History Says This Will Not End Well

The debt-fueled buyout boom is becoming an all-out frenzy... History says this will not end well... An insider's take on the second-biggest tech deal in history... Only four days left to watch Jeff Brown's exclusive presentation... Want to go surfing with us – and a world champion – in February?...

The debt-fueled buyout boom is becoming an all-out frenzy...

In the months before a U.S. presidential election, corporate merger and acquisition ("M&A") activity usually slows to a standstill. And for good reason... A new president can make dramatic changes to antitrust regulations and other policies, which can derail agreements and cost companies millions of dollars in lost fees.

But that has not been the case this year...

In total, the Wall Street Journal reports U.S. companies have made an incredible $248.9 billion in deals so far this month. This is the most M&A activity in a single month in history... and well above the previous record of $240 billion in July 2015.

Even more impressive, an all-time record $177 billion of this total came in the last week alone... including AT&T's (T) $85 billion deal to take over Time Warner (TWX), British American Tobacco's (BTI) deal to buy Reynolds American (RAI) for $47 billion, and perhaps most notably, Qualcomm's (QCOM) agreement to buy NXP Semiconductors (NXPI) for $47 billion in the second-largest pure technology deal in history. (More on this in a moment.)

Incredibly, there could be even more on the way...

Yesterday, we learned business-telecom companies CenturyLink (CTL) and L-3 Communications (LLL) were in "advanced talks" regarding a $30 billion merger. General Electric (GE) is also reportedly considering a similar-sized deal to merge its oil-and-gas business with oil-services provider Baker Hughes (BHI).

Analysts note the frenzy is especially surprising in light of the government's growing "war" on business. The U.S. Department of Justice has already moved to block several deals this year. And this trend is only likely to accelerate if Hillary Clinton wins the presidency next month.

So what is driving this frenzy? The answer should sound familiar to regular Digest readers. As the Journal reported this morning...

With sales growth hard to come by in a slow economy, companies are casting about for ways to cut costs and keep profit growing. But after years of belt-tightening they need new sources of efficiency, such as a merger with a rival. Many are also looking to deploy their cash hoards in ways that will ensure future growth after spending years aggressively buying back stock.

And investors are egging them on. Like with the potential telecom deal, shareholders of both Qualcomm and NXP cheered their union, driving up both companies' stocks sharply.

In other words, companies are likely turning to M&A for much the same reason they've been buying back boatloads of their own shares... As the real sales and earnings growth has declined along with the economy, many companies are becoming desperate to boost earnings any way they can.

History says this will not end well...

Unfortunately, these moves have come at a serious cost... U.S. companies are as heavily indebted as they've ever been. As Porter explained in the September 30 Digest...

Of greatest concern to me is the overall level of corporate debt. Corporate debt in the U.S. has consistently topped out at a little less than 45% of GDP. Historically, the debt cycle has turned at that point. Defaults rise, issuance declines, and a bear market begins. Today, that level sits at 45.4%...

And yet, while defaults are already quietly marching higher... companies continue to borrow more while shareholders cheer.

Reckless behavior like this is a familiar and unmistakable sign that precedes every major market top. This boom may not end tomorrow, but it will end... and history suggests it will not end well.

An insider's take on the second-biggest tech deal in history...

One more note on this week's M&A activity...

As we mentioned earlier, yesterday Qualcomm – the largest semiconductor manufacturer of microprocessors for the mobile phone industry – announced it will acquire NXP Semiconductors for $47 billion.

The deal is notable for a couple of reasons...

First, it represents the second-largest pure technology deal of all time... as well as the single biggest acquisition in the history of the semiconductor industry.

Second, both companies happen to be former employers of our friend and colleague Jeff Brown.

As we mentioned in yesterday's Digest, Jeff – who now works for our corporate affiliate, Bonner & Partners – is one of the most experienced and connected tech experts in the world.

Not only is Jeff an active "angel" investor who has funded dozens of technology startups, but he has also been a leader at several of the world's biggest and best technology companies.

In this case, Jeff was the former head of global strategy of a division at Qualcomm. He was also recruited by NXP to help engineer a turnaround of one of its struggling subsidiaries (which he successfully did within two years).

Suffice it to say that Jeff has an insider's knowledge of both companies that only a handful of folks in the world can claim. And he graciously agreed to share his thoughts on the deal with Digest readers today. As he wrote in a private e-mail this morning...

The motivations to me are obvious. Qualcomm has struggled over the years to expand its business into adjacent markets with too many failed acquisitions and investments to count.

