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Friday Five: A $100 Billion Week of M&A

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories from 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: First this week, we got Fed minutes, and it didn't really surprise anyone, including the market.

Glaser: Not particularly. The market pretty much yawned when these minutes were released, and they showed what we were expecting. The Fed is worried about global growth and what impact it could have on the United States, but they're very split as to exactly how big that impact is going to be.

Obviously they noted what's happening in Europe, what's happening in China, what's happening in Japan. But they are seeing pretty good strength in United States, and that gave them the confidence to end the quantitative easing program and also to set the stage for that rate increase sometime in the middle of 2015.

It seems like the market is still very much pricing in that outcome; that's what people are expecting right now. We'll see what will happen if it comes a little bit sooner, or if it comes a little bit later. We didn't really get a whole lot of new information from these minutes.

Stipp: Global growth is a concern, and that heightened this week, as Japan fell into recession. What were the drivers behind that?

Glaser: This really was a surprise. Japan did have a big contraction two quarters ago, when they increased their consumption tax. The expectations were that there would be some bounce-back this quarter, even if growth wasn't going to look great. In fact the [Japanese] economy contracted again. That second straight quarter leads into what many people consider a recession.

This is just another sign of how fragile global growth is and how fragile Japan's recovery has been. Now of course Japan has a lot of idiosyncratic things going on. They have some demographics issues; they have a huge debt load. You have the government trying to tighten up a little bit and trying to pay down some of that debt, while the Bank of Japan has been very expansionary. So you don't want to over-generalize that what's happening in Japan could mean a recession everywhere, but it certainly is a sign that the global economy is pretty weak. It's going to have some political ramifications in Japan as well. Snap elections have been called for December, and it looks like the next sales tax increase is going to be postponed. So we'll see if that makes a difference.

Stipp: In corporate earnings news, both Home Depot and Lowe's reported; they had better-than-expected quarters. Their results also had some hints about the broader economy.

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Glaser: Both of the home improvement retailers did have better-than-expected quarters. They also said that their outlook for the next couple of quarters looks pretty good, as they are seeing a decent amount of strength in the housing market--kind of a continued slow and steady increase. I think that's really the interesting part of these earnings. Both of these companies look to be pretty fully, if not overvalued right now, so probably from an investing standpoint, they are not that interesting.

From an economy standpoint, it is certainly interesting to get their take on what's happening in the housing market. People really cut back on renovations, cut back on those home products when they were underwater, when they thought there was no hope of ever getting any of that back when they sold their house. And now that prices are up so much, people are feeling more confident. They are out there spending, making these improvements. And I think that's a sign that the housing market is improving.

We are seeing some data that remains kind of flat. We got starts this week that weren't great, that show that we're not seeing acceleration there. But I think this is potentially a place that really could drive economic growth for the next couple of years, as housing gains a little bit of steam and people feel a little bit more confident.

Stipp: After a deal that looked shaky as recently as this weekend, Halliburton did confirm this week that it's buying Baker Hughes. What's our take on that deal?

Glaser: The timing of this announcement was a little bit surprising. There were rumors over the weekend that there was going to be big proxy fight, and that Halliburton was going to oust the Baker Hughes board, and instead they came to an agreement for Halliburton to buy Baker Hughes for around $35 billion. And we think this deal does make a lot of sense. Baker Hughes shareholders are getting a nice premium over where the shares are trading before the rumors of the takeover happened. So they get out of this pretty well.

Halliburton is really paying a fair price. It's not cheap by any stretch of the imagination, but they are not paying some kind of ridiculous, impossible multiple to make it work for them. And combined, these oil services companies will be able to better compete against wide-moat Schlumberger, and we even think there is a possibility that the combined company could get a wide moat of its own, depending on how the integration goes. That's really going to be the key to a lot of this. But this is a deal that does seem to make quite a bit of strategic sense.

Stipp: Also in M&A news this week, Actavis announced that it's going to be buying Botox maker Allergan. The mechanics behind this deal are maybe a little bit different.

Glaser: This was a $66 billion deal. So we had $100 billion of M&A on Monday. And this deal has a little bit less strategic rationale. Some synergies are going to be there; they think about $1.8 billion. There is going to be some tax savings, because Actavis is an Ireland-based company. So you get some things there, but really the way that the two drug portfolios match up, there is not necessarily a ton of synergy, but we still do think that the deal will make sense over the long run.

The other wrinkle here is that Valeant and Bill Ackman's Pershing Square Capital have been trying to go after Allergan for some time. Their last public offer was around $180 per share. This deal values Allergan at $219 a share. That difference is probably great enough that they are not going to jump into this, and we are probably not going to get a bidding war. Our analyst Michael Waterhouse thinks that this deal is likely to happen at this price.

Stipp: Jeremy, another great set of insights on the market news. Thanks for joining me.

Glaser: You're welcome Jason.

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