Mergers: A Bit of Mania for 2005

Conditions are shaping up to favor more dealmaking next year. Though still not a boom, the action should be plentiful

By Steve Rosenbush

Everyone remembers the tech bubble. But the period from 1998 to 2000 was also remarkable for the historic boom in Wall Street dealmaking. Back then, mergers, acquisitions, and public offerings were often far more critical to building market capitalization than traditional business activities such as marketing, sales, and generating profits. Wall Street manufactured deals worth a stunning $1.5 trillion a year during that period, doubling prior records.

Then, of course, the bubble burst in early 2000, taking the stock market down and the economy along with it. Dealmaking all but dried up: Volume dropped to less than half a trillion dollars in 2002. Thousands of highly paid stock analysts and investment bankers were tossed out on the street, their Hermes ties flapping in the wind.

Now an M&A recovery is starting to take hold, as a new round of mega-mergers like Sprint (FON ) and Nextel (NXTL ), Sears (S ) and Kmart (KMRT ), and Oracle (ORCL ) and PeopleSoft (PSFT ) make headlines.

NEW WAVE.

  The value of announced deals for 2004 was $767 billion as of Dec. 15, up 40% from 2003's $544 billion, according to Thomson Financial Services. That's a big increase, but it restores M&A volume only to a level below where it stood in 1997, when it hit $887 billion.

This new wave's foundation is a combination of a stronger economy, a buoyant stock market, and low interest rates. Companies also have an unprecedented amount of cash on their balance sheets at the same time that growth in many industries is slowing down. That's forcing corporate leaders to think more seriously about an M&A strategy, says Stefan Selig, vice-chairman of Banc of America Securities, a unit of Bank of America (BAC ). He believes companies will invest most of their cash on mergers and acquisitions.

Many of 2004's deals were masterminded by so-called private equity investors. Wall Street is now populated with thousands of new, private boutique-investment companies, many started by laid-off bankers. They were the most aggressive buyers in 2004. They still have a lot of money to spend, and will remain active in 2005.

CALMER ENVIRONMENT.

  But Selig thinks the private-equity firms will face more competition from strategic buying by big corporations, now less inhibited about spending cash and investing in the future than they were during the last year. Selig thinks that could help big integrated banks such as Bank of America, Citi (C ), and JP Morgan (JPM ), which tend to serve large, strategic buyers.

Several problems that made CEOs wary of M&A in 2004 -- such as electoral and regulatory uncertainty, rising oil prices, disappointing job growth, and a stock market that often resisted merger plans -- have abated, according to Selig. When Wrigley (WWY ) announced that it was buying Lifesavers, Altoids, and other brands from Kraft (KFT ), Wrigley shares rose, even though the deal wasn't immediately accretive to earnings. That sort of reaction was unthinkable before late 2004. "So for all these reasons, M&A activity is likely to increase in 2005," Selig says. "The environment is much more conducive to dealmaking."

Industry experts expect the pickup to be broad-based. Instead of being concentrated in tech, "M&A activity will rise across the board," says Mort Pearce, head of M&A at law firm Dewey Ballantine.

TECH AND TELECOM.

  Still, the tech sector will have plenty of deals. The software industry will continue to consolidate, as companies seek to reduce the number of vendors they buy from. Oracle's successful bid for Peoplesoft also forced the Justice Dept. to establish regulatory precedents that could clear the way for more deals. Some investment bankers believe Microsoft (MSFT ) might try to beef up its security products by acquiring McAfee (MFE ).

As for telecom, it's not clear how much more consolidation will take place. The year began and ended with huge deals in wireless, as Cingular acquired AT&T Wireless and Sprint agreed to acquire Nextel for $35 billion. But not many independent wireless companies are left, short of T-Mobile, which is owned by Deutsche Telekom (DT ). Unless Verizon (VZ ) or another third party tries to break up the Sprint-Nextel deal, wireless consolidation may be limited to smaller, regional players.

Mergers that combine long-distance companies such as AT&T (T ) with local carriers like Verizon might still be a way off, if they ever occur. More likely, consolidation will take place among long-distance providers. Combinations between AT&T, MCI (MCIP ), Level 3 Communications (LVLT ), and Quest (Q ) are all possibilities.

RETAIL AND HEALTH CARE.

  Other sectors will also see plenty of action. Now that Kmart has agreed to acquire Sears, more deals in retail are likely. Struggling retailers with valuable real estate, such as Toys 'R' Us (TOY ) may find ready buyers. And the financial-services industry still has far too many players. Washington Mutual (WM ), for example, is seen as a perennial takeover target.

The health-care industry will continue to consolidate because the industry is growing, and it has a huge opportunity -- not to mention economic need -- to lower costs. Johnson & Johnson's (JNJ ) acquisition of medical-device maker Guidant (GDT ) for $25 billion, announced Dec. 16, is just one sign of things to come. Device maker Medtronic (MDT ) may want to do more deals to better compete with giant JNJ. Big pharmaceuticals may also join forces to bolster their new-drug pipelines. Bristol Myers Squibb (BMT ) and Merck (MRK ) is one possible pairing.

One new development to watch in 2005: Foreign-based companies will be looking hard at the acquisition of U.S. assets. "Whenever the dollar is cheap, companies from other countries come into the U.S. to pick up assets," says Jeffrey Williams, a veteran Morgan Stanley telecom banker who now runs his own shop, Jeffery Williams & Co. He expects European companies to poke around the U.S. looking for deals.

CHINA WATCH.

  Chinese outfits may also be some of Wall Street's best customers in 2005, says Williams. "Every investment bank and consulting firm has Asian companies in its pitch book," he says. Chinese buyers will be on the lookout for U.S. manufacturing companies that have their own distribution systems, he believes. For example, by buying power-tool maker Black & Decker (BDK ), a Chinese company would gain a U.S. sales force, as well as Black & Decker's relationships with retailers. Other makers of auto parts, hand-held tools, pumps, motors, axels, and springs could be in demand, he says.

Although the M&A recovery will pick up speed in 2005, don't expect a return to the glory days of the late '90s. Still, after the brutal downturn of recent years, it's a major shift to see Wall Street back on its feet and Corporate America ready to deal.

Rosenbush is a senior writer for BusinessWeek Online in New York

Edited by Amey Stone

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