M&A is hot even though stocks are not
Thursday October 13, 10:45 am ET
By James B. Kelleher
CHICAGO (Reuters) - It's a puzzle that would probably intrigue U.S. investment bankers -- if they weren't all so busy doing deals. The mergers-and-acquisitions marketplace is enjoying its best year since 2000, thanks to a flurry of acquisitions, combinations, divestitures and buyouts. But the U.S. stock market is on track for its worst year since the bear market of 2000 to 2002.
That disconnect is unusual. Historically, big waves of M&A in the United States have coincided with rising stock prices, according to researchers like Robert F. Bruner, dean of University of Virginia's Darden School of Business.
That was true of the 1895-1904 horizontal merger boom that brought together companies in the same market and created corporate behemoths like Standard Oil, as well as the 1925-29 crush of vertical combinations that produced the giant U.S. utilities, Bruner said.
Ditto with the conglomeration wave of the 1960s, the leveraged buyout boom of the 1980s and the strategic buyer frenzy of the 1990s as highflying stocks -- or a giddy market's appetite for junk bonds -- provided currency for deals.
But it's not true today. In the first nine months of 2005, U.S. companies have inked $797.9 billion worth of mergers, according to research firm Dealogic. That's up 33 percent from the first nine months of 2004, making it the U.S. market's best nine-month showing in five years.
Yet the stock market is lower and, barring a fourth-quarter surge, heading for its worst year since 2002.
"What's going on?" Bruner said.
PRIVATE EQUITY
Experts say a number of factors are contributing to the dealmaking -- from the generosity of lenders to healthier balance sheets among both acquiring and target companies.
But the primary force driving the countercyclical -- and counterintuitive -- burst in deals is the explosive growth of private-equity firms, which have raised record amounts of money and taken advantage of attractive borrowing costs.
"It's the combination of the tremendous liquidity of the financial sponsors and the favorable conditions in the leverage finance market -- both leveraged lending and high-yield," said Jim Glerum, a Chicago-based managing director of investment banking at UBS.
What's more, private-equity investors have learned to play nicely together, teaming up in massive "club deals" -- like September's $15 billion purchase of Ford Motor Co.'s (NYSE:F - News) Hertz unit by Clayton, Dubilier & Rice, the Carlyle Group and Merrill Lynch Global Private Equity.
"They're able to raise funds that they never would have able to raise in the past and do deals the size of which they'd never been able to do in the past," said Dealogic Managing Director Jody Drulard. "It's absolutely had an impact."
Private-equity firms have accounted for $1 of every $7 spent on M&A so far this year, up 19 percent from a year earlier, Dealogic said.
CASH SEEKING A HOME
Other factors driving the unusual activity: the rebound in corporate profits in recent years, coupled with the sustained low interest rate environment, which has forced many companies to put their cash to use in the M&A market.
"If you run a company that has high cash flows, what do you do with them?" said Richard Sylla, a professor of business history at New York University's Stern School of Business. "If you put it into Treasury bills, interest rates have been so low, it's just not attractive. So you buy a company because you get a better return."
What's more, many potential targets look more attractive because of the equity market's troubles, which compress price-to-earnings ratios and make companies seem cheaper than they were five or six years ago, Sylla said.
Of course, those lackluster stock markets are a primary reason why private-equity shops are finding it so easy to raise so much money in the first place.
"Historically, private-equity funds have had better returns than the market," said Steven Bernard, the head of M&A market analysis at the Chicago office of Robert W. Baird & Co. Inc., a Milwaukee-based investment bank. "So more and more institutional investors are committing money to the private-equity and buyout markets."
Simply put, the more the stock market falters, the more money some investors will entrust to the private-equity shops. And since those shops have to turn around and put the money to work somewhere, that means more and more deals -- whether the stock market is up, down or unchanged.
Indeed, private-equity firms' increased heft may constitute the kind of fundamental change -- what Bruner calls "strategic turbulence" -- that some academics have long suspected was the real driver of M&A activity.
In the past, however, those paradigm-shifting changes -- a disruptive new product, a change in consumer buying habits, a new regulatory framework -- were generally confined to the industries or regions where the deals were getting done.
Now the strategic turbulence has spread into the M&A industry itself, where the buyout shops are, in the words of Dealogic's Drulard, "changing the business."
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