The overall market for smartphones will shrink by about 3% year on year compared with 2015, and Qualcomm has been faced with stiffening competition from the likes of giants like Samsung, MediaTek (Taiwan), Huawei (China), and even Intel. You can see it in the numbers as well. Qualcomm's fiscal year 2016 revenues are forecast to decline 8% year on year.

Many do not realize this, but Qualcomm's strength comes primarily from its intellectual property. In the early 1990s, Qualcomm placed major bets on code division multiple access (CDMA) technology that played out to the company's favor. Even more relevant is the business model that Qualcomm successfully asserted on the industry at the time... It receives a defined percentage of the average selling price of any phone that incorporates Qualcomm's intellectual property.

Need proof? Every quarter, on average, Qualcomm generates about 35% of its revenues from just licensing fees. The rest comes from the manufacturing and selling of its semiconductors for the mobile industry. It has been a black box that just keeps printing money.

But Jeff says this has been changing. As each new generation of wireless technology is developed, more companies contribute intellectual property to the industry standards... meaning Qualcomm's "grip" on these technologies is weakening.

As a result, Jeff says Qualcomm needs to "buy" new revenue. And the most logical targets would be industries other than mobile technology... which is exactly what it gets by buying NXP. Here's more from Jeff...

NXP Semiconductors, after its acquisition of Freescale last year, became the largest semiconductor supplier to the automotive industry... an industry that Qualcomm has been unsuccessfully trying to break into for years. NXP is also the leader in chips for near field communications (NFCs), which go into mobile phones, as well as small payment terminals used for cashless transactions.

NXP became an attractive acquisition candidate after it sold off its standard products business to a group of Chinese investors in June. The standard products division was seen as an unattractive asset to a player like Qualcomm because it is comprised of highly commoditized semiconductors in a very competitive market with much lower margins than Qualcomm is used to. By jettisoning this division, NXP set itself for sale.

Unfortunately, while the deal makes sense on paper, Jeff believes Qualcomm – like many other acquiring companies – may ultimately regret this decision...

The deal is a good one for NXP, earning it a high takeout multiple, currently valued at more than 16 times its earnings before interest, taxes, depreciation, and amortization (EBITDA). Qualcomm, on the other hand, paid too much for a company that it will struggle to incorporate into its business and manage once the acquisition is complete by the end of 2017. Expected synergies are only forecast to be a mere $500 million on a $47 billion deal and aren't forecast to be realized until the end of 2019.

As we mentioned yesterday, Jeff believes this is the most exciting and potentially profitable time in history to invest in the technology sector.

His Exponential Tech Investor strategy targets companies before they go public... in cutting-edge fields like gene editing, cybersecurity, the Internet of Things, and Big Data.

His approach is clearly working... Since launching last October, Jeff's subscribers have already booked several big winners, including gains of 73% in 284 days, 239% in 126 days, 97% in 98 days, and 100% in 27 days.

These incredible returns aren't by chance. Jeff uses the same approach in Exponential Tech Investor that he uses personally as an angel investor, where he has more than doubled his money several times.

Jeff is one of the brightest people we've met. After all, he has a degree in rocket science. And we're proud to call him our colleague. That's why we invited him to present last month at our annual Alliance meeting in Las Vegas. We weren't surprised when his presentation stunned the audience. He even shared one of his recent recommendations...

Until now, this exclusive video was available only to Stansberry Alliance members... folks who paid as much as $15,000 for this access. But because this information is so valuable, we're "unlocking" Jeff's video presentation for the next few days.

Plus, Jeff has agreed to offer a huge discount exclusively for Stansberry Research readers. But don't delay... This offer goes offline at midnight on Monday... and we can't promise we'll ever offer Exponential Tech Investor at a price this low ever again. Click here to watch Jeff's presentation and learn more about this special offer.

Want to go surfing with us – and a world champion – in February?

We'll turn the rest of today's Digest over to our colleague Sean Goldsmith, who has a special opportunity for a handful of readers...

I (Sean) got to live out a dream of mine this summer...

I took 10 days and flew to Los Angeles. I wanted to learn how to surf. I have a goal of joining a group of my friends for their annual surf trip in Indonesia in 2018. And I need a lot of practice before hitting those world-class waves...

Before I left, I called my colleague Steve Sjuggerud – a surfing fanatic – to tell him about my trip. I wanted to talk to him about which boards I should buy for my voyage. He shipped one of his boards to LA for me as a gift. But, in his words, he "did me one better."

Steve called me back the next day to let me know his friend, Sean Poynter, a world-champion surfer, was going to be my instructor.

