Sweet Times For Dealmakers
While workaday traders and portfolio managers were struggling to generate returns in 2005, one corner of Wall Street was thriving: mergers and acquisitions. When the books close on the year, U.S. M&A activity likely will have touched $1 trillion, up from $824 billion in 2004, according to Thomson Financial (TOC ).
Many signs point to an acceleration in deals in 2006. The hottest sectors, according to market watchers: finance, technology, and energy. Plus anywhere cash-rich private-equity funds care to dabble. Naturally, M&A specialists such as Goldman, Sachs & Co. (GS ) and Morgan Stanley (MWD ) will happily egg on -- and profit from -- the action as well. "The environment is pretty ripe," says James W. Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management. "You have a rising stock market, tons of corporate cash, and low interest rates," he says.
Financial-services mergers were relatively scarce in 2005. Bank of America's (BAC ) $35 billion acquisition of credit-card outfit MBNA Corp. (KRB ) in June -- one of the largest financial-sector deals in recent memory -- grabbed headlines, but 2005 will likely turn out to be the second slowest year ever for deals involving banks with at least $500 million in assets. With 27 through early December, 2005 has well below the average of 50 deals a year seen during the 1990s.
But "things will pick up [for financials] in 2006," says Thomas Michaud, chief operating officer for Keefe, Bruyette & Woods Inc., a New York boutique investment bank specializing in the financial-services industry. In particular, regional banks -- always a target -- have seen an uptick in consolidation that seems likely to extend into the new year. Four of the 15 companies on Keefe Bruyette's June, 2005, takeover list have since been acquired.
Right now, Keefe Bruyette has West Palm Beach (Fla.)-based Fidelity Bankshares (FFFL ) high on its roster of buyout candidates. At 32.74, Fidelity's shares trade near their all-time high of 33.21, well off their year low of 22.27. They no doubt have a fair amount of takeover speculation already baked in. But Keefe Bruyette sees Fidelity as the most attractive banking target in the Sunshine State. Its rather high expense-to-income ratio, in particular, makes it ripe for a suitor looking to wring cost savings out of an acquisition. Potential buyers include Winston-Salem (N.C.)-based BB&T (BBT ), Montgomery (Ala.)-based Colonial Bancgroup (CNB ), and Greenville (S.C.)-based South Financial Group (TSFG ). Keefe Bruyette sees Fidelity potentially fetching a takeout price of $36 a share.
The technology sector, now nearly six years removed from NASDAQ 5000, is poised to see more capitulation, in which companies grappling with slower growth decide to sell to better-positioned rivals. Case in point: Cisco Systems Inc. (CSCO ) recently snapped up cable-television boxmaker Scientific Atlanta (SFA ).
Nowhere is the trend more apparent than in software, where Oracle Corp. (ORCL ) has been a serial acquirer, completing its $10.3 billion takeover of rival PeopleSoft in January and bidding $5.85 billion for Siebel Systems Inc. (SEBL ) eight months later. "A software company is like a shark," says John C. Rizzuto, software analyst with Manhattan-based Lazard Capital Markets LLC. "It has to keep moving to survive." Bit players that offer one tool or application need to ask themselves if they can afford to keep going it alone when the Oracles and Microsofts (MSFT ) are becoming more entrenched and looking for extra pieces to fit into their sprawling product suites. "It's now about getting a bunch of little things from one vendor," says Rizzuto.
He points to TIBCO Software Inc. (TIBX ), an integration software maker in Palo Alto, Calif., with about $500 million in annual revenue, as a company that can't afford to remain independent. "They'll inevitably lose market share as bigger competitors encroach," he says. Other software makers that have bolt-on appeal to larger rivals include BEA Systems (BEAS ), Vitria Technologies (VITR ), and IONA Technologies (IONA ), says Rizzuto -- all sub-$10 stocks.
The same forces are bearing down on hardware makers, says Mark Zanoli, JPMorgan Chase & Co.'s (JPM ) head of tech banking. He views struggling printer maker Lexmark International Inc. (LXK ) as a candidate to sell out to a larger, more diversified vendor. Lexmark's stock has plunged 47% from its high this year because of poor earnings.
The energy sector should see some dealmaking, too. During the late 1990s energy was a classic consolidation-capitulation story, with $15-a-barrel oil prompting an unprecedented wave of megamergers as companies sought to cut costs. Now, with oil at more than $50 a barrel, surging profits and share prices could fuel deals. With supply tight and refining capacity strained, "companies will find it cheaper to buy than develop resources," says Todd S. Lowenstein, co-portfolio manager of the $500 million HighMark Value Momentum Fund (HMVLX ).
Lowenstein says Suncor Energy (SU ), which operates in Canadian oil-sands fields, is a compelling acquisition candidate. Oil sands are swaths of petrol-rich ground where oil can be extracted, but they're tapped only when crude prices are high enough to make the costly process worthwhile. Suncor makes respectable profits when crude is at $28 a barrel, says Lowenstein. At current prices, the company is "just printing money." There's more than profitability involved, however. "You have no exploration risk," says Lowenstein. "It's a secure resource in a friendly country."
Utilities are primed to continue their long, if fitful, consolidation. The Energy Policy Act of 2005 repealed Depression-era limits on utility cross-ownership and will shrink the number of utilities from 100 to just 10 or 20 over the next decade, says Lowenstein. The big guns agree: In May, Iowa's MidAmerican Energy Holdings Co., which is owned by Warren Buffett's Berkshire Hathaway, announced plans to buy PacifiCorp (SPI ), an Oregon utility, for $9.4 billion.
The need for almost half a trillion dollars' worth of energy grid upgrades -- laid bare for the world to see during the Northeast power blackout of 2003 -- underscores the importance of scale. A company such as Raleigh (N.C.)-based Progress Energy Inc. (PGN ), with a relatively digestible market capitalization of $11 billion, could soon end up in someone else's arms, says Lowenstein.
The wild card in the M&A game is private equity. According to Buyouts Magazine, a record $151 billion of sponsored leveraged buyouts were completed from January through the end of November, vs. $137 billion for all of 2004. Nine of the top 10 biggest-ever private equity deals were announced in 2005, according to deal tracker Dealogic. (The largest is still the $25 billion buyout of RJR Nabisco in 1988.)
Record inflows into private-equity funds are giving them plenty of ammunition. Their capital bases are "astonishing," says Terrance Bessey, a Washington, D.C.-based partner at law firm Patton Boggs LLP who specializes in private equity. Indeed, according to the private equity practice at Ernst & Young LLP, U.S. fund-raising in the sector has hit $120 billion so far this year, triple the figure for all of 2004. That's making funds more aggressive. In September a private-equity consortium of Clayton, Dubilier & Rice, Carlyle Group, and Merrill Lynch Global Private Equity (MER ) outbid Blackstone Group, Texas Pacific Group (TPG ), Bain Capital, and Thomas H. Lee Partners for rental car giant Hertz (HTZ ), which brought $15 billion, including debt, for parent Ford Motor. (F ) Grocery chain Albertson's Inc. (ABS ) and newspaper publisher Knight-Ridder Inc. (KRI ) are now weighing bids from suitors.
Analysts expect generous buyout prices to persist as long as low borrowing costs make that possible. John O'Neill, Americas director of private equity for Ernst & Young, foresees private equity purse strings loosening at least through the first half of 2006: "The recipe for deal success has one main ingredient -- cash." The recipients of any such largesse, shareholders, are in no hurry to see that feast end.
By Roben Farzad