With the stock market stuck in neutral and trading volumes on Wall Street looking tepid, the world of corporate marriages may be remembered as the bright spot in an otherwise fairly unexciting year on Wall Street, analysts say.
Stock indices are basically flat for the year after a mammoth rally in the second half of 2003, and some investors are beginning to wonder if the stock market can make much headway through the rest of 2004.
A number of headwinds now face investors: Corporate earnings appear to have hit their peak in the second quarter, the Federal Reserve embarking on what is expected to be a prolonged credit-tightening cycle and the Presidential Election this November is expected to stymie trading activity.
But after strong showing in the first half this year, the climate for corporate marriages is still red hot, analysts say, and so with stock prices and earnings unlikely to deliver a boost for companies, many are looking to gain competitive advantage and ultimately increase shareholder value through M&A. And some say the trend is likely to continue into 2005.
“Corporate deal making was off the chart in 1999 and 2000, and 2001 and 2002 were below trend, but now we’re back above the trend line,” said Rich Peterson, a market strategist at Thomson Financial. “The number of deals has been going up each quarter this year, but we are not at the point we were at in the late 1990s when we saw thousands of deals every month; there is more deal flow and activity volume, and bankers are more active in hiring for M&A positions.”
Highest level since 2000
Despite the threat of higher interest rates, rising oil prices and continuing concerns about the situation in Iraq, corporate M&A activity saw its highest level of activity since the year 2000 in the first two quarters of this year, with the total volume of deals reaching $862 billion, according to the latest data from Thomson Financial.
A handful of big deals in the financial services area — like the recently completed $58 billion marriage between banking giant J.P Morgan Chase and Bank One — drove the rise in deals during the period noted Peterson. By comparison, U.S. deal-making activity in the first half of 2003 amounted to $205 billion.
The resurgence in U.S. deal-making outstripped European levels, where the volume of M&A activity in the first half of the year was $266 billion, flat from the year before said Peterson. French pharmaceuticals maker Sanofi-Synthelabo’s $78 billion takeover of rival Aventis was the main deal in the region, he said. Worldwide, M&A deal volume was $862 billion in the first half, up from the period a year before, according to Thomson.
For ordinary investors, cashing in on the deal bonanza isn’t simple, Peterson says. One way is to invest in one of the handful of merger arbitrage funds available, in which a fund manager simultaneously buys the stock of a company being acquired and sells short the stock of the company doing the acquiring. Another more complicated strategy is to try to pick the next acquisition target in the sectors leading the current deal-making binge: financial services, healthcare and telecom.
A number of key factors, from a greater availability of equity capital to a growing confidence on the part of company executives in the economy and their businesses, are driving the U.S. deal-making surge according to Tom Taulli, author of “The Complete M&A Handbook" and a professor of business at the University Southern California’s School of Business.
There is a significant amount of pent-up demand after so many lean years, Taulli notes: “The M&A market has been a ghost town for so long, we’re seeing it come back in a big way. And when you have headlines out there for big deals, like the one between J.P. Morgan and Bank One, you find other companies in the sectors saying the industry is consolidating and so it’s probably the right time to jump in before someone else does.”
Caution in the boardroom
Many companies are taking the Sarbanes-Oxley Act of 2002, which will soon impose tougher financial governance responsibilities on companies and their executives, very seriously, Taulli notes.
“These deals take time and they are taking even longer now because companies are doing more due diligence,” Taulli said. “And because of all the cutbacks on Wall Street in recent years there are fewer bankers left to do these deals. There’s probably a lot of triage going on, with bankers focusing on the big deals, and that’s a reason why I think we’re going to see this deal trend continue for some time.”
The cautious trend in company boardrooms is having an impact on the market for initial public offerings, which is struggling according to Taulli, who says he is seeing a trend where companies come close to going public, then reverse course and sell out. A recent example is online marketing firm Advertising.com, which agreed to be acquired by Time Warner for $435 million in cash.
“Technology companies appear to be still suffering from scars of past, and company boards are really taking their jobs seriously,” Taulli said. There is a lot of difficulty for companies to go public right now, and to sustain the aftermarket performance. The IPO market is very tough and stocks are getting hammered. And with all the responsibilities that come with Sarbanes-Oxley, companies are looking for alternatives to going public, and in the case of Advertising.com they are having doubts and cashing in on mergers.”
Some analysts have expressed concern that the current spate of M&A may slow in the second half of the year — something that may well happen if the pace of economic growth begins to moderate in the second half of the year as interest rates rise according to Thomson’s Peterson.
“M&A activity tends to track GDP, and although it’s not a perfect correlation, somewhere in the second half, if the level of GDP begins to cool, we could see a decline in deal-making, but we won’t be going back to where we were in 2001 and 2002 when we had two consecutive weak years,” said Peterson.