Having Sean teach me to surf is like hiring Michael Jordan to teach some kindergartners to play basketball... But of course, I accepted. To give you an idea of what I'm talking about, here's a picture of Sean at work...

For the next 10 days, I lived the surfer life in California. My dad flew in from Georgia to spend time with us.

I rented a bungalow in Venice Beach... I even lived in an Airstream trailer in Malibu for a few days.

But every morning, Sean and I got on the water. We'd drive through Malibu looking for the best waves, hopping from surf spot to surf spot. And Sean, displaying incredible patience, taught me to surf. After each morning riding waves, we would eat a huge breakfast on the Malibu Pier.

And by the end of the trip, not only did I make a new friend... but I was riding waves!

It really was the trip of a lifetime for me. I was totally unplugged, surfing with a world champ every morning and spending time with family and friends.

Frankly, you can't even pay for the experience I had in LA.

As you probably know, Porter and Steve are also avid surfers. They even spent some time (albeit a long time ago) with another world-champion surfer, Kelly Slater...

Left to right: Kelly Slater (the greatest surfer of all time), Steve Sjuggerud, and Porter Stansberry.

You probably didn't know… Stansberry Research may not exist without surfing. One reason Porter and Steve wanted to start working together is because they were surfing buddies.

And surfing also changes your world view. From Steve...

It's fantastic to see the world with a mission, as opposed to just as a tourist. Fiji, Hawaii, Australia, New Zealand… the list goes on and on. Instead of seeing the sights, you're challenging yourself in them. It's a whole 'nother thing.

While it's hard to get motivated to go to the gym just to stay in shape, it's easy when you have a mission to get ready for, whether it's a paddleboard race across Hawaiian islands (that Sean Poynter and I did together) or a surf trip where you don't want to be tired when the conditions are good...

Steve, Sean, and I are hosting an investing and surfing retreat in Punta Mita, Mexico. We'll stay at the Royal Suites Punta de Mita by Palladium. Sean chose the location because the surf is great for all experience levels. And he has taught a surfing and stand-up paddleboarding ("SUP") retreat there before.

Sean is also bringing Ian Cairns to help instruct. Ian is a living legend and one of the most sought-after surf and SUP coaches in the world. He has more than 30 years of experience and has coached past and current world surf and SUP champions.

The trip will take place February 15-19. We'll get in the water up to two times a day to practice surfing and SUP. You can sign up for fishing, whale watching, snorkeling, and plenty of other water activities, too. Or you can just drink some margaritas and enjoy Mexico with your friends. In short, whatever you want to do, we'll make it happen.

We'll also have an investment curriculum – we've asked Steve and Porter to present one evening.

The cost will be approximately $6,500 for four full days in Mexico. That includes ground transportation, lodging, food, alcohol, world-class surf instruction, and activities each day. The final price will vary depending on attendance.

We're finalizing the details this week, but this trip is sure to sell out fast... If you'd like to attend, please e-mail us as soon as possible. And we'll reach out to you to confirm your attendance.

Since surfing with Sean in LA, I've jumped at every opportunity to get back in the water – surfing both Montauk and the New Jersey shore. I've already made some amazing new friends surfing. And it's a sport I'll continue for the rest of my life.

I hope you'll join us in Mexico for this event. You'll have fun regardless of your experience level – beginner to expert. After four days with Sean and Ian in the water, you'll no doubt leave a better surfer. And you may even learn something on the investment side of things.

New 52-week highs (as of 10/27/16): TTM Technologies (TTMI) and short position in General Growth Properties (GGP).

In today's mailbag, one reader finds an "error" in P.J.'s latest essay... and another appears to be working through some personal issues. Send your questions, comments, and cries for help to feedback@stansberryresearch.com.

"I think there was a typo in P.J.'s essay today: 'As far as I can tell, the only reason we had moderators in the real-world 2016 debates was to bring the average IQ on stage up to three figures.' I think that last word should be 'fingers'!!! If you disagree with that, maybe 'average' should have been 'total'!!!" – Paid-up subscriber Carl S.

P.J. O'Rourke comment: I think I know just which fingers Carl means... But when it comes to giving the debate the finger, I only have two hands.

"Please stop emailing well-known Marxists. We despise you guys." – Paid-up subscriber Erica Natalya Efros

Brill comment: As you may have forgotten, the Digest is sent only to paid Stansberry Research subscribers. It appears you felt a little differently when you voluntarily subscribed to our evil capitalist investment newsletters. Which begs the question... are you a typical Marxist (a hypocrite), or are you just confused?

Regards,

Justin Brill
Baltimore, Maryland
October 28, 2016