Will Merger Mania Extend to 2005?

''Pressures to demonstrate growth coupled with abundant financing and cash reserves'' should keep deals humming next year, says one analysis.
Stephen TaubDecember 16, 2004

While we’re not witnessing the delirious flurry of mega-transactions of the late 1990s, the volume of mergers and acquisitions is on the rise.

So far this year, there have been 9,837 deals, up more than 15 percent from the total of 8,525 at this time last year, reported Mergerstat. The dollar value of deals so far this year stands at $789 billion, 43 percent higher than the $552 billion at this time last year, added the research company.

No surprise, then, that this revival is boosting Wall Street’s fortunes. Lehman, which on Wednesday became the first investment bank to report 2004 results, announced that its revenues from mergers-and-acquisitions advice nearly doubled to $179 million. The firm is currently advising Sprint Corp. on its agreement to buy Nextel Communications Inc. for about $35 billion, and Kmart Holding Corp. regarding its $11 billion agreement to buy Sears Roebuck & Co.

According to data from Dealogic, Lehman ranks fourth, advising on 59 deals worth about $102 billion. Leading the pack are Goldman Sachs, J.P. Morgan Chase, and Banc of America Securities.

Will this momentum continue into 2005?

It all depends. If the economy continues to strengthen and the stock market continues to rise, then you can certainly expect increased merger activity next year.

Another factor that drives deal flow is activity within a particular industry. A perfect example is the software industry, thanks in part to PeopleSoft’s capitulation to Oracle. Now come reports that Symantec Corp. is interested in acquiring Veritas Software Corp. for more than $13 billion. Indeed, Albert Pang, an analyst with market research firm IDC, told the San Jose Mercury News that the number of software mergers could double 2004’s total of 30 deals.

Pang singled out U.K.-based accounting and business software developer Sage and personal-finance software maker Intuit as potential takeover targets. “We are entering the thick of software consolidation right now,” Pang told the paper.

At PricewaterhouseCoopers, the transaction services group is calling for a “moderate pick-up in 2005” in M&A. “While corporate acquirers continue to approach mergers and acquisitions with caution, pressures to demonstrate growth coupled with abundant financing and cash reserves should raise the levels of corporate M&A next year,” wrote PwC in a new report. “At the same time, cash-laden private equity buyers are already seizing many deal opportunities and will continue to compete with strategic buyers for middle market deals over the next 12 months.”

The firm pointed out that companies will be more active across the board because they have a lot of cash and there’s a lot of debt financing available. As proof, in a little less than a year, financing sources have moved from financing acquisitions at 2.25 times EBITDA to 5-plus times EBITDA.

PwC’s Bob Filek noted that as M&A financing sources chase yields and try to beat their benchmarks, they’ve been willing to go into lower-quality issues and take on longer maturities. “Executives will also be shifting their focus from Sarbanes-Oxley compliance matters to growth and acquisitions,” he added.

The deal drivers in 2005 figure to be cost and growth, added PwC. Greg Peterson, a transaction-services partner focused on the private equity sector, says buyers are asking, “How can we improve the cost structure, and once we do that, what’s the upside growth potential?” The upshot: Deals that don’t offer growth potential won’t get done, despite cost savings. That’s true for both the corporate side as well as the private equity side.

Breaking it down by industry, according to PwC: retail banking should experience continued consolidation as companies seek growth; insurance will see more activity in light of regulatory shake-ups; health-care deals will be driven by consolidation and government mandates; consolidation will continue in consumer products as retailers step up demands and manufacturers discard brands with little growth or profit potential.

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