Deal or No Deal? The Drivers of This Week's M&A News

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five: Morningstar's take on five stories in the market this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome Jason.

Stipp: You have a few pieces of M&A-related news this week. The first one is Walgreens choosing not to do a tax inversion after they complete their acquisition of Boots. What was their rationale?

Glaser: Ending months of speculation, Walgreens management said that they aren't going to try to execute this tax inversion at the completion of this acquisition. An inversion is basically moving your corporate headquarters from the U.S. to Europe to take advantage of lower tax rates on those foreign earnings.

Management said they couldn't get comfortable with the structure, even though there was a heated internal debate. They were worried that they were going to come under intense IRS scrutiny, and that they'd really rather focus on the business instead of dealing with those regulatory issues.

This comes on the heels of a boom-let of these inversion deals, particularly amongst pharmaceutical companies. It's become a hot political issue. It will be interesting to see if this Walgreens decision is a one-off and we continue to see more of these deals, or if this is maybe the tide turning against them a little bit. We'll have to wait and see.

For Walgreen's business, Vishnu Lekraj, who covers the company for us, thinks that the acquisition does continue to make some sense for them on a strategic standpoint, but that Walgreen is still a no-moat company and that even after the big sell-off following this announcement, there is not a lot of value in Walgreen's shares.

Stipp: Another M&A story: Sprint is giving up on its potential acquisition of T-Mobile. What was their rational and what does it mean for these two companies now? This is a story we've been following for a little while.

Glaser: We have. Sprint decided that they weren't going to get the regulatory approval in order to combine with T-Mobile to give them that scale to compete better with Verizon and AT&T, the two behemoths in the U.S. wireless space.

The regulators seem very keen on having four big players. They like the price competition, and I think they are worried about what would happen if they went to only three. But Mike Hodel, our telecom analyst, does think that both T-Mobile and Sprint in the long term are going to need a partner in order to compete, and that without it, they are going to be laggards compared to the big players.

He sees T-Mobile as still being a better partner for someone else, given that they are growing a little bit faster and they are being a little bit more innovative. But it seems like that partner is not going to be an existing U.S. wireless carrier. It's either going to be another potential U.S. firm, maybe DISH, that wants to get into the wireless space, or potentially even someone from abroad that would want to come up with the money. Either way, this isn't the end of telecom M&A, but it does seem like for now the regulators really do want to have four players.

Stipp: Another company that's walking away from a deal they wanted to get done is 21st Century Fox. They are not going to try to acquire Time Warner now. What was the rational there and what does it indicate for both of these companies?

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Glaser: It was a bit surprising to see 21st Century Fox walk away from this potential deal so quickly. There are really two things driving this, the first being the decline in share price of 21st Century Fox. Since they announced this deal, shareholders obviously were not too happy about it, and also Time Warner's management was steadfastly opposed to any sort of combination.

I think it is a good sign for stewardship that Rupert Murdoch and 21st Century Fox decided that they weren't going to overpay for Time Warner, they weren't going to chase them, and if they didn't have shareholders behind them and if they had to raise the price too much, they were going to walk away.

But now Time Warner is really going to have to prove that it was worth walking away from this potential combination, and that they are going be able to create value over time. Time Warner shareholders will obviously be watching closely for that. If it doesn't happen, I think it's not inconceivable that 21st Century Fox would come back if there was some weakness in Time Warner's share price, and maybe make another offer some time down the road.

Stipp: In financials news this week, regulators found that several banks' so-called "living wills" were unacceptable. What are these living wills and what was wrong with them?

Glaser: The big banks were required to create these so-called living wills in the post-crisis world in order to avoid the kind of issues that we had with, say, the Lehman Brothers bankruptcy. These living-will documents show how these firms could be wound down in bankruptcy without government help.

And somewhat surprisingly, the regulators--the Fed and the FDIC--said that for 11 big banks, including JPMorgan, Citigroup, and Bank of America, these documents just weren't up to par yet. They still need a lot of work and substantial improvement in order to really make sure that these businesses could fail if there were some sort of pressure on the system.

This is just another sign of how difficult it is to be an investor in lot of these banks, as they're still really trying to figure out exactly what the relationship with these regulators is and what they are and are not going to be able to do.

After these wills have been deemed insufficient, the regulators have lot more power up to potentially breaking up some of these businesses or forcing divestments in order to make sure that they could be wound down.

One note is that Wells Fargo actually was not included in this list, given that they have a much simpler business model. Their living will was deemed acceptable by the regulators.

Stipp: Finally, we had some uninspiring economic news out of Europe this week. Is it time for investors to start worrying here?

Glaser: I think for U.S.-based investors, you might not need to be too worried yet, but there definitely are signs that Europe is slowing down.

Italy had a second quarter in a row of contracting GDP. Some of the German manufacturing data did not look so good, potentially showing that Germany, which was really the growth engine of Europe, might be slowing down a little bit as well. Inflation remains incredibly low at 0.4% year-over-year growth, much lower than, say, in the United States and elsewhere.

Then you also have these new Russian sanctions, and an even though Mario Draghi, head of the ECB, says it's too early to tell exactly what the impact will be, there very well could be an impact, particularly if the crisis continues to escalate.

It's not time to panic or worry too much. It seems like the European institutions are much better equipped to deal with the slowdown than they were a few years ago. We see the ECB being more active. You see when Portugal had their mini-banking crisis, they stepped in very quickly with that bail-in and breaking up some of the troubled banks and setting up bad banks, and dealing with those problems. I think that's a good sign, but it definitely is an area for potential concern that investors should keep on their radar.

Stipp: Great insights as always on the week's news. Thanks for joining me.

Glaser: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.