Forbes Magazine
Stayin' Alive in ' 05
Thursday December 9, 7:02 pm ET
Slow growth ahead could spark a merger binge next year, promising boom times for investment bankers--and new bets for investors.
Pick your motto--bigger is better, stayin' alive in '05: The case for a boom in merger and acquisition deals is overwhelming. Companies have gobs of cash, growth is slow, and industry after industry faces overcapacity. Rarely has there been a better time to be a dealmaker.
The S&P Industrials, an index of 383 companies that excludes financial firms, had almost $600 billion in cash on hand this year, up from $260 billion five years ago. "There is no precedent for this amount of cash. There was no precedent for it last year," says Howard Silverblatt, an S&P equity analyst.
This money needs to be put to work, but where? A boom in capital spending or hiring is a long shot because many industries have too many factories. So companies have three options:They can increase dividends, boost share buybacks or rev up M&A. So far this year 243 companies in the S&P500 have announced dividend increases. Total buybacks were at almost $260 billion, up 43% from the first three quarters of 2003. Yet merger activity sits well below historic levels. Deal values typically run 7% to 9% of the market's total capitalization but this year have been at only 5%, or $660 billion, says Goldman Sachs.
Obstacles that blunted a merger wave last year are falling, says S&P equity research chief Stephen Biggar. Oil prices may have peaked; the election ended smoothly; the jobs picture is improving; and despite expectations that the Fed will raise rates, corporate borrowing costs are dropping along with ten-year Treasurys. And now foreign firms have a cheap dollar to play with.
Some industries could endure takeovers in the wake of myriad mishaps and scandals of their own making, such as financial services (fallout from Marsh &McLennan) and drugs (the Vioxx debacle at Merck). Elsewhere, here is a quick take on who might eat whom:
Retail
Kmart-Sears was just a warm-up. The Wal-Mart effect and a surplus of stores will fuel a new wave of consolidation. "I think there's too much square footage in department stores and too little demand," says Peter J. Solomon, whose investment banking firm arranged the $400 million acquisition of Barneys by Jones Apparel.
First on many lists: A combination of Federated Department Stores, owner of Macy's, and the May Co. Combining Federated's 393 stores with May's 500 would create a chain with overlap only in southern California and New England. "They could get rid of duplicate stores, centralize buying and expand their private-label business," says Laurence Leeds, chairman of Buckingham Capital Management.
Next might be some combination of chains like Nordstrom, Saks and Dillard's. Leeds thinks Federated is a logical buyer of Nordstrom so it can trade up to more-fashionable lines.
Tech
With tech spending stubbornly flat--Merrill Lynch says IT budgets will rise an average of 2%next year--there's little to do but bulk up. Acquiring new customers through mergers can be messy--ask Larry Ellison--but it offers more accounts to generate service revenue and software-maintenance fees. Customers want fewer vendors and a bigger range of offerings. Symantec bought Brightmail this summer for $370 million to beef up its antispam offering. Computer Associates is paying $430 million for Netegrity to add identity management software.
Microsoft, with $11 billion in cash (even after its $37 billion dividend), is poaching bankers from CSFB, Goldman Sachs, J.P. Morgan and others for its strategy group. Paul Deninger, chairman of Broadview International, the biggest M&A banker for midsize tech companies, says business has doubled from a year ago, and he expects a lot of the companies that went public in late 2003 and early 2004 will be buyers. Raj Judge, a partner at tech's blue-chip law firm Wilson, Sonsini, Goodrich & Rosati, estimates its M&A deals are up 30% over last year, mainly in software and telecom. Among his busiest shoppers: Hewlett-Packard, Cisco, IBM and Siebel.
Auto Parts
Escalating raw material costs and production cuts at Ford and General Motors have slammed suppliers already reeling from overcapacity and labor costs. This is a war of attrition:Some 10,000 suppliers in 2000 will shrink to 4,000 by the decade's end, says Accenture. The big suppliers like Visteon and Delphi are too weak to buy, they'll likely sell unprofitable businesses. European suppliers like Siemens,Bosch and ThyssenKrupp may use the weak dollar as an excuse to prowl for cheap U.S. suppliers. "We're actively involved in looking for whatever we can find," says David Royce, head of mergers and acquisitions for North America at Siemens VDO Automotive. "There's potential to buy assets at a big discount."
Energy
Plenty of oil and gas exploration companies show up among cheap stocks. Midsize E&P firms will continue buying small-cap exploration companies as well as older fields from the majors--ExxonMobil will soon market $1 billion in oil and gas producing fields in Texas and Louisiana. Small companies have also grown tired of meeting all the Sarbanes-Oxley requirements. According to energy bankers at Simmons & Co., over the past 12 months $6 billion in transactions of at least $100 million have been announced in the E&P sector, up 28% over the prior year. Crude producers like Devon, Apache and Anadarko could merge to bulk up.
Let's Make a Deal
Companies strapped for growth ideas are starting to sniff around for deals. Here's an assortment of relative bargains in industries that are ripe for consolidation.
Company/business Enterprise multiple¹ Operating income² ($mil) Recent price Market Value ($bil)
Louisiana-Pacific/forest products 2.0 $1,218 $24.87 $2.7
Devon Energy/oil & gas exploration 2.7 5,636 38.08 9.3
MCI/telecom 2.8 2,279 18.88 6.0
AT&T/telecom 3.2 7,061 18.49 14.7
Tesoro/oil refining 3.6 871 32.17 2.1
Micron Technology/semiconductors 5.0 1,463 12.17 7.4
Leap Wireless International/telecom 5.3 217 22.08 1.3
Charming Shoppes/specialty retailing 5.3 197 9.10 1.1
Synopsys/software 5.4 376 17.86 2.7
Sybase/software 6.4 199 17.48 1.7
¹Prices as of Nov. 19. 1Market value of common plus net debt divided by operating income. ²Past 12 months earnings before interest, taxes, depreciation and amortization. Source: Reuters Fundamentals via FactSet Research Systems.
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