| News Back Big Mergers Are Making A Comeback as Companies, Investors Seek Growth By DENNIS K. BERMAN and JASON SINGER Staff Reporters of THE WALL STREET JOURNAL Mergers and acquisitions are climbing to a level not seen since the 1990s Internet boom, driven by factors from low world-wide interest rates to an excess of corporate cash. After several years in which companies have closely watched costs and avoided the management challenges of big deals, world-wide merger and acquisition volume for the year to date surged to more than $2.3 trillion this week. That marks the most active market for transactions since the all-time high of $3.3 trillion in deals in 2000. Just last Monday, companies across the U.S. and Europe rolled out new transactions valued at more than $40 billion, in industries from telecom to health care. Among the targets in this year's boomlet have been well-known names such as credit-card issuer MBNA Corp., athletic company Reebok International Ltd. and telecom icon AT&T Corp. Helping feed the trend are investors who normally are cautious about big-ticket deals but this year have tolerated -- and in a few cases even rewarded -- the wave of mergers. In the 10 largest U.S. deals announced this year, half the acquirers saw their stocks rise during the first week after an announcement. Overall, six of the acquirers' stocks have outpaced their respective peer groups, according to data from research firm Baseline. This week, when Bon-Ton Stores Inc., which has a market capitalization of $278 million, announced it was purchasing 142 department stores from Saks Inc. for $1.1 billion -- all funded by bank loans -- its shares surged 24%, near an all-time high. Besides market acceptance, the merger boom reflects growing hunger for deals in Europe, low interest rates, eager bank lenders and a corporate cash stash that now represents 10% of all corporate assets -- the highest level in 20 years, according to Morgan Stanley. Moreover, even though the Standard & Poor's 500 Index has been virtually flat this year, executives and directors of acquirers express confidence in the economy. Conditions are "not the best I've seen, but pretty favorable," says Bon-Ton chief executive Byron L. "Bud" Bergren. "For us to try to build 142 [stores] is almost impossible," he says, given the cost. "It's a lot better to buy." There also are emotional factors at work. With CEOs under heavier scrutiny from boards and investors to show measurable returns -- the average CEO's tenure is down to about five years -- many are pushing to establish legacies as builders rather than just write dividend checks with their extra cash. "The psychology of management has changed," says veteran banker Felix Rohatyn, now head of his own advisory firm. "It's more confident. It knows where the Fed is going [on interest-rate policy] and currencies are stable." Adding power to the wave are private-equity firms -- which themselves are getting lots of cash as investors seek better returns than they're getting in U.S. stocks. Through October, private-equity firms -- which invest private pools of money on behalf of endowments, pension funds and wealthy individuals -- had poured $202 billion into new deals this year, according to Goldman Sachs -- 50% above their total volume in 2004. Even as the wave surges, there are warning signs. Private-equity firms, for instance, haven't paid such rich prices for companies in five years -- and are taking on more debt than anytime since 1997 to do so. Moreover, as a flurry of deals close before the end of the year, investors will be watching closely in 2006 to see whether the mergers pay off, since many big deals fail to fulfill their executives' rosy scenarios. Still, confidence is brimming, especially in Europe, which last month notched its third-most-active period for deal-making ever, trailing only the abnormal market peaks of early 2000. The biggest companies across Europe have built up giant reserves of cash because of "startlingly better corporate profits than expected since 2002," says Bob McKee, chief economist at Independent Strategy Ltd., a London-based investment consulting firm. The pile has grown larger since European companies haven't been investing as quickly as profits have been rising. Even those that are investing are doing so in Asia and Eastern Europe, where production costs are lower. To grow at home, they've been buying each other. The current wave of European deals started in April, when liquor distributor Pernod Ricard SA of France launched a nearly $13 billion takeover of larger spirits maker Allied Domecq PLC, of the United Kingdom. Investors rewarded Pernod by bidding up its stock price, which had risen more than 20% by the time the deal closed in July. Italian bank UniCredito Italia SpA enjoyed the same treatment following its move in May to take over Germany's HVB for nearly $19 billion in Europe's largest-ever cross-border banking deal. Shares of the Italian bank are up about 10% since announcing the deal. For big corporate buyers, the strategy underlying some deals is finding growth in a solid, but unspectacular economy and in the face of rabid competition. Nearly all big mergers these days are focused around melding two similar firms, cutting out duplicative costs and harvesting more profits. In justifying mergers, companies are reluctant to mention possible "revenue synergies" -- the idea that two disparate income streams can boost each other. That was a key rationalization for Time Warner Inc.'s troubled purchase of America Online Inc. in 2000 -- the notion, for instance, that AOL's online service would help Warner Brothers sell movie tickets. "There's a lot of money willing to bet on cost savings of a merger," says James Q. Crowe, CEO of telecom company Level 3 Communications Inc. Level 3 announced the $680 million purchase of WilTel Communications on Monday, predicating much of the deal on cost cuts. Its shares are up 1.4% since the announcement. "The market is certainly much more skeptical of the intangible kind of synergies," Mr. Crowe says. That's made the recent string of deals somewhat predictable formulations, with buyers rarely straying from companies outside their core industries. All 10 of the largest U.S. deals announced during October were same-industry concentrations, such as life insurer and annuity-provider Lincoln National Corp.'s $7.6 billion buy of Jefferson-Pilot Corp. The conservatism is stretching to how the deals come together. Acquisition premiums are at around 27% year-to-date, according to Thomson Financial data, a figure that has showed little sign of budging since the deal-drought days of 2002. What's more, companies are using cash for about 58% of what they buy, Thomson says, with stock making up the rest. Academic studies have shown that deals that use stock generally underperform those using cash -- often because the shares used as currency are overinflated. "It's consistently active," says Jonathan Turner, who heads the Internet practice at Credit Suisse First Boston. "But it's not the days when you heard about a deal on Monday, were in a hotel conference room by Friday, and had a press release by the next Monday." Like any crest in an economic cycle, there are troubling signs amid the record-breaking figures. One sign is the debt being stacked on some companies in private-equity deals. Last quarter, bond investors and banks tolerated average debt of more than six times companies' equity, according to data from Standard & Poor's. The figure is higher than at any time since 1997. And what they're buying is only getting more expensive: In deals valued at more than $500 million, private investors are paying an average of about 7.8 times their target's cash flow -- the highest level in five years.Corrections & Amplifications:The name of Italian bank UniCredito Italiano SpA was incorrectly given as UniCredito Italia in this article. 11-05-2005 Back |