The Wall Street Journal-20080115-The Game- What to Expect As Deal Makers Revise Strategies- Buyers May Be Plotting Timing- Funding Twists- -Weakness- as Strength
Return to: The_Wall_Street_Journal-20080115
The Game: What to Expect As Deal Makers Revise Strategies; Buyers May Be Plotting Timing, Funding Twists; 'Weakness' as Strength
What separates a good year in mergers-and-acquisitions from a bad one? By the Pavlovian measure of Wall Street, it is simple: The more deals, the better the year. But 2007 revealed the fallacy of this approach. Buyers gorged on cheap credit, overpaying along the way. Some raced to rip up transactions signed months earlier. More deals, more problems.
In this piece, the second annual M&A Buyer's Guide, it is worth remembering the distinctions between the Street and the rest of us. Here are four major themes for the year ahead, all of which show that a good year or bad year -- as measured by the real world -- can have nothing to do with the size of a bonus check.
-- M&A Can Save the World: Thank you, Ken Lewis.
In bailing out Countrywide Financial, the Bank of America CEO might have spared the kind of worst-case meltdown the market has been fearing for months.
"This was good for the financial system," is how one of the people involved in the transaction put it. Had Countrywide "gone doughnuts" in Street parlance, it would have touched off a wave of dangerous defaults that could have pulled down the overall economy, this person explained.
Similarly, M&A might be the best option available for companies facing severe problems created by the deepening credit crisis. That's true for companies that have been gradually deprived of funding that is the lifeblood of their business, such as student lender SLM (Sallie Mae) and Rescap, the mortgage unit of GMAC Financial Holdings, which is the nation's seventh largest home lender. A person close to Sallie Mae says a new funding agreement should be in place by Friday. The same can't be said for Rescap, where company officials said Sunday that "all options are on the table."
An important player in the midst is Treasury Secretary Henry Paulson. The Street rumor mill was thick with theories that he helped engineer the Countrywide deal. His office denies it. But with credit markets still in deep freeze, the stakes are rising by the day. A behind-the-scenes matchmaker may be the best defense between taxpayers and a few terribly large bailouts.
-- Going Against the Tide: When is the best time to cut a big M&A deal? When no one else is doing it. Prices tend to come down -- as they did during the 2002-03 recession -- and there is less competition, too. Just look at deal values from the fourth quarter of 2007, when corporations were valuing acquisition targets at 12 times their earnings before interest taxes, depreciation and amortization, according to figures from CapitalIQ. That ratio stood at 8.6 times in the first quarter of 2004.
Of course, boards and CEOs don't often think that way. They are driven by social pressures much like the rest of the market.
That is why you can expect a few maverick deal makers to emerge during 2008, acting specifically because their rivals are too frightened by the economy. Private-equity firms pursued that strategy aggressively six years ago, with outstanding results. The lesson of that deal "vintage" still linger. Where, for instance, did Blackstone Group just place one of its largest recent investments? A dam project near the shores of Uganda's Lake Victoria.
"We get excited about a world where it's not so easy, and where you have to be creative," says Terry O'Toole, co-managing partner at Tinicum Capital Partners, a $1.2 billion buyout fund.
-- Stocking Up: With lenders and corporations hoarding cash, corporate acquirers will have one major acquisition tool at their disposal: Stock. This wasn't the case last year, when just 12% of deals were structured as share-for-share swaps, according to FactSet MergerMetrics, compared with 23% in 2004.
This is a mixed development for shareholders. Most research shows that all-cash deals outperform stock transactions over time. And share swaps aren't necessarily a panacea for those who want to get a deal closed quickly and painlessly.
In all-stock deals, a buyer typically issues a fixed ratio of stock to be awarded to selling shareholders. This can inject large, destabilizing fluctuations in values between announcement and closing, as happened when America Online bought Time Warner back in 2001.
The main question is how much sway shareholders will have in readjusting these stock-swap deals. They've spent years, quite successfully, clamoring for ever-larger cash-buyout offers. Can the same still hold during 2008?
So far, the answer is yes, says Louis Friedman, vice chairman of investment banking at Bear Stearns. "There's no crawling back into the cave for these directors," he says.
-- "Weakness Is the New Strength": Of course, 2008 promises an especially ripe bounty of rationalizations and excuses, as chiefs and boards try to sell shareholders on deals done out of weakness.
Beware of Orwellian flair. Especially when CEOs discuss how a deal brings "financial flexibility," or a "long-term partner" to explain a deal done for less than the market price, or that is highly dilutive to shareholders.
These may well be necessary steps, particularly if the economy is headed to recession. But shareholders should demand candor from a CEO who is doing a deal because of a crisis.
Countrywide's chastened CEO Angelo Mozilo struck the right tone when he blandly described his fire sale to Bank of America as "the right decision."
Simply eradicating CEO hyperbole would make 2008 a glorious year for M&A. During the tumultuous months ahead, we just may get the chance.
---
Email [email protected]. Get an up-to-the minute take on deals and deal makers at wsj.com/deals.
