A Dark Mood In the M&A Market with a few Rays of hope

The last multi-year slump in dealmaking coincided with the turn of the decade from the 1980s into the 1990s. In hindsight, the slack period was largely a way station between one lengthy mergers and acquisitions boom and another of even more explosive dimensions. But it was a painful pause for buyers, sellers, and the corps of professional advisers that populate the m&a market, leading many observers to regard the ’80s as a flash in the pan and the early ’90s as the start of a prolonged malaise. Indeed, when the deals recovery began in mid-1993, it erupted with striking suddenness and almost no advance warning. Some parallels with the current downturn that began in late 2000 are striking. The economy is laboring, the stock market stuttering, bank credit tough to get. Many companies are in deep distress – ranging from traditional retailers to new-fangled dot-coms – and bankruptcies are rising. Within the m&a market, buyers and sellers are trying to adjust price and value expectations. Some sellers won’t bite for the reduced prices being offered while many buyers think any price tag is too risky these days. The key added starter this time around is the great uncertainty triggered by the September 11 terrorist attacks that, beyond jolting an already troubled economy, forced decisionmakers of all stripes to face the realities of a world filled with increased tensions and dangers. These are just some of the often-conflicting factors that deal pros are sorting out while trying assess the m&a climate for 2002. At stake is whether the environment will induce corporate and financial buyers to resume making big bets in heavy numbers and how much business there will be for the service infrastructure. Conventional wisdom is that 2002 will shape up as a better year than 2001, when deals volume was in a tailspin. Some of the speculation may be wishful thinking, i.e., it couldn’t get any worse. But, many experienced pros who have been down this road before are balancing the myriad countertrends that buffet the m&a market and concluding that when the winds of uncertainty abate, the strongest acquisition drivers will regain influence. The downturn in 2001 was stunning. The number of merger, acquisition, and divestiture completions priced at $5 million or more totaled 6,224, according to the preliminary report by the Thomson Financial Mergers & Acquisitions Database. This was down 32% from the upward-revised total of 9,183 in 2000 and touched the lowest level since 1994. Dollar value, based on reported prices for less than half of the number of deals, plunged 36% to $1.14 trillion from an upward revised $1.79 trillion in 2000, a historical record. That was the lowest volume since 1997, the last year before confirmed dollar value crossed the trillion-dollar threshold. When delayed information is eventually captured by the database, the declines might not be so precipitous. Upward revisions for new deals data are common. For example, the most recent 2000 levels include additions of 678 deals and $38.1 billion from the figures reported in the February 2001 M&A Almanac. But for a bad year, an unusually large number of deals with big price tags and heavy strategic impact were executed. More than 100, for example, reached the megadeal class, with prices of $1 billion or more. Several of the largest completions were long lead-time deals, hatched in 2000 and carried into the following calendar year by industry and/or antitrust regulatory screens. These included the $164.7 billion merger of America Online Inc. and Time Warner Inc. into a media behemoth, the oil industry megamerger of Chevron Corp. and Texaco Inc., valued at $42.9 billion, and a pair of smaller but high-profile food and beverage deals – PepsiCo Inc.’s $14.4 billion acquisition of Quaker Oats Co. and the General Mills Inc. purchase of Pillsbury Co. from Diageo PLC for $10.5 billion. In other cases, the dealmakers managed the proposal and the wedding within 2001 such as American International Group Inc.’s $23.4 billion acquisition of American General Corp., the largest transaction ever done in the insurance business. Volume held up remarkably well in a number of industries that led the m&a wave during the 1990s, including banking, health care, media and telecom, oil and gas, food, and utilities. These were industries that either had momentum going or took relatively light hits from the economic downturn. And even while most buyers and sellers remained on the sidelines, some bold moves during December belied the deals slump and generated flickers of hope for a modest rebound. Comcast Corp. won a cliffhanger battle for AT&T Broadband, beating out several other contenders by ponying up $47 billion in stock and assuming another $25 billion in debt. When completed later this year, the new ATT Comcast will become the largest cable TV organization in the country and, according to some forecasters, trigger another round of large deals to develop like-sized rivals. The highest-priced transaction ever done in the biotechnology field developed when Amgen Inc. agreed to buy anti-inflammatory drugs producer Immunex Corp. for $16 billion. And the media industry had another landscape-changing megadeal when France’s Vivendi SA, which is in the process of becoming a global multi-media giant, took an important step in that direction by anteing up $10.3 billion to obtain the entertainment business of USA Networks Inc. – notably the Universal Pictures film studio and the USA cable TV channel. Yet, the realities of the aforementioned economic weakness, vacillating stock market, and tight credit conditions – which negatively impact the confidence to buy and the optimal use of primary acquisition currencies – restrain full-blown optimism for a rapid recovery in big-time dealmaking. Ironically, this same depressing combination plagued the economy and the m&a market well into 1993 and showed little sign of easing. Why then did m&a take off so suddenly at the mid-point of that year? The one key dealmaking influence that remained intact was the dramatic change shaking up most major industries as a result of technological innovation, geographical spread, deregulation, and shifts in economic stakes, which had cast acquisitions as preferred responses to the challenges of evolution. Those buyers that led the way determined they could no longer defer timely acquisitions, regardless of surrounding conditions, while many badly wounded sellers decided that their