Feeling a sense of dιjΰ-vu about the current takeover frenzy? It's different this time—but only up to a point.
Last year, as global merger activity breached the giddy levels of the dotcom era, markets partied like it was 1999. The bankers and lawyers who work on deals braced themselves for hangovers. But instead, glasses were refilled, the music cranked up and the guests were invited to dance through the night. Some $2 trillion of deals have been unveiled so far this year, putting it on track to smash the record set in 2006 by a whopping 60% or more. That would exceed even the rosiest predictions on Wall Street.
The Dow industrials has lately hit new highs with unusual frequency. China's markets have surged on record trading volumes, despite efforts by officials to talk them down. Forget the turmoil of late February: the markets' strength is encouraging more deals. So euphoric is the mood that even acquirers, usually penalised on the expectation that they will overpay, are seeing their share prices jump: Alcoa's rose by 8% on the day of its bid. To cap it all, Warren Buffett, not normally one to follow the crowd, says he would spend as much as $60 billion on the right deal—far more than the investor has ever forked out on a single acquisition.
This has inevitably led to comparisons with the 1990s merger boom. But there are several big differences. The most obvious is that the 1990s were fuelled by stock, whereas today's frenzy runs on credit. With interest rates low, it has become easier for companies to finance themselves with debt than with equity. Cash is the main coinage.
This trend has played into the hands of the big private-equity firms, which now lead a fifth of all takeovers, measured by value. They still have giant war chests to empty—the biggest funds are touching $20 billion in size—and are spending at a record pace. With such resources to hand, they are becoming bolder (some would say less discriminating). The average buy-out has tripled in size since 2005, to $1.3 billion. And taboos are being broken, as evidenced by the recent takeover of a utility and a bank, two industries previously considered immune to private equity.
Another difference is that this boom is broader-based than the last, both in terms of industry and geography. No single industry is far ahead of the rest, as telecoms and the internet were last time. Excitement surrounds financial services, metals and mining, power generation, property and consumer goods. And whereas the deals in the 1990s were concentrated in America, this time they are more evenly spread. In April twice as much was spent in Europe as in the United States.
Moreover, today's merger wave is driven not by enthusiasm for a nebulous “new paradigm”, but by global trends, such as demand for commodities, the globalisation of capital markets and the rise of budding multinationals in developing countries. Companies are using cheap funding as an opportunity to expand into new markets—hence the rise in the share of mergers that are cross-border, to a record 46% in the four months to April.
Reassuringly unfriendly
Today is more like the 1980s than the 1990s in another way, too: the hostility of the buyers. The dotcom era was nauseatingly cosy, with only 4% of deals struck in 2000 deemed hostile or unsolicited. This year the level is hovering close to 20%. One reason for this is the growing influence of shareholders, notably hedge funds, whose patience is short. Given this new breed of owner-agitator, managers of targeted firms are less likely to “dig trenches and stay there,” says Victor Lewkow, a merger lawyer with Cleary Gottlieb. Pension funds and other once-staid institutional shareholders are also becoming more willing to entertain offers as they strive to increase returns.
As in the 1980s antitrust authorities seem to have become more relaxed than they were in the 1990s, especially in America. Mr Lewkow thinks some companies are rushing to do attractive but “dicier” deals (from an antitrust standpoint) in the hope of getting them approved before the change of president, and a possible tightening of enforcement policies. Even so, the likes of Alcoa and Thomson face daunting obstacles. Credit Suisse puts the chances of success for the Reuters takeover at 60%.
But getting a deal past the antitrust police is only half the battle. Research shows that mergers often fail to bring expected benefits: look no further than the break-up of DaimlerChrysler after nine unhappy years. M&A advisers dispute this, pointing to studies that show buyers outperform the market, at least in the year after the deal. But the danger of overpaying clearly increases as competition for transactions heats up and stockmarkets scale new heights. There are signs that this is happening: the average premium being paid, when measured as a percentage of the target's cash flow, is higher that at any time since the bursting of the last bubble.
Moreover, there are fears that mergers will be used to paper over cracks. Profit growth for companies in the S&P 500 will fall to 7% this year after several years of double-digit expansion, reckons Thomson Financial. Firms may join forces to hide their own deteriorating performance.
That should worry shareholders.
For those who advise on deals, however, the bigger concern is what might bring the party to an abrupt end. A sharp economic slowdown in America? The collapse of a giant buy-out? A credit crunch with no clear trigger? In private, most bankers say it cannot go on for much longer. In public, they will just keep clinking their glasses.
By: N. Peter Kramer
