Buyout pop for stocks may be fading
How much longer can the buyout boom keep boosting stock prices - and investors' portfolios?
LONDON (CNNMoney.com) -- Buyout firms haven't been the only ones benefiting from the rash of deals taking a host of big companies private - investors have also been cashing in on the takeover party.
The buyout boom, oftentimes led by private equity firms, has helped drive a broad global stock rally, making millions of investors richer, at least on paper, around the world. Many of those investors have enjoyed an even bigger boost to their portfolios when one of the stocks they own has been picked off by private equity or has been "put in play" - Wall Street parlance for a company that's become a takeover target.
But with some experts already seeing a leveling off in buyout activity, and borrowing costs rising, the luster that buyout deals provide for stocks may start to lose some shine.
To be sure, private equity buyout deals will keep coming since buyout funds have raised huge amounts of capital that need to be put to work, according to Bernard McAlinden, investment strategist at NCB Stockbrokers.
That will continue to support stocks, but the biggest pop from the buyout boom is probably already past, a number of market analysts say.
"The issue is the extent to which [private equity deals] can drive equity values yet higher in an environment where the cost of debt has been rising," McAlinden said.
Deep-pocketed private equity firms usually pay a high premium when they buy companies. Blackstone Group (Charts) is paying $47.50 a share for Hilton Hotels (Charts, Fortune 500), a 40 percent premium to where the stock closed before news of the deal began circulating in the market. The deal is valued at $26 billion when debt is included.
Whenever a major takeover is launched, stocks in that sector generally enjoy a lift as the market chews on the prospect of other deals getting done, according to Mike Lenhoff, head of equity research at stockbroker Brewin Dolphin Securities.
Shares of Starwood Hotels (Charts, Fortune 500) and Marriott International (Charts, Fortune 500) both jumped 9 percent in early trading on the New York Stock Exchange Thursday on the back of Blackstone's agreement to buy Hilton. Blackstone announced the deal after the stock market closed Tuesday in New York. U.S. financial markets were closed Wednesday for Independence Day.
But with buyouts hitting almost every stock sector and investment banks churning out a nearly endless stream of reports trying to predict the next targets, a takeover premium has already been factored into the price of many stocks.
Furthermore, private equity firms, which borrow heavily to do their deals, are facing tougher market conditions as the cheap money that has fueled the surge in leveraged buyouts and corporate mergers has come under pressure.
"There is a feeling that it is becoming more difficult to raise debt in the debt markets for more aggressive deals," said Oliver Russ, a European fund manager at Argonaut Asset Management.
Interest rates are also rising in many parts of the world. The Bank of England raised interest rates to a six-year high of 5.75 percent on Thursday. The European Central Bank, which sets rates for most of Europe, kept rates steady but many economists expect a hike in the fall.
"Once interest rates rise beyond a certain threshold, then it's game over for all kinds of corporate activity, not just private equity," said Lenhoff. But even though rates are creeping higher, they aren't yet at the critical levels that would bring an end to the merger frenzy, he added.
After enjoying favorable conditions for so long, private equity is running into more obstacles. But the beat goes on for now, and few are ready to mourn the end of the buyout craze.
Market analysts said that as long as the global economy and corporate earnings remain strong, the deals will keep humming along - and keep providing at least some support for the broader market.
"At one point, the merger boom is going to run out of steam when liquidity dries up. But it doesn't look like we're anywhere near there, and that's positive for equities," said Peter Cardillo, chief market economist for Avalon Partners in New York.