An M&A Boomlet with Legs?

Flush with cash at a time when Wall Street is flat, companies have to grow somehow -- hence an urge to merge that's likely to continue

By Steve Rosenbush

At its midpoint, 2005 is looking like the year that may be remembered for a robust rebound in mergers and acquisitions. SBC (SBC ) has announced plans to acquire AT&T (T ), while rival Verizon (VZ ) is buying MCI (MCIP ). Washington Mutual (WM ) said it would fill out its banking business by acquiring Providian (PVN ), and Sun Microsystems (SUNW ) announced it was purchasing StorageTek (STK ). Federated Department Stores (FD ) is buying rival May (MAY ), and Kmart (SHLD ) bought Sears.

The value of announced M&A deals -- which rose more than 40% last year, to $825 billion, according to Thomson Financial -- is on track to break $1 trillion in 2005. While that still pales beside the record $1.7 trillion in announced deals in 2000, the M&A market looks brisk by any measure. And there's no sign of a slowdown in sight.


  Why? A key difference separates this acquisition spree from M&A eras of the past. The deals of the late 1980s and late 1990s had strong stock markets for a backdrop. That allowed companies to use their stock as currency, driving prices through the roof. That's hardly the case now. The Standard & Poor's 500-stock index, a broad measure of the stock market, rose less than 10% last year. And it's down a fraction of a point year-to-date in 2005.

The result: Buys can be had, not just due to flat valuations but also because of some still-lingering effects of the tech bubble bursting and corporate scandals. Consider telecom pioneer MCI. It was bought by rival WorldCom for $37 billion in stock and cash in 1998. Now, Verizon is acquiring the combined entity, which emerged from bankruptcy, for $8.4 billion in cash.

Buyers are funding their purchases in several ways, but a combination of low interest rates and lots of cash is the key driver. Just as consumers have taken advantage of those low rates to buy real estate and refinance existing mortgages, corporations have used them to finance investments (see BW Online, 6/8/05, "Filtering Out the Economic Noise"). Leveraged buyouts hit $71 billion in 2004, up from $21 billion in 2003, according to Thomson Financial. That was the best year since 1988, when they hit a record $97 billion. They're on track to hit last year's mark, or come very close, in 2005.


  In most cases, though, buyers have little need for financing. Why borrow when you can just a write a check? Companies, private-equity firms, and hedge funds are awash in cash.

The money is flowing from a few major sources. Corporate profits hit a record $766 billion in the first quarter of 2005, according to Thomson Financial. That money is going to a variety of uses, including capital spending, stock buybacks, dividends, and M&A. And private-equity firms and hedge funds, loosely regulated and defined investment vehicles, are raising more capital than ever. That has helped them play larger roles in the M&A world.

One alley off Wall Street still isn't doing so well. With a sluggish stock market, the initial public offering business remains torpid. Even seemingly attractive IPOs are finding it tough to hold their own. Shares of Lazard (LAZ ) have dropped about 12.5% from their debut last month at $25. That discourages other companies from going public.

But the M&A market is so strong that it may eventually bolster the stock market, turning the traditional link between M&A and stocks on its head. That's because companies are more willing to pay a premium to acquire assets in a competitive situation, according to a June 6 report by Lehman Brothers stock strategist Henry Dickson. Verizon, for example, was forced to raise its original bid for MCI from $6.7 billion because it faced fierce rivalry from Qwest (Q ).


  The M&A boom represents more than mere opportunism, though. It's driven by strategic reasons that go beyond the expediency created by low rates and lots of cash. Companies also need to find a way to expand revenues. The huge run-up in corporate profits has resulted from deep cost cuts. Balance sheets and operating expenses have decreased, driving margins higher.

Companies, however, can cut only so much before they cut to the bone. If the corporate world expects to keep the profit machine in motion, it's going to have to increase revenues. And one way to do that is to buy other companies. That holds particularly true in markets such as software, which has matured in recent years. Companies like Sun don't have time to build new lines of business in unfamiliar markets such as data storage. They need to buy their way in.

As regulators in Washington and even Brussels give companies a freer hand to do more or less what they want, there's little reason to think the current M&A boom will end any time soon. The prices and volume may not match the swashbuckling '80s or '90s, but this boom may prove more durable.

Rosenbush is a senior writer for BusinessWeek Online in New York

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