VideoWhen London-based National Grid agreed in 2006 to a $12 billion deal for East Coast energy giant KeySpan, National Grid CFO Steve Lucas couldn't have known that lending markets would collapse in mid-2007 — just a few months before his merger closed. But the design of the terms proved so prescient that he could be credited with a hint of omniscience.
As a hedge against the evaporation of then-prevailing easy credit, Lucas skipped the customary financing for such all-cash deals, which involves using bank credit facilities and issuing long-term debt to pay them off after the close. Instead, National Grid issued $7.5 billion in bonds ahead of time. "Not only did we minimize our risk, we also saved a ton of money," says Lucas, estimating that between $300 million and $500 million was sliced from its interest rates and bank fees. Even now, he adds, "National Grid would like to do further value-enhancing deals in the U.S."
Of course, deals did unravel — something that was sure to happen as the M&A landscape took acquirers "from Goldilocks to The Perfect Storm," in the words of Lee LeBrun, co-head of M&A in the Americas at UBS Securities. If the confluence of problems started with the subprime-mortgage crisis and resulting tumble in credit availability, he says, the stock-market correction and the plunge in the dollar's value quickly compounded the problem.
But in some ways the experience of buyers during the challenging 2007 M&A market — superheated at first, then severely chilled at midyear — bolsters the argument that many companies are doing deals better even as they face adversity. Through November, U.S. deals approached $1.5 trillion, leading some experts to suggest that when the economy slips, companies step up the quality of dealmaking. That could augur well.
"What we tend to see with the M&A market is higher returns for deals done in down markets," says Jeff Gell, co-head of M&A for The Boston Consulting Group (BCG). Even LeBrun expects overall deal activity to fall less than 20 percent from last year, mostly reflecting the squeeze on private equity that won't ease until the more than $200 billion in leveraged-buyout debt is sold. The heightened activity by cash-paying U.S. strategic buyers will continue to be augmented, he says, by foreign investors drawn to the weak dollar.
Indeed, a recent UBS report declared: "The current M&A wave is far from over," as cash-paying strategic buyers step up, replacing some of the dealmaking done last year by private-equity players.
The New Advisers
The volume achieved in such a tumultuous year confirms that M&A has become an accepted tool for corporate growth. Such acceptance may have been in doubt as recently as 2000, when the AOL/Time Warner miscalculations and WorldCom and Tyco International scandals, among others, gave acquisitiveness a bad rap.
With improvements in corporate governance, though, certain "serial shoppers" — General Electric, Cisco Systems, and Oracle among them — have enhanced their reputations for doing value-producing deals. And internationally, companies like National Grid, which counted KeySpan as its sixth U.S. acquisition since 1999, refined systems for valuing deals, completing them cost-efficiently and integrating targets effectively.
The success has shown up in value-creation measurements. Management consulting firm McKinsey & Co. used a "deal value added" index to compare market capitalization immediately before and after an announced transaction, and found that — to Wall Street, anyway — the increase in value has been steadily climbing to a current level of 10.6 percent last year, from 2.1 percent when the research started in 1997.
Some credit may go to two relatively new variables in the M&A equation: the elevated oversight of boards in corporate decision-making and the greater influence of shareholder groups that have value-creation as their central goal.
"You see a noticeable change in the role of boards," says Bob Filek, head of transaction services at PricewaterhouseCoopers (PwC). Directors these days often hire their own M&A advisers to get a view independent of management. And certainly the ousting of Merrill Lynch CEO Stan O'Neal for unilaterally exploring a deal with Wachovia is a prime example of boards' rising power.
As for pressure from investors, that's seen in the thousands of hedge funds, pension funds, and private individuals that have sought to influence managements — especially in encouraging a deal, or objecting to one that has been proposed. As 2007 was ending, hedge fund Pardus Capital Management, for example, was making headway in pressing Delta Air Lines and United Air Lines to create the world's largest carrier by merging, in one of the more visible examples of the trend. While activists may seem like flies in the ointment, evidence suggests that their positions enhance M&A value, in addition to ratcheting up dividends and squeezing executive compensation, according to a recent BCG report.
Further, says PwC's Filek, companies have been performing more-thorough due diligence, and starting the process earlier. In fact, these days due diligence often begins well before signing the letter of intent. New technology tools for valuing, analyzing, and integrating deals also are helping companies improve their acquisition record, he says.
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