Money, Money Everywhere for Chasing Deals: Financial and strategic buyers will be squaring off in the M&A market

Enormous amounts of money are looking for a home and might very well find it in the mergers and acquisitions marketplace. The 2007 M&A market is shaping up as an arena for a clash of well-heeled titans eager to put their funds into a wide spectrum of deals spanning all sizes, markets, and geographies. To dealmaking pros, the mixture of means and ardor points to a third straight blockbuster year for M&A deals, not only in deal volume but in creativity, strategic reshaping of markets, and pricing based on intense competition. Financial firepower resides with virtually every dealmaking agent. Private equity buyers blazed through a spectacular string of expensive, high-profile deals last year, barely making a dent in the mega-billions in their war chests and leaving huge sums at the ready for encore performances this year. If these captive funds weren’t impressive enough, lenders and other debt market forces are eager to pony up copious amounts of borrowed funds to augment financial buyer wherewithal. Meanwhile, corporate buyers are packing sterling balance sheets and unprecedented sums of free cash together with the option of using their shares as acquisition currency, thanks to sustained strength in the stock market. In fact, M&A experts suggest, the principal change in deal drivers this year may be a more aggressive tack by strategic buyers who are under intensifying pressure to channel uncommitted cash into growth-oriented initiatives such as acquisitions. And that could lead a U.S. company anywhere in the world that opportunity arises, notes Ravi Chanmugam, a Partner in Accenture’s Strategy/M&A group. “Right now, growth is a huge factor,” he says. “The key question is, Where do we get more growth?’ Inevitably, the answer to that question comes when someone on the board asks, What are we doing in Brazil, Russia, India, or China?’ Increasingly our clients are looking at acquisitions or minority investments in those countries. It’s still a small portion of the deal flow but we see that continuing to increase as companies weigh their options.” Douglas Brockway, Managing Director of Innovation Advisors, an investment bank specializing in technology deals, says growth concerns also will be among the acquisition drivers in that field. “Take the large public companies that promise 20% growth this year,” he notes. “They realize they can do 15% by themselves but where’s the other 5% going to come from? They need acquisitions to get that additional 5%.” Corporate buyers also are being encouraged by an attitudinal shift in the stock market to reward good acquisitions, says Alan Alpert, Managing Partner-M&A Transaction Services at Deloitte Tax. He agrees that the market “usually reacted negatively” in the past and that “CEOs were not getting good publicity when they did deals.” “I think that’s changed,” Alpert says. “The long and short of it is that when the company does a deal, it’s getting a favorable response in connection with its stock price.” MidMarket Capital Advisors founder and Managing Director Patrick Hurley also sees efforts to win favor from the stock market. “Strategic buyers are looking at the market,” he says. “Even if it has some ups and downs, the trend is so strong that you had better deliver on your next act. I don’t see anybody out there doing silly things. I see people that are thoughtful, calculating, and not afraid to pay what anyone would agree would be rich prices because they’re on a mission. Corporate development people are burning the midnight oil because CEOs are saying that they have to meet their targets.” It wasn’t that corporate buyers were sitting on the sidelines watching deal competitors in the PE ranks pick off the juiciest plums. Strategic acquirers, in fact, captured their typical majorities in both deal numbers and values. But few of their deals matched the star power enjoyed by financial buyers, who, largely by assembling bidding teams, pulled off such impressive buys as HCA ($35 billion); Clear Channel Communications ($18.7 billion); Freescale Semiconductor ($17.6 billion); Harrah’s ($17.1 billion); Univision ($13.7 billion), and ARAMARK ($8.3 billion). There also was little creative rivalry for other PE-centered deals, such as the strategic/LBO coalition that bought supermarkets giant Albertsons for $17.1 billion and Cerberus Capital Management’s acquisition of a 51% stake in the General Motors Acceptance unit of General Motors for $14 billion. Nevertheless, strategic buyers racked up a record that was hardly shabby. The biggest deal of the year – the mammoth hookup of AT&T and BellSouth valued at roughly $86 billion – closed on the last business day of 2006 when the FCC gave the go-ahead on the transaction. Corporate buyers also scored big deals in such disparate industries as financial services with Bank of America and MBNA, $35.8 billion; Wachovia and Golden West Financial, $25.5 billion; and Bank of New York and Mellon Financial, $17 billion; natural resources with ConocoPhillips and Burlington Resources, $35.4 billion; and Freeport-McMoRan Copper & Gold and Phelps Dodge, $26 billion; and health care with Boston Scientific and Guidant, $27.3 billion. Deal pros attributed the LBO shops’ ability to win the image race to their unswerving commitment to pursuing their primary business – doing deals – and willingness to outbid both strategic and financial rivals in the inevitable competitions that surrounded the most sought-after targets. With lots of money and credit still at their fingertips and sustained excitement to continue the deals chase, they say, private equity remains on the prowl for more transactions this year. “Fundamentally, the economy remains strong,” says Jean-Pierre Conte, head of Genstar Capital. “Because of that strength, Corporate America’s coffers are flush with cash. So companies are taking more risk on the acquisition and expansion fronts. I think the debt the markets will be equally compelling, so financial buyers will be in full swing again. I think the IPO market will again be strong and the equity markets as well. So it’s almost like every cylinder is firing as it was in 2006.” Mark Sirower, leader of PricewaterhouseCoopers’ M&A strategy practice, says that private equity’s drive for deals never wanes. “PE firms look at opportunities every hour of every day. What they do for a living is look at opportunities. That’s a big advantage over strategic buyers who are reactive and only look at some opportunities,” he states. That scenario leads to the question of whether the two main buyer segments ultimately will run into each other, triggering massive overpricing and follow-on problems in making acquisitions work. Although deal professionals concede that bidding slugfests may develop, they also see prospects for