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As Economy Goes, So Go Takeovers, Even as Bargains Abound
By STEVEN M. DAVIDOFF
New York Times
October 18, 2011, 7:28 pm
The merger market is like a pack of lemmings. If the economy is good , the takeover market will follow, but when times are bad, the market stalls.
For the moment, there are still mega-deals, like Kinder Morgan’s $21.1 billion acquisition of the El Paso Corporation, and takeover activity is up. The volume of global mergers and acquisitions was up 22 percent, to $2.748 trillion, for the last 12 months ending in August from the period a year ago, according to Thomson Reuters. The increase in deal volume was driven in part by a threefold increase in hostile offers and strong company balance sheets.
Yet many major economies in the world are growing sluggishly, if at all. The negative economic outlook is likely to counteract some otherwise strong drivers for deal-making.
The International Monetary Fund estimates growth for advanced economies at just 1.6 percent this year and only 1.9 percent in 2012, compared with a historical average of about 3 percent. In the United States, unemployment remains stubbornly high, and 2011 G.D.P. growth was recently estimated by a National Association for Business Economics poll of economists to be about 1.57 percent.
The European sovereign debt crisis has worsened the economic growth problem. And the uncertainty over how far the crisis will spread in Europe is bound to drive down takeover volume.
Then there is the stock market. In a presentation last week at the Penn State M&A Institute, Jane Wheeler, a senior managing director at Evercore Partners, noted that since 1985, takeover volume had grown in only two years when the Standard & Poor’s 500-stock index had declined.
So we have the lemmings problem again. Takeover volume follows the stock market, and the market is down. Its recovery is fragile given the negative trends.
Also weighing on the merger market are signs that the Obama administration is stepping up antitrust enforcement. Last year, the federal government made a second request for information, an indication of an in-depth investigation of a transaction, in 4.1 percent of deals, compared with 2.5 percent in the last year of the Bush administration, according to a joint report submitted to Congress by the Federal Trade Commission and Department of Justice.
Mergers are also being challenged more often, and antitrust enforcement appears to be becoming even more aggressive in recent months. Although Continental and United Airlines cleared antitrust review by the Obama administration in August 2010, the federal government is suing to stop AT&T’s acquisition of T-Mobile USA after effectively blocking Nasdaq’s bid to acquire NYSE Euronext and Avis’s effort to acquire Dollar Thrifty.
All this spells a decline in takeover volume. Deal makers do not want to take undue risks, and fear of uncertainty and a downturn is real even beyond the heightened regulatory scrutiny.
Yet there remain some forces that should be putting wind in deal makers’ sails.
The takeover market’s pattern of following equity prices is counterintuitive. When stocks are down, valuations are low and takeovers should make the most sense from a value perspective. Right now, price-earnings multiples are about 15 times earnings, compared, according to Standard & Poor’s, with a historical average approaching 20 times earnings. One would think companies would be rushing to scoop up low-priced assets.
This is particularly true since credit is easy, at least for some. The high-yield market is choppy at best, but good companies can borrow at incredibly low rates for long periods. The Norfolk Southern Corporation, for example, priced a $400 million 100-year bond with a yield of 6 percent.
Even beyond credit there is cash, and companies have plenty of it. Standard & Poor’s estimates that American companies have more than $2 trillion of cash on their balance sheets. Although much of it is held abroad as companies wait for the federal government to lower the dividend tax on the repatriation of cash, certainly hundreds of millions of dollars can be spent domestically.
Private equity firms are also sitting on big cash hoards. Globally, private equity still has almost $1 trillion in dry powder, according to a study by Bain. Leveraged buyouts currently average a mix of about 40 percent equity and 60 percent debt. Private equity therefore has enough firepower for more than $2 trillion in buyouts.
So where are they? The industry remains notably hesitant to make deals. Only 6.5 percent of global M.& A. transactions through the first nine months of 2011 were private equity acquisitions, according to Dealogic.
While it is hard to know what in particular is holding private equity back, they too are most likely following the economic cycle, afraid to invest in a volatile, potentially down market.
Must-do deals will still happen, like the El Paso acquisition, which Kinder Morgan’s chairman and chief executive, Richard D. Kinder, called a “once-in-a-lifetime transaction.”
Yet the overall trend is that of M.&A. rushing toward a cliff. Companies that might have pulled the trigger on an acquisition will instead spend their cash on dividends and stock buybacks.
Sure, some brave companies will take a plunge and try to acquire at a lower value. And the slowdown in initial public offerings may also spur takeover activity.
These are likely to be small blips. For the next few months, investment bankers are going to have a hard year as they try to point to the positive factors in the market to sell deals. But they are going to be running against those lemmings.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.