Mergers for Small Companies On the Rise

Industrial sector breaks out of 19-year lull.
Helen ShawMay 3, 2006

A total of 76 merger and acquisition deals were announced for smaller companies in the first quarter of 2006, which represents a 17 percent increase above the first quarter of 2005. If the deals continue apace, this year could witness an estimated 304 deals worth $117 billion, according to a report by Merrill Lynch small-cap strategists.

In their study, Merrill strategists Satya Pradhuman and Michael Kantrowitz note a rising trend in merger and acquisition activity for companies with market capitalizations between $200 million and $1.0 billion. Further, the duo contends that the trend is likely to continue given the companies’ pursuit of growth and the lack of organic growth.

Indeed, more than 80 percent of the companies responding to the Merrill Lynch Smaller Firms Survey for the first quarter rank sales or revenue growth as the most important corporate initiative currently. About 62 percent cited a growing market share as most important; 26.9 percent named cost cutting as their prime directive; and 16 percent cited foreign expansion as the most important initiative.

The sectors with the most surprising study results were the basic industrials and biotechnology segments. A total of nine deals were announced for the basic industrials sector in the first quarter of 2006—a sharp increase compared to the average four deal-per-quarter tally that has existed for the past 19 years. In the long-run, the basic industrials sector should benefit from the overall trend of relatively low supplies and the high oil prices, according to the report.

The biotechnology sector also departed from its average deal activity. Only two biotech merger announcements surfaced in the first quarter of this year, compared to the average five deals announced in each of the last two quarters of 2005. However, the pursuit of growth by large pharmaceutical companies should prompt acquisitions in the near future, say the report authors.

Additionally, the number of leveraged buyouts (LBOs) of small companies continues to rise, with 13 deals announced in the first quarter of 2006. (The report defines small companies as those with a market cap below $2 billion.). If activity keeps pace with the first three months of the year, there could be 52 leveraged buyouts this year, a level that has not been reached since 2000. In the small-cap universe, there were 39 leveraged buyouts in 2005, compared with 29 in 2004, and 23 in 2003. About $33 billion flowed into private equity in the first quarter.