Submitted by David Stockman – The Contra Corner Blog
The hordes of Washington politicians promising to boost the nation’s economic growth rate and the posse of monetary central planners and their Keynesian economists (excuse the redundancy) lamenting that “escape velocity” appears to have gone MIA have one thing in common. To wit, they have never looked at the chart below, or don’t get it if they have.
Plain and simple, the sum of Washington policy is to induce the business economy to eat it seed corn and bury itself in debt. Capitol Hill does its part with a tax code which provides a giant incentive for debt finance, and the Fed completes the job through massive intrusion in the money and capital markets. The result of systemic financial repression is deeply artificial, subsidized interest rates and free money for carry trade gamblers—–distortions which have turned the C-suites of corporate America into stock trading rooms.
As a case in point, the $46 billion of bonds sold by the owners of Budweiser last night where priced at a ten-year yield of 3.67%, which means that after taxes and inflation, the company’s borrowing cost was hardly 1%. Yet, as explained more fully below, the only point of this massive offering was to fund with nearly free long-term capital the huge payday for speculators in SABMiller stock that will result from the $120 billion Anheuser-Busch InBev (BUD) takeover transaction.
But consider the economic context. As astounding as it may seem, US net business investment in fixed assets last year was 10% below its turn of the century level. And that’s in nominal dollars—-in real terms its down by nearly one-fifth.
Moreover, net investment is the right measure, and its not at all comparable to the what Wall Street stock peddlers, who claim to be economists, are always bloviating about. Their favorite metric is the quarterly gains in the nonresidential investment component of the GDP accounts, which they trot out as evidence that all is awesome. Actually, that’s just gross!
Stated more clinically, it represents gross investment. Upwards of 85% of the $2.3 trillion annual rate for private nonresidential fixed investment is needed just to replace the capital consumed or depreciated in current production. If you don’t do that, you slide back to horse and buggy times real fast.
So what counts for growth is the net investment in machinery, equipment and technology, but that has been sliding southward for 15 years. Now it’s just a shadow of its former self. Thus, US net investment by business in 2014 amounted to just 2.3% of GDP or barely half the 4-5% range that prevailed during the high growth era of the 1950s and 1960s.
Needless to say, over any sustained period of time, tepid investment means tepid productivity growth; and that, in turn, means a stagnant economy. Unless, of course, you have booming labor force growth, which is the very opposite of the US, where 102 million or 41% of the adult population is not gainfully employed.
At the same time, the going nowhere green line in the chart below is not for want of available capital. In fact, business debt securities outstanding have doubled since 2000, and have been growing at a 6.4% annual rate since 2008. Indeed, the blue line in the chart betrays not even a semblance of the Great Financial Crisis (GFC) or the supposed deleveraging response to it.
So corporate debt has been off to the races, and even then the chart above does not do justice to the full story. If you count all business debt including bank loans and obligations of non-corporate enterprises, total credit outstanding has surged from $10 trillion on the eve of the GFC to $12.5 trillion today.
And that gets to our current theme. Where did that $2.5 trillion go?
You can’t count gross business investment because most of that was funded with internal depreciation. Yet net investment is still below 2007 levels, meaning that no outside capital has been used at all on an aggregate basis.
So here’s the short answer. This Bud’s for you, Wall Street!
Like the monumental bond deal priced by BUD last night, all these borrowed trillions have gone into financial engineering—–both to stock buybacks and to perfectly pointless M&A deals like the BUD purchase of SABMiller.
Believe me, from an economic efficiency and wealth creation point of view merging the #1 beer behemoth of the world with the #2 giant is truly pointless. Consumers everywhere are voting with their dollars for craft beer by the pint from micro-breweries, not suds by the tanker load from yesterday’s dinosaurs.
Indeed, this combination of AB InBev with a 20% global market share and SABMiller with 10% will have a $340 billion TEV——–a magnitude-roughly double the GDP of Greece. That is, it will constitute an unmanageable globe spanning monstrosity with $60 billion in sales spread among scores of highly differentiated regional and national beer markets——lumbering toward centralization in just the opposite direction from where the consumer market is going.
Stated differently, in the absence of drastic financial repression by the world’s central banks there would be no case whatsoever for the globe-spanning beer merger now at hand. The latter will only create more dis-economies of scale as all the pieces and parts from two decades of financially driven M&A create another artificial, discombobulated enterprise which is too big to manage and wrong-sized for the nature of the market which it serves.