survival as stand-alone companies was questionable. Sound familiar? Many of the same strategic considerations are influencing decisionmaking in early 2002, leading m&a pros to again count on the strategic imperative as an ace in the hole. Industries still are in the throes of major change that have been managed through acquisitions and there is some betting that the need to acquire soon will overcome myriad depressing forces. Even if dealmaking ardor is pent up, buyers, sellers, and advisers can’t easily dismiss the curbs on m&a. The economic turbulence restrains confidence in corporate managements to undertake major initiatives in almost every business area, including acquisitions. Although companies with the strongest credits still can obtain acquisition funding, the tightfistedness of financial institutions depresses m&a in the far-flung middle market and dealmaking by leveraged acquirers. Stock market inconsistencies make it tough to craft share swaps that appeal to both sides. The m&a market, moreover, resembles a contentious no-man’s land, even with an occasional spark of accomplishment. Both public and private sellers are having trouble adjusting to bid prices that have receded from 1990s levels and taken their companies off the block. Many buyers, in turn, seek only bargain-priced properties. In the wake of the September 11 attacks and the ensuing war on terrorism, deal negotiations over terms that allow buyers to easily break agreements are often fractious. Acts-of-war clauses as deal-breaker excuses have become more common. On the flip side, there are a series of factors that could feed a brisker pace of deals sooner rather than later. As in 1993, a number of scarred and troubled companies could be looking for buyers that need their assets and attributes at attractive prices. The increased security consciousness prompted by the war on terrorism could lead to increased acquisitions in a host of industries, such as military electronics, security equipment and services, teleconferencing, germ warfare detection equipment, and specialized vaccines. And consolidation of fragmented service industries, which has been on hold, is a candidate for early resumption. Dealmakers also will have to work their way through a host of other factors of varying influence, including: Elimination of Pooling – This will be the first full calendar year for operating under the Financial Accounting Standards Board (FASB) edict that scrapped pooling-of-interest accounting treatment and made purchase accounting treatment uniform. Dealmakers still are learning how to operate under the new system. Despite initial wailing, many m&a pros now see the shift as a dealmaking stimulus. With the demise of pooling, acquirers will be able to divest unwanted parts of the targets quickly (instead of having to wait two years) and more easily manage share buyback proposals to support their stock prices. The accompanying new standard that dumped annual amortization of acquisition goodwill in favor of one-shot write-offs when that intangible asset loses value also is a plus for deals. Buyers won’t have to be as worried as in past about huge overpayments for hard-to-identify assets. Several companies already have started to clear the decks, most notably AOL Time Warner, which plans a $60 billion write-off of impaired goodwill. Corporate Restructuring – A new wave of corporate divestitures of non-core or fringe businesses has been widely predicted. Sell-offs held up well during the 1991-to-1993 slump and could rumble sooner than most dealmaking sectors, even though pricing may not be particularly appealing to companies looking to slim down. The first major deal announced in 2002 was a sell-off – an agreement by Raytheon Co. to peddle its aircraft integration systems business to L-3 Communications Holdings Inc. for $1.13 billion. Raytheon is not atypical of the large companies that will be trying to shed operations. The systems unit is not a core business and Raytheon can use the funds to pay down debt. On the buy side, L-3 Communications reflects the type of buyer that is trying to bulk up in the defense electronics area, with the acquisition of other firm’s unwanted businesses representing a potentially rewarding route. Regulation – Dealmakers generally predicted an easier regulatory climate in the Bush administration. On the antitrust side, neither the Department of Justice’s Antitrust Division nor the Federal Trade Commission has been exactly a soft touch, but policy is still playing out. A more relaxed stance is being flashed by other regulatory agencies, notably the Federal Communications Commission, which is looking at rolling back restrictions on acquisitions of radio and TV stations, owning broadcasting properties and newspapers in the same market, and the reach of cable TV systems. Distressed Companies/Bankruptcies – Acquirers have been more skilled in navigating the bankruptcy court maze to buy all or pieces of companies in financial trouble. And more companies operating under court protection are trying to telescope the process through advantageous sales. In 2001, SunGard Data Systems Inc. was able to bulk up its disaster recovery business by purchasing a competing operation from Comdisco Inc. The key event in 2002 has been the auctioning of the energy trading business of the imploded Enron Corp. Look for savvy buyers to spend more time fishing for deals either in bankruptcy or in troubled out-of-court waters where there are lots of companies whose assets are better than their finances. Technology firms that have yet to get into the black, collapsing dot-com and other Internet-related firms, and telecom issues that haven’t turned the corner are considered among the prime “rescue” candidates. Attractive prices could be a good draw. Leveraged Buyouts – The credit squeeze has fallen especially hard on LBO firms and cut deeply into their ability to do deals. Sponsors also are plagued by poor performance at their portfolio companies. Any easing in the general economy and the credit markets will be catalysts for stronger leveraged activity. Going Private – Scores of publicly owned small-cap and mid-cap companies whose stocks have been pounded in recent years have been looking to maximize value by repurchasing their stock and going private. A flurry of going-private deals were done in late 2000 and early 2001, but the movement slowed around mid-year, largely because the credit squeeze braked buyback plans for controlling owners and financial buyers.