How Acquirers Dealt With the Shock Of Roiled Markets

The m&a market was jolted in the summer of 1998 by a declining stock market which added another uncertainty to the volatility in capital markets and global economies, along with a slowdown in the U.S. economy. While some dealmakers pulled back, others moved smartly ahead, and a recovery followed a temporary halt in dealmaking. Three m&a veterans from the investment banking world assess the drivers of activity that created these choppy trends and bode for solid dealmaking in the future. Pausing to Reassess There were ample reasons for many acquirers to pull back in the summer of 1998, when the sliding stock market exacerbated the negative trends in world economies and fears that the U.S. economy was slowing. The uncertainties had major implications for deals on the burner, including the prospects of potential targets. But the m&a professionals correctly forecast that too would pass and the slippage in dealmaking was largely a lull because of strategic imperatives. Stock Market Shock Waves If the stock market drop temporarily stymied dealmaking, there isn’t much chance it will become a permanent roadblock. Acquirers have ample cash to do transactions dictated by strategic imperatives. One possible measurable impact could be a rise in hostile offers for targets with battered stock prices. Absence of Specters A major source of optimism for dealmaking into 1999 is the failure of key impediments that hurt m&a in its 1990-91 slump to reemerge. Dealmakers see no major tightening of credit by lenders and they don’t see willing sellers exiting because they don’t like offering prices. Picking the Spots Even in the most cautious times, competition remains intense when a good target is on the block. But lesser-regarded companies were becoming hard-sells in the long, turbulent summer of 1998. On balance, the m&a market shifted from a seller’s market to a buyer’s market. Pausing to Reassess M&A: After going great guns for the first half of 1998, m&a activity has slowed down in August and September. What, in your opinion, accounts for that and do you think this is mostly a lull and that activity will recover? Foussianes: When considering the present lull and its causes, it’s important to consider the three prime drivers of the increased m&a activity that we experienced through the middle of 1998. First, there has been an ample supply of currency, both cash and stock, to complete acquisitions. Second, the regulatory environment has been favorable. Finally, there has been intensified pressure on companies to deliver earnings growth, much of which has been achieved through acquisitions. With the strong U.S. stock market and economy, and low interest rates, the m&a market has had a solid foundation on which to grow. Uncertainty about the economy in general, including a major dislocation in interest rates or financing availability and/or a major down-draft in stock prices, could absolutely have a very negative effect on m&a activity. Likewise, large and visible failed deals, as well as increased regulatory blocks, would hurt the confidence of the market and impede activity. The uncertainty that exists today will persist until the market gains confidence that the underlying fundamentals are still solid. Harris: I think I would break the situation into two or three pieces. For example, with the stock market down, some acquirers are reluctant to use their lower-priced shares to do deals. With the Asian turmoil, acquiring companies not only are reluctant to buy there but also are very wary of domestic companies that have significant business dependence on Asia. And the economy may be at a crossroads. The uncertainty growing out of these developments makes companies reluctant to take significant actions going forward. When you add up all of these factors, that suggests that CEOs at present don’t have the confidence to go ahead with acquisitions and other key strategic commitments. This is a change from earlier in the year when they were quite confident that their decisions would pay off. We, too, have seen a slowdown but we also think it’s more of a lull than a permanent decline. Lavine: I have an entirely different view. We find that the m&a business is up in recent weeks and that the deal flow is moving strongly. Our m&a business is doing quite well while other parts of the firm have clearly been hurt by these market changes. Our clients want to move ahead with deals because their strategic imperatives are more important than current market conditions. You will be surprised by the number of transactions being announced over the next month. Stock Market Shock Waves M&A: How will the decline in the stock market affect m&a activity? Foussianes: In general, acquirers are reluctant to use their stock as acquisition currency if the resulting combination is dilutive to earnings or overly dilutive to ownership or control. Those factors will continue to drive an acquirer’s financial analysis. It’s true that when an acquirer’s P/E drops, there is a greater chance that stock transactions will appear dilutive. These transactions will not be dilutive, of course, if the acquisition price drops by a similar amount, which is quite possible in such an environment. That’s why I believe that reduced stock prices in general need not have a dramatic negative effect on m&a activity, especially after the initial market dislocation is dealt with. Unsolicited activity should also increase in such an environment, given the reduced price tags on target companies. Lavine: I expect to see an increase in bear hugs. When the stock market declines, there always seems to be a rise in hostile takeover offers. In addition, expect to see an increase in m&a premiums paid. Acquirers see good buying opportunities if a target company’s share price has dropped. The stigma of launching a hostile takeover has faded in recent years. When companies such as AT&T and Johnson & Johnson are making hostile offers, the practice takes on a new, acceptable light. Harris: One other point to bear in mind is that m&a activity does not have to rise and fall with the stock market. Many companies have excellent cash reserves that they need to invest and they are willing to use the cash if they need to acquire to fulfill a strategic imperative. Cash is very viable in all but the very largest transactions. It will be interesting to see, as m&a activity recovers, how many deals are done for stock and how many are done for cash. Many sellers might be reluctant to take stock right after the stock market has gone through such a volatile period. Absence of Specters M&A: The 1990-91 period clearly was the nadir for m&a activity over the last decade and a half. Among the key factors that contributed to that decline were the tightening of credit by lenders and sellers taking their businesses off the market when offering prices dropped. Are these factors emerging during the recent lull? Lavine: We have fallen from the heights, but we don’t see those factors recurring this year. Some banks may be experiencing problems because of currency losses and the like but their conditions in 1990-91 were far worse. Remember, they had a lot of non-performing real estate loans and they had to publicize their exposure to HLT loans. So, many shut the loan window for m&a transactions as well as other corporate borrowing needs. Credit has gotten tighter and somewhat more expensive