They’ve Come Undone

With buying activity sharply down, merger breakups made the biggest headlines last year.
Stephen BarrJanuary 1, 2002

In late summer, with the economy slouching toward recession, it was clear that deal-making in 2001 would fall far short of the prior year’s stunning $1.7 trillion record.

Looking for some positives in the situation, investment banker Jon Melzer, of Houlihan Lokey Howard & Zukin, in New York, prepared remarks for a luncheon panel. “The dip was dramatic, but not as dramatic as many assumed,” he wrote. Sponsored by the New York Association for Corporate Growth, the panel was to have taken place on September 11. “I didn’t even call to find out if [the event] was canceled,” he says of his reaction to the morning’s terrorist attacks. “I just went home like everybody else.” So much for positives.

As of November 10, the announced deals of 2001 were off 35 percent from 2000, according to Thomson Financial. Their total value was down 56 percent, to $739 billion. Megadeals, those of more than $10 billion, had fallen 73 percent. The five largest deals were worth a combined $155.9 billion, well below the single biggest deal of 2000 (and all time), AOL’s $183 billion purchase of Time Warner. The number of deals under $1 billion fared no better, plunging 35 percent.

“There’s been a pullback across the board,” says Rick Escherich, a managing director in the M&A group at J.P. Morgan in New York, with significant declines “no matter how you try to view the market– large deals, small deals, sectors, private companies, and so on.” As of November 30, valuations had slipped 16 percent, to a median premium of 32.8 percent. And for the first time since 1997, cash has been the preferred currency in a majority of transactions (53 percent).

In fact, the most noteworthy trend in M&A last year concerned the number of deals undone–by regulatory intervention, by doubts about a target’s prospects, by a buyer’s stock-price volatility, or by just plain bad September timing.

“Before 9/11, it was the economy and the financing markets,” says John Reiss, global co-head of the M&A practice for the New York office of law firm White & Case LLP. “Since then, people are not willing to exclude the effects of 9/11, because they are even less certain about how the [target] business will perform going forward.”

The Cruelest Month

While no real spike is shaping up for that final year-end tally of canceled deals, last year’s broken mergers certainly represent a larger percentage of the total bids announced. In July alone, antitrust regulators shifted the two largest deals of the year: General Electric Co.’s combination with Honeywell Inc. and the UAL Corp.-US Airways Group Inc. merger. Indeed, the $53.3 billion value of the terminated deals in that one month exceeded the amount of busted deals for nearly every quarter since 1997.

Late November saw the spectacular collapse of erstwhile energy- trading high-flier Enron Corp., which tried desperately, and unsuccessfully, to find some salvation in an $8.5 billion acquisition by Dynegy Inc.

But tough business conditions scuttled other deals all year. In April, Ariba Inc. cited “challenging economic and market conditions” as it put the kibosh on its $2.5 billion purchase of Agile Software Corp. In late September, FelCor Lodging Trust, the nation’s second-largest hotel real estate investment trust, blamed “the aftermath of the terrorist attacks” for the decision to terminate merger plans with MeriStar Hospitality Corp.

And the year’s most controversial deal–Hewlett-Packard Co.’s $23.7 billion bid for Compaq Computer Co.–was testing the trapdoor as 2002 approached. The agreement fomented a remarkable Hewlett and Packard family rebellion. HP’s shares plunged 19 percent, to a five-year low, after the September 4 announcement of the deal, and climbed again in October only after relatives of the company’s founders started fighting to scotch the merger.

A Surprise in the Data

If nothing else, the HP saga illustrates the fast change in the climate for M&A. At the height of the late-1990s merger wave, it hardly mattered if a deal failed to make sense. If shares traded down initially, the stock would likely climb again, lifted by the booming overall market.

“Two years ago, this deal would likely have gone through even with the initial drop in [HP’s] share price,” says Mark Sirower, who leads the M&A practice in the New York office of the Boston Consulting Group. “Nobody worried about the impact [of an announced deal] on their share price, because the market was going up and that would cover up any mistakes. Now nobody wants to be seen as doing something silly and stupid, so you see executives being a lot more thoughtful and prudent.”

