Serious Money:Hannibal Lecter is back. The anti-hero's return to our movie screens is timely given the feeding frenzy taking place in the market for corporate control. The value of mergers and acquisitions reached record levels last year as buyers forked out more than $4 trillion to devour more than 30,000 companies.
As advisers and bankers indulge in "fava beans and a fine Chianti", investors need to know whether the current merger boom will end as each of the previous five merger waves since the late 19th century - in tears.
Each wave has its own version of the mega-deal from hell, be it the formation of US Steel in 1901 through JP Morgan's purchase of Andrew Carnegie's steel interests or the merger of America Online and Time Warner almost a century later. Despite the verdict of history, a new generation of optimists believes that this time it is different. Could it be true?
The historical evidence shows that roughly two of every three deals fail to deliver the synergies assumed in the original purchase price. In other words, mergers typically fail to deliver value for the buyers' shareholders and serial acquirers seem to destroy the most value for investors. Indeed, the cumulative spending of America Online and Time Warner amounts to roughly $350 billion since 1990 - money well spent, I think not.
However, more recent evidence says otherwise, as companies seem to be getting better at all aspects of the acquisition process, from the price paid to subsequent integration. According to the highly-paid consultants, we should sit back and enjoy the ride.
It is true that the current merger wave has seen big business get better in the latest foray into the market for corporate control. There are certainly features in the current boom that distinguish this cycle from its predecessors.
It is truly global, as America's share of global volume has dropped materially; more hostile, as the number of unsolicited bids has soared; and increasingly shareholder-friendly, as debt commands a greater share of deal prices.
Share prices have reacted well following an approach and have continued to do so after deals have been consummated. The evidence to date suggests that the current boom should not lead to the massive wealth destruction that followed the "new era" of the late 1990s.
Reports on the market for corporate control sound great and even more so given the reputations of consulting firms such as McKinsey, from which the ideas were spawned. Unfortunately, not one of these high-brow reports includes an analysis of the buyout industry. The omission is important given that buyouts accounted for one-fifth of the dollar volume of all deals in 2006 as compared with little more than 4 per cent of deal volume in the 1990s.
Private equity has become the vehicle of choice for investors of all varieties in the hunt for incremental return. Buyout funds are awash with cash and, not surprisingly, the deals get ever bigger. Supply and demand have coalesced to propel the industry into the spotlight, so much so that the hedge fund kings of five years ago have been dethroned as the investment vehicle of choice. Allocations have increased by 50 per cent in recent years and surveys indicate that institutional exposure will continue to rise.
The influx of new money has led to a number of unfavourable trends. Capital under management has grown eightfold since 1990 and, not surprisingly, buyout valuations move ever higher.
The average buyout price as a multiple of Ebitda or earnings before interest, taxes and non-cash charges has jumped from six times in 2001 to more than eight times today.
All else being equal, higher valuations require a greater proportion of debt financing if returns on equity are to be maintained, and therefore it comes as little surprise that debt participation has soared from 65 per cent five years ago to more than 80 per cent today, while interest coverage has dropped to just two times.
Furthermore, the buyout specialists have resorted to dividend recapitalisations - the assumption of more debt to pay equity participants a special dividend, in order to boost returns. Welcome to the world of private equity or "21st century capitalism" as described by the Carlyle Group's co-founder, David Rubenstein.
Private equity will continue to thrive as fundamentals continue to be ignored in today's liquidity-driven markets, but the music will eventually stop and, when it does, investors will be faced with a wave of defaults. Investors continue to exhibit return-chasing behaviour, which always ends badly. Albert Einstein defined insanity as "doing the same thing over and over again and expecting different results". Astute investors should take note.