but it is still available. These conditions are a long way from what we experienced in 1990-91. Harris: Over the last five years, we have seen conditions that were extraordinarily conducive to m&a, both the bullish stock market and the availability of extremely attractive financing from banks and other lenders for cash deals. As of now, we haven’t seen any sign of tightening of actual credit by the banks, although some may draw lines as to the sizes or the multiples in certain deals that they are willing to finance. This does not suggest anything like a rationing of credit for m&a, although it does indicate that some lenders think this is a time to be cautious. I haven’t seen any exodus by sellers who were disappointed in the bids they received. For some targets, divesting the business is as much of a strategic imperative as it is for the buyers. Selling to a larger company that has the resources to make the business grow may be important to the target’s survival. Foussianes: I agree that the situation is quite different than it was in the 1990-91 period. It’s true that fixed income markets, including the banks, have begun to exercise caution in many situations. Nevertheless, it’s not nearly to the extreme that we saw in the early ’90s, mostly because today’s difficulties have been a result of recent market volatility as opposed to underlying economic factors, as was the case in 1990-91. Decisionmaking Crossroads M&A: With the drop in the stock market, the IPO market also has faded. My research indicates that when this happens, there is an increase in the number of companies that change their mind about going public and put themselves up for sale. Lavine: That correlation is correct. If an IPO offers the best choice, they will go public and in effect keep control of the company while gaining a publicly traded stock to make acquisitions and improve the position of the company. But if the IPO market disappears, as it almost has during the last two months, selling the company may be the only route for achieving liquidity in the near term. This is especially true for financial owners such as the LBO funds where liquidity on their investments may be their most important objective. Harris: I agree with what you said. Even in the best of times for the IPO, many companies pursue a dual-track strategy when they file a registration statement with the SEC. They can either follow through on the IPO or draw enough attention from potential acquirers to draw an attractive offer. This has happened a few times this year. One of the most recent examples was Tropicana. Seagram Co. filed a registration statement to divest that business in a public offering but wound up selling it to PepsiCo. Foussianes: While it’s true that sellers tend to favor the market that offers the best valuation multiple, their choice is highly dependent on their strategic as well as financial objectives. As an example, most change-of-control transactions tend to be m&a-driven. On the other hand, some situations, such as when a private company is looking for a public acquisition currency, will point toward the IPO, often even in difficult markets. In my view, it is very tough to draw the conclusion that there will be a marked, sustainable increase in m&a activity due to a soft IPO market. If anything, private equity funds or venture capitalists will be the first to take up the slack. Picking the Spots M&A: Historically, when there is an economic slowdown or a period of uncertainty, competition for targets in the m&a market eases up. Is this happening in the current environment and does this create opportunities for the sharpest buyers who are willing to hang in? Lavine: If you are asking if there are fewer bidders, the answer is probably yes. This may be a temporary situation until the uncertainty we have talked about is cleared up. But when a prize company comes up for sale, you can bet there will be competition. The really strong company with a proven track record takes some of the risk and uncertainty out of the deal. It is able to perform under tough conditions. Harris: We are seeing a twist on that. Pricing has eased a bit, at least temporarily because some typical acquirers are on the sidelines. It is also a bit harder to sell some companies that would have been easier to market a few months ago. But, in general, the environment in the m&a market has shifted somewhat to favor buyers, especially those who are willing to proceed with deals to meet strategic needs. Foussianes: All of that goes hand-in-hand with the previous comments contrasting the uncertain conditions with a company’s need to acquire for strategic purposes. We obviously don’t know how long this period of uncertainty will last. We do know, however, that many industries remain in a state of change and that companies must take a long-range view of how acquisitions may benefit them. This underlying pressure results in strong demand for well-positioned acquisition candidates, even in less-than-strong markets. Lavine: Make no mistake about it. The m&a market has changed from a seller’s market to a buyer’s market. That means some easing of prices, but it also means that there are good buying opportunities for the companies willing to move forward and to fill strategic needs. We have only had about a two-month experience with these uncertain conditions. When things clear up, we could see some shift back to the sell side, but of course we don’t know when that will be. Foussianes: Many companies find themselves in a situation where acquisitions are a key component of growth or enhancement of a competitive advantage. At the same time, many of these same companies are somewhat wary in the current market environment. I believe that while we may see many of these firms on the sidelines for a while, they will ultimately resume their m&a activity given its strategic importance to their success. In doing so, it will have the natural supply/demand effect. Out for Business M&A: As for your own firms, how are you managing the current situation in regard to your m&a units? Are you continuing to hire, and what types of professionals are you bringing in? Harris: From our perspective, we see m&a as a good long-range business. There is a lot activity still to be done and a good professional services organization has a strong role to play. Besides the corporate buyers that need to make strategic acquisitions, there also are the financial buyers who have huge amounts of equity capital to invest in deals. In fact, the drop in the stock market may make it more conducive for financial buyers to execute going-private acquisitions of significant size. We are continuing to hire and look for skilled professionals to staff our m&a department. They may be specialists with specific industry expertise or more generalist types in such areas as finance or strategy. Foussianes: We also have tremendous confidence in the m&a business. In the future, we will no doubt see good and bad markets. Staying power, deal flow, experience, and industry expertise will be crucial to positioning our firm so that we can continue to offer the best possible advice to our clients. We will continue to hire top-flight people that can add to our capabilities and capacity. Lavine: As I mentioned at the beginning, our m&a deal flow continues to do very well and we are very busy. We are always looking to add skills and professionalism to our m&a department.