supercycle and credit bubble – it has made the management team at InBev think that their (so far very effective) formula walks on water. It makes a 17-times multiple of top-of-the-cycle EBITDA and a return on investment of less than 5 per cent look fine because the mega brewer will have so many brands in so many countries that fast enough growth to justify this huge price is guaranteed, isn’t it? Well this is what the Vodafone management, the BHP team and Sir Fred said, and look where their growth assumptions got them and their shareholders.
Bond yields will go up, BPAPs will de-rate and mega deals that were done to exploit this investment theme will destroy value. The bell has been rung.
Hugh Sergeant is CIO for equities at River and Mercantile Asset Management.