Following two years of wrenching decline, bankers are hoping that merger and acquisition volume is ready to pick up again.
By Samantha Rowan
February 2003
Institutional Investor Magazine
After almost a decade of skyrocketing mergers and acquisitions activity, deal volume fell 35 percent in the U.S. in 2001. As bad as that was, 2002 was even worse, with M&A volume plunging a further 51 percent. “Investment bankers are optimistic by nature, so the decline in 2002 did come as a surprise,” says Mark Mealy, head of M&A at Charlotte, North Carolinabased Wachovia Securities. “There is always a feeling that tomorrow is another, brighter day that has a Pollyannaish aspect.”
With total volume of $520 billion, 2002 M&A was down a stunning 68 percent from the record $1.64 trillion of 2000 and back near 1995'96 levels, according to Dealogic. The number of deals was down less, 35 percent, which reflects the paucity of large deals in 2002. Indeed, the $60 billion acquisition of Pharmacia Corp. by Pfizer made up 11.5 percent of the year’s dollar volume.
The most obvious reason for the decline is the steep drop in the stock market. During the glory days of technology investing, most acquisitions were made in stock -- often the highly inflated stock of tech or Internet companies. AOL Time Warner comes to mind. But the collapse of the bubble has changed all that. Potential acquirers are less inclined to use their deflated equity for acquisitions, and potential targets are far less willing to accept it. Even debt is in shorter supply these days. Banks are less willing to finance acquisitions, unless the companies in question are high-quality, investment-grade players.
Then there are the ramifications of the new Sarbanes-Oxley bill. Aimed at permissive accounting and corporate ethics, the bill requires CEOs to personally certify the accuracy of financial statements. An unanticipated effect is that CEOs could end up liable for sins committed by an acquisition target. “Large corporations are wondering whether it is worth it,” says Wachovia’s Mealy. “The downside is so much greater because of the personal liability and the liability for the company.”
Still, M&A advisers point to major deals such as the $14 billion acquisition of Household International by HSBC Holdings, which went through despite concerns about these new regulations. “There have been large deals that have been done quickly, with a high level of due diligence,” says the global co-head of M&A at a bulge-bracket firm.
M&A advisers say prospects are improving. Wachovia’s pipeline of deals is 40 percent higher than at this time last year, says Mealy. M&A activity is likely to increase in less volatile industries like consumer products. “We are quite confident that we will bounce off of these levels,” says David Cohen, co-head of the M&A group at J.P. Morgan Chase & Co. “We don’t think those factors that drive acquisitions have gone away entirely.” Fundamentals, such as a need to increase efficiency and find nondomestic growth, will help bring activity back on track, he says. “There is substantially more growth outside of the U.S. than in the U.S.”
The focus is expected to shift to smaller deals rather than the jumbo acquisitions of the late 1990s. Companies have been cutting costs for two years and will now look for acquisitions to spur growth. But the emphasis will be on building-block deals, such as Cadbury Schweppes’ acquisition of confectioner Adams from Pfizer and Bank of New York Co.'s purchase of the Pershing stock-clearing unit from Credit Suisse First Boston. Also fueling such deals will be corporations trying to narrow their focus by selling nonstrategic assets. Prime buyers for these units are private equity firms, which are sitting on about $100 billion of uninvested money and are interested in acquiring assets cheaply. “There is a lot of pressure for the funds to put money out,” says Mealy.
But a revival is not a foregone conclusion. “To get the M&A business buzzing again, we need sustained increases in the stock market, and banks need to be able to lend to leveraged companies,” Mealy says.