Too be sure, the whole thing is predicated upon operational synergies. But that’s just a euphemism for front-end jobs cuts which get labeled as “synergies” and taken as one-time “ex-items” charges which don’t count by the lights of Wall Street’s hockey stick purveyors. The fact is, these job cut synergies may or may not be sustained over time; and they are as likely to cause operational disruptions and setbacks as efficiencies and gains.
Indeed, merger synergies are one of the great scams of our bubble finance regime. They fail to account for the fact that at the scale of giant global businesses involved in these mega-deals, diseconomies of scale are just as likely as economies of scale. Long ago the former would have been punished by honest free markets, meaning that most of today’s mega-deals would never happen. But the casino does not punish failed M&A deals; its just rewards corporate executives for taking restructuring charges when failure becomes undeniable.
In fact, since cheap debt always trumps expensive labor, Wall Street’s M&A machinery just keeps creating one giant malinvestment after another. And our monetary central planners keep braying that the labor market is still too weak and that it must therefore keep rates lower for longer.
Just maybe, however, the Fed’s new financial stability monitoring group might note something suspicious about these mega-debt issuances percolating up through the deal machinery. Namely, that in this case, and in most others, the merger partners are already vastly over-valued momentum plays that can be explained only by the fact that the financial markets have been turned into gambling casinos.
Specifically, the combined TEV (total enterprise value of debt plus market equity) of the two beer giants is currently around $340 billion, yet in the most recently reported LTM period, BUD generated just $13.3 billion of free cash flow (EBITDA less CapEx) and SABMiller just under $5.3 billion. In sum, their combined number for that crucial valuation metric is just $18.5 billion, meaning that they are trading at 18.5X free cash flow.
Folks, these two momo plays are in the suds business, not social media! The overwhelming share of their cash flow is generated in Europe and North America were volume has been flat for two decades, as shown below. Even on a global basis, industry growth over the last 17 years has averaged only 2% per annum; and most of that is attributable to China where competition is plentiful, prices cheap, profits scare and the government is increasingly unfriendly to foreign companies.
So what we have here is a giant overvaluation bubble in the suds business. Yet the inexorable result of systematic central bank falsification of financial asset prices and valuations is just more of the same.
In fact, at the planned $125 billion bond and bank loan financing package, the merger company’s leverage will reach nearly 7.0X free cash flow. In a no-growth business in a world where interest rates must eventually normalize–——that is sheer lunacy.
But it well explains why our monetary politburo is so reluctant to let interest rates normalize and is so deathly afraid of a Wall Street hissy fit. It has fueled such a massive eruption of unproductive corporate debt issuance to fund financial engineering that it has literally taken itself hostage to the mother of all corporate debt bubbles.
None of this would happen in a world with honest interest rates and stable two-way capital markets for the simple reason that the financing could not be raised; boards and CEOs would have no momentum driven stock market inducing them to engage in patently irrational mergers; and, in any event, short sellers would swiftly punish serial roll-up machines that destroy rather than create sustainable economic value.
So here’s the thing. This deal is not an outlier—its par for the course. Last year, US M&A volume reached an all-time high of nearly $2.5 trillion. Yet since most of these deals are driven by the availability of cheap debt finance, and the C-suite’s pre-occupation with financial engineering and goosing stock options, it is fair to say that the Wall Street M&A machine has morphed into an anti-growth monster.
The dirty secret is that the massive disruptions to business operations which are implicit in the graph below is a product of bubble finance, not the quest for free market business efficiencies. The fact is, the overwhelming share of true profit and wealth creating efficiencies on the free market have nothing to do with economies of scale. But that’s the sum and substance for the logic which created the sprawling mess called Hewlett-Packard, for example, and Tyco International and thousands of others in between—-most of which get unwound, restructured, spun-off and written down after a half decade or so.
Yet since Wall Street rakes in some $25 billion in M&A fees annually, the current insane level of deal making keeps rising, wrecking honest capitalist enterprise and jobs as it blunders on. Indeed, when it comes to monumental economic foolishness like the beer barrel roll-up or the current mega-deals in health care and telecom, Wall Street isn’t telling, and Washington is too bought and paid for to ask.
Thus, it is hardly noted that every one of the giant bond deals of the last few years—–there were $182 billion last year attributable to deals over $10 billion—-have been used to fund M&A deals and other financial engineering maneuvers. Virtually none of them have funded the purchase of new assets, and yet that was originally the whole point of the long term bond market.
Indeed, after two decades of bubble finance, Wall Street has turned the corporate bond market into a fee scalping machine that enables an endless churning of existing corporate assets without much economic rhyme or reason and with virtually no financial market discipline on C-suite empire building and deal-making.
And they wonder why growth is slouching to a halt.