Have Merger Prices Hit Rock Bottom?

Although U.S. M&A activity seems to be reaching its lowest point in seven years, that very lack of activity could mean the time is ripe for acquisi...
David KatzJune 28, 2010

Over the past six months, U.S. companies, preoccupied with cleaning up their balance sheets and amassing mountains of cash, have had little time to think about big merger deals. Indeed, with the results of the first half of 2010 just about in, it appears that deal activity has slowed to a crawl.

For the year to date, the volume of M&A activity targeting companies here plunged to $339 billion, a figure that could mark the worst start of a year since the $187 billion recorded in the first half of 2003, according to preliminary figures released by Thomson Reuters on Friday. To be sure, deal volume (the equity value and assumed debt of companies acquired) rose to $171 billion in the second quarter, a 2% rise over the first quarter. But the second-quarter total also represented a 15% drop from Q2 2009 volume of $202 billion.

Since U.S. companies hit a peak M&A volume of $968 billion for the first half of 2007, their attention has seemingly wandered elsewhere. “We see a lot more capital-market activity, with companies cleaning up their balance sheets, raising cash,” and paying back debt, says Matt Toole, head of deals intelligence at Thomson Reuters. “Companies don’t necessarily do a lot of large-scale M&A transactions when they’re not really sure what their business models are.”

But that very lack of activity could mean that the time is ripe for acquisitions, dealmakers assert. For one thing, there’s less competition out there, since private-equity firms are “not going to participate on larger-scale transactions because they don’t have the kind of leverage they did three years ago,” says Bob Filek, a partner in PricewaterhouseCoopers’s transaction services unit. Further, potential acquirers are likely to be looking at targets with earnings that have been heavily restrained by the downturn — and are thus cheaper than they might be at other times.

Potential acquirers are gaining confidence that targets are priced low enough to buy, says Steve Krouskos, global markets leader of transaction advisory services at Ernst & Young. “If you go back a year, when we talked to companies about the current pricing environment, probably three quarters said we think prices have more to fall. That’s not a good sign for deal-making,” says Krouskos. “Today, the vast majority of companies we’re talking to are saying prices have leveled out.”

Indeed, M&A activity has been surging on a number of less-visible fronts than that of the megadeal. For instance, volume in the middle market, which Thomson Reuters defines as deals under $500 million, rose 39% (to $293.7 billion) in the first six months of 2010 compared with the same period in 2009. As companies continue to look for ways to shed costs, divestitures of noncore divisions have also become more alluring.

Another promising sign is the huge growth in cross-border deals. The volume of acquisitions made abroad grew for the fifth straight quarter in the second three months of 2010, reaching $198 billion. U.S. companies are the most acquisitive buyers of foreign companies in the world, accounting for 23% of all transborder acquisitions.

The tax increases that seem likely to be enacted by year’s end will also spur deals, Filek says. He expects capital-gains tax rates to be at least 5% higher next year. Contemplating the likelihood of such a tax hike on the sale of a sizable family business in 2011, for instance, would be a strong inducement for an owner to sell now. “There will be a rush for middle-market transactions to close on 12/31,” the consultant predicts.

Thomson M&A activity