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The Start of Something Big?

A blockbuster fourth quarter gives even pessimists hope that M&A activity has finally turned the corner.
Roy Harris, CFO Magazine
January 1, 2004

What a difference a quarter makes. The first nine months of 2003 looked bleak enough. Despite a slight uptick year-to-year in the number of U.S. mergers and acquisitions, the value of the dealmaking fell sharply—threatening to lengthen the slide in M&A to three full years since 2000's all time peak. As the fourth quarter dawned, the year's only $10 billion-plus deal was the $11 billion purchase of John Hancock Financial Services Inc. by Manulife Financial Corp. And that had sneaked in just under the wire, the last weekend in September.

Then came an even bigger deal the first week of October: General Electric Co.'s $14 billion combination of its NBC brand with Vivendi Universal Entertainment. True, it grew from a bidding war that had been waged for months. But it was followed just days later by another announced deal from the reinvigorated GE acquisition team: the $9.5 billion all-stock purchase of British medical diagnostics and life-sciences company Amersham Plc. In another area of health care, Anthem Inc. announced it was buying WellPoint Health Networks Inc. for $16.4 billion. And on the same day came the capper: Bank of America Corp.'s (BofA) $47 billion deal with FleetBoston Financial Corp.

Suddenly, the quarter was special. Even before tallying December's numbers, a hefty full-year rise was assured, and the stage seemed set for a 2004 revival that would reflect the expected continuation of the U.S. economic recovery (see "Turning on a Quarter," at the end of this article).

Is the long-awaited dealmaking resurgence finally under way? After two-plus years of false hopes, prognosticators are skittish about 2004. "Whether or not the overall M&A market is going to rise considerably, it's too early to call," says Robert A. Kindler, managing director of J.P. Morgan Securities Inc.

But something is different as 2004 begins. The underpinnings for consolidations are now there, with the economy stronger and the stock-market recovery looking long-term. "You're going to have a wave of mergers because there are some very good values," says Prof. Arie Y. Lewin, who teaches an MBA course on strategic alliances at Duke University. Most forecasts don't suggest an explosion yet, because the only companies reentering the merger arena "are the ones that had identified their targets, then waited for the right timing," says Lewin.

"We've clearly reached stability," says Kindler, "and I haven't said that at year-end for three years, much to everyone's chagrin here." M&A will keep climbing, he says. "The question is how much."

It's no accident that banking and finance deals are leading the way: they often foreshadow broader M&A activity ahead. "Some people think that [banking and finance deals] will represent 25 to 30 percent of overall merger activity, and I think that's accurate," Kindler says. "You still have about 11,000 banks in the U.S., and many are relatively large-cap entities." Besides BofA—Fleet, more than a dozen finance-related deals announced last year tallied in the $2 billion—plus range, topped by the $16.1 billion St. Paul Cos.—Travelers Property Casualty insurance combination announced in November.

Banking On a Rebound
Bank of America CFO James Hance maintains that the acquisition of FleetBoston is predicated on the improved economic climate. "It played a role in both the timing and the pricing," he says. "It was our view that certainly Fleet was rebounding nicely in the economy, and secondly that the economy was likely to keep rebounding as well, and to pick up steam. Therefore, the risk was less, because when the economy picks up, it's good for banks," with higher interest rates improving the spreads that drive banking profits.

Acknowledging that BofA shares have fallen, in part because investors believed the premium for Fleet was too steep—about 40 percent over its $31.53-a-share price before the deal—Hance argues that the price was appropriate in the current bullish economic mood. Premiums paid for acquisition targets are based on the future cash flow and earnings the buyer expects them to produce, along with unique characteristics that the buyer believes will increase the deal's value. "You don't see franchises like Fleet become available much. It is a franchise no one else can duplicate, and it deserves a premium," says Hance. "And, it had a number of suitors."

The press has noted that some other large deals may have been stymied by BofA's postannouncement stock-price decline. But Hance doesn't think the slippage should discourage other acquirers. Rather, he believes the initial hit the shares took reflected investor surprise—his company had been saying that acquisitions weren't likely—and the falloff reflected "a typical pattern." He adds, "We're getting some rebound."

Subsequent deals that have been announced—Hance mentions specifically the private-equity agreement for Time Warner's music operations—indicate that both the economy and M&A are healthier. "It's comforting to see others doing deals," he says.

Health in Health Care M&A
Bain & Co. senior partner Chuck Farkas, who follows both banking-finance and health care, says that the heightened M&A activity in those two sectors "has kept me in the boiling kettle the second half of the year." And he sees no end in sight for banking and health-care mergers in 2004. The outlook for potential combinations, he says, is "very different from what companies saw 12 months ago."


To Farkas, the Anthem-WellPoint deal is especially significant because it represents an early case of a health-care company looking at the political environment in Washington, D.C., and "betting on some fundamental changes in the direction of how medical care is paid for." While it is uncertain how President Bush's plans for health-insurance coverage will play out, "we will need some kind of national solution," Farkas avers, pointing out that if current trends continue, "in 2008 or 2009, more than half the U.S. population will be uninsured." So Anthem's acquisition aims to help it "win a position in a national Medicare prescription-benefit program, or whatever other form develops."

Not that deals are new to the company. "Anthem has been a voracious acquirer over the years," says Farkas, "but a majority of its acquisitions have been of relatively poor-performing health plans where Anthem believed it could turn someone around," and expand geographically. Targeting WellPoint, a top industry performer in highly competitive areas, "signals a very smart change of strategy."

In the finance realm, the Manulife-Hancock deal "was a triggering event," says Farkas. "Fleet had been on Bank of America's radar screen for a long time." But as the stock market climbed back, and then Hancock was purchased, "I think it started a chain reaction." BofA was moved to grab Fleet, "and we'll see many financial-services transactions ahead," he predicts.

CFO Hance denies that the Hancock purchase had any influence on BofA's acquisition of Fleet. But he agrees that more deals lie ahead in the banking and finance area—eventually. "There's not a huge amount of pent-up need," he notes.

A Private Equity Bonus
Across such business categories as technology, media, and manufacturing—the supposed followers of banking's M&A lead—J.P. Morgan's Kindler sees hints in 2003 that the pattern will be repeated, with broader activity following that in finance. He expects combinations in manufacturing to take place in deals of $500 million to $1 billion, with media deals somewhat larger. "There are a lot of independent media out there," he says. "We'll see a continuation of bigger private-equity deals," he adds. "Financing markets are now wide open, and there are large amounts of money available for these."

Not for a long time—if ever—will overall dealmaking totals return to the levels of 1999 and 2000, says Kindler, when market capitalizations soared beyond realistic levels. "What we're really doing gets back to the more normalized valuations of 1995 to 1997, before we had the tech-telecom bubble," he says.

But with more than 10,000 deals done in those prebubble years—at values approaching $1 trillion—many in these early years of the 21st century would gladly settle for that.

Roy Harris is senior editor at CFO.

Top of the Crop
Banking and finance deals dominated the list in 2003.*
AcquirerTargetDateValue**
Bank of AmericaFleetBoston Financial10/2747.00
AnthemWellPoint Health Networks10/2716.44
St. PaulTravelers Property Casualty11/1716.14
GE (NBC)Vivendi Universal10/814.00
Manulife FinancialJohn Hancock Financial Services9/2811.06
GEAmersham10/109.50
Liberty MediaQVC7/37.90
CitigroupSears, Roebuck Credit Card7/157.10
*Deals with North American acquirer
**$ billions
Sources for charts: Thomson Financial, press reports







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