Among other deals on the brink, some analysts predict that the purchase of General Motors Corp.’s Hughes Electronics unit by EchoStar Communications Corp. may also be blocked by regulators. It was 2001’s second-largest announced deal, and one that evolved only because of another collapse of negotiations, this time between GM and Rupert Murdoch’s giant News Corp.

Proof of buyers’ aversion to ’90s-style merger risks may be found in what is perhaps the most surprising M&A factoid of the year: For the first time since 1997, the average market reaction to announced mergers was positive. From five days before the announcement to five days after, the median change in an acquirer’s stock was plus 1.4 percent, with the reaction to cash deals up 2.3 percent. (For stock deals, investors sent shares down an average 2.2 percent.) “The transactions that get done seem to be more fundamentally sound,” says Escherich of J.P. Morgan.

What’s the prognosis for 2002 deal making? A return of credit and high-yield markets certainly would help stimulate merger activity, as would corporate earnings growth, a rising stock market, and a stronger economy. Some deal makers insist robust signs are already evident. “Though the number of completed transactions has not yet increased,” says White & Case’s Reiss, “there is much more activity in the market, as evidenced by more auctions of companies and serious interest.”

How September 11 is continuing to affect M&A will be clearer when fourth-quarter numbers come out in the coming weeks. Anecdotal evidence suggests many buyers walked away from deals not yet announced, and focused instead on internal issues. Would-be acquirers that did continue to pursue opportunities took more time to get comfortable with their target companies. “I’ve seen a lot more rigor in assessing deals since 9/11,” says Houlihan Lokey’s Melzer.

Perhaps there’s a clue to the future in that canceled luncheon on merger trends, where Melzer had been set to talk. When it eventually took place in mid-November, the event had grown so popular that it had to be moved from the Union League Club to the larger Yale Club.

“I don’t know if that’s a sign of the economy picking up,” says Melzer, “or that people don’t have anything better to do.”

Stephen Barr is senior contributing editor of CFO.

Deal Breaker of the Year

Known as “Super Mario” to his trust-busting fans, Mario Monti, the head of the European Union’s competition commission, went toe-to-toe with “Neutron” Jack Welch over General Electric Co.’s $43 billion bid for Honeywell–and didn’t back down.

Even though U.S. regulators gave their blessing to the world’s largest industrial takeover bid, Monti worried about the combined aircraft- related businesses of the two players. GE tried to remedy things, and Welch flew to Brussels to lead the talks personally. But Monti wanted more than GE would concede. The stalemate left EU antitrust officials with no choice but to block the merger. Welch, who stayed on at GE an extra year to see the transaction through, had to throw in the towel.

GE was not the first to be tripped up by Monti, who in 2000 scuttled the MCI Worldcom-Sprint deal and forced AOL Time Warner to sell off a major music label. And it probably won’t be the last: Monti is expected to take a hard line against Microsoft when he reviews its landmark antitrust settlement with the U.S. government and alleged anticompetitive practices in Europe. — S.B.

Breaking Up Is Easier to Do

How canceled deals have soared.

Year Announced Deals Value ($ bill.) Canceled Deals Value ($ bill.)
2001* 7,850 $675 293  $87
2000  9,566 $1.7 241 $166
1999  9,278  $1.5  278  $36
1998  8,008  $1.6  195  $125
1997  7,850  $885  202  $60

* Through 12/7/01.
Source: Mergerstat LP

Big Ones That Got Away

A wide range of giant mergers fell apart.

Month canceled Acquirer Target Value ($ bill.) What happened
July General Electric Honeywell $42.0 The first U.S. merger thwarted solely by  European regulators
July UAL US Airways $11.3 Grounded after the Justice Dept. threatened an antitrust suit
Nov. Dynegy Enron $9.0 Enron imploded so fast, the price became less and less of a bargain
April FPL Entergy $8.0 Financial clash short-circuited formation of the largest U.S. electric utility
Sept. FelCor Lodging Trust MeriStar  Hospitality $2.7 Hotel merger cited post-9/11 impact on the financial markets
April Ariba Agile Software $2.5 Economic deterioration claimed this one, the largest technology deal to crash
Oct. General Dynamics Newport News Shipbuilding $2.1 The U.S. feared a nuclear-sub monopoly; Northrop stepped up instead

Sources: Mergerstat LP and News Reports

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