both groups to navigate separate channels without getting in each other’s way. Brockway, for example, expects both PE and strategic buyers to ply technology but believes they can co-exist. Strategic buyers, he says, will be looking for targets that can add products and technologies, expand customer bases and geographic territories, or offer skills in selling to customers that the acquirer may lack. PE buyers, who would “never touch” a technology player a decade ago, now are gravitating toward the more mature spaces and like build-up projects. “PE firms are aggressive,” he says. “They will buy a platform and roll up other companies. They will take a $500 million company and turn it into a $3 billion or $4 billion company.” Gerald Adolph, Senior Vice President and head of M&A and restructuring at Booz Allen Hamilton, notes that private equity players, expanding their vistas in search of rewarding situations, have made it “more socially acceptable to go after troubled companies.” “Private equity is here to stay, and not just because there’s a lot of money around,” he says. “That’s the financial explanation. They’re transforming themselves into turnaround artists, going after companies that are not performing.” However, Adolph also sees strategic buyers becoming more interested in underperformers and troubled companies if they’re in businesses they know. An increased number of divestitures is on the docket and the consensus is that they largely will appeal to financial buyers. “Private equity is better geared to move quickly, pay cash, and take over an underperforming business and also lever it up if it has high cash flow and stability,” says Accenture’s Chanmugam. Sirower notes that large numbers of divestitures generally track strong M&A activity, and that private equity players historically are “heavy buyers” of corporate cast-offs. Although the movement into China likely will draw investors from both camps, emerging trends seem to be tipping the balance to the strategic side, in part because of the aforementioned drive for growth. According to Glenn Gurtcheff, a Managing Director at Harris Williams & Co., there has been a shift in strategic directions aimed at capitalizing on the explosion of the middle class in China. Until a year or so ago, he points out, most inbound investment was aimed at sourcing – securing low cost product. More recently, the goal has been to “penetrate China from a consumer point of view.” That movement runs along the manufacturing front as well as the retail front, where recent deals included entry by Wal-Mart and Home Depot. Gurtcheff advises care before setting expectations and acting. “The Holy Grail for most manufacturers has been that there are billions of people and a burgeoning middle class,” he adds. “When demand starts to show up, we’ll do great. But culture is important. If something plays well in Peoria, that doesn’t mean it’s going to play well in Shanghai, whether there’s a middle class or not. Certain products and services will do well but others won’t.” Buyers’ appetites also are delineated by industry specifics, with some appealing more to financial buyers than strategic acquirers and others tending to fall into the corporate camp. Growth rates, capital intensiveness, maturity, and cost profiles are among the dividers. When deal pros weave drivers like money and scrappiness with strategic rationales, such as consolidation of fragmented industries, reaching for the leading edge in technology, bulking up in mature sectors, and globalizing industries, their prognosis is powerful deal flow throughout most of 2007. Consolidation can be executed by financial players through roll-ups or by strategic buyers angling for scale. Sirower, whose studies have shown that M&A volume usually tracks the stock market, says that corporate buyers are well primed to move because “they have the currency to do deals.” However, a few dealmakers candidly admit that the late stretches of the year are not so clear as to whether the economy will remain stable, the capital markets will remain satiated and easy to tap, and the stock market will maintain its lofty levels. But even amid a mentality of “get it while it’s hot,” many dealmakers echo Hurley’s view that nobody in either the financial or strategic ranks is ready to put cash on the barrelhead for a property simply because it’s there. Gurtcheff, for example, says that bidders on both sides are putting targets’ owners and managers through their paces by asking lots of tough questions. “The degree of difficulty in getting deals done has gone up because the due diligence process is more thorough now. People are looking at businesses and forecasts for 2007 with a more jaundiced eye,” he remarks. PE groups, in particular, are spending more time on due diligence than they were a year ago, he adds. Aside from examining the books, operations, customer bases, etc., due diligence is leading bidders to some unique terrain. Costs and pricing power are premier issues in scores of current deals, Gurtcheff reports. “With China and Asia so relevant (in sourcing), people are starting to focus on pricing power,” he says. “What evidence do you have and what can you point to that will give me comfort that in a rising cost environment you’ll be able to maintain your margins and that you have pricing power? That’s where some of the savviest buyers are focusing.” “There have been cost pressures in the system,” says Gurtcheff, who points out that resin costs, because of the oil price spike, have “gone through the roof” and cut into packaging companies’ margins. “People want to make sure they’re buying off forward numbers that they can believe,” he adds. “That can be especially tough for a middle-market company in a field with larger players that is caught in a squeeze between competitors and customers.” An interesting trend involves the incremental expansion of the buyer populace through formation of dedicated financial boutiques, which confine themselves to a handful of deals a year and try to stay out of the bidding fray by smoking out special situations. A recent addition is Admiralty Partners, run by 30-year deals veteran Jon Kutler, who specialized in the aerospace and defense industry at Jefferies and Quarterdeck Partners and continues to focus on that realm. Eschewing fundraising, Kutler has committed personal capital, searches for opportunities “under the radar,” stays away from auctions, emphasizes high internal rates and return, and feels no compulsion to exit quickly. He has averaged a deal a year for the last three years and says he follows up on only a fraction of the opportunities that come his way. “It’s a hot industry but it attracts a lot of people who don’t know the aerospace/defense industry,” he says. “We can operate whether it’s a hot or cold market.” (c) 2007 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com