Mega Deals Mask Stagnant Mid-Sized M&A Market That Pays More

Big deals are back. M&A is not.

Large acquisitions, led by Verizon Communications Inc.’s $130 billion purchase of its wireless business from Vodafone Group Plc, pushed mergers up 42 percent in the third quarter to $671 billion, data compiled by Bloomberg show. That belies stagnation in takeovers below $5 billion -- the heart of dealmaking -- where volumes fell about 2 percent. Those smaller deals matter to bankers who count on them for close to 90 percent of advisory fees, according to Freeman & Co.

The big deals, fueled by cheap debt, are concentrated in industries including telecommunications and technology, where companies grappling with disruptive innovations or saturated markets are prepared to pay high prices to secure growth. Smaller companies, meanwhile, are holding off on deals because of lingering concerns about the economic recovery as a surge in stock prices makes targets expensive.

“The softness in M&A is evident in the $1 billion to $5 billion range,” said Cary Kochman, head of North American M&A for Citigroup Inc. “A number of large deals in 2013 could have been done five years ago or five years from now.”

While the large deals grabbed headlines, there were only 15 of them in the quarter, compared with about 6,500 valued at less than $5 billion. The bigger acquisitions account for just 14 percent of the $7 billion in fees that will be paid to investment banks for deals announced during the quarter, according to estimates by Freeman, a New York-based researcher.

During the buyout boom that preceded the 2008 recession, the largest deals generated 18 percent of the fee pool at most. The disparity occurs because banks typically charge a greater percentage of the value of smaller transactions.

Asian Slump

Buyers from North America were the most active among larger acquirers, accounting for 10 of the 15 big deals announced. In Asia, meanwhile, buyers both large and small were sidelined by falling currencies and stock markets. Only one large deal was announced, and the value of purchases by Asia-based buyers fell to $121 billion in the quarter, from $145 billion a year ago.

The largest deals last quarter were struck by companies in the technology, telecom and drug sectors -- industries facing rapid changes that drive them to pay high prices to gain size, new technology or market reach.

“Those are three sectors that are consolidating and the values tend to be large,” said Michael Carr, head of Americas M&A for Goldman Sachs Group Inc., in a telephone interview.

Publicis, Omnicom

In July, Publicis Groupe SA and Omnicom Group Inc. agreed to merge into a $35 billion advertising company that will be the world’s largest, while in September, Microsoft Corp. spent $7.2 billion to acquire Nokia Oyj’s flagging handset business. In August, biotech giant Amgen Inc. agreed to acquire Onyx Pharmaceuticals Inc. for $10.4 billion in a play to get Onyx’s bone marrow cancer drug Kyprolis.

Dealmaking in telecom and technology will continue, said Gavin Deane, the co-head of global technology, media, and telecom at Deutsche Bank AG in London. Vodafone is freshly armed with cash it could use on acquisitions, and Lenovo Group Ltd., the world’s largest maker of personal computers, said in September that it’s looking for acquisition targets.

Also in September, Time Warner Cable Inc. Chief Financial Officer Artie Minson said the second-largest U.S. cable operator would consider taking on more debt if it came across an attractive enough merger or acquisition.

Cheap Debt

In telecom in particular, “businesses tend to benefit from scale, and quite materially so, because the infrastructure is inherently large and the footprint wide or the offerings aren’t desirable to consumers,” said Deutsche Bank’s Deane.

Cheap financing, resulting from the U.S. Federal Reserve keeping interest rates at about zero, can substantially lower the cost of a large takeover and is also pushing the big deals forward, said Citigroup’s Kochman.

“Interest rates and the depth of liquidity are facilitating deals of that size,” he said.

At the same time, stock market gains have pushed the valuations of targets higher, creating a “seller’s market” that is limiting opportunities for smaller buyers, he said.

The Standard & Poor’s 500 Index has rallied 18 percent this year, poised for the biggest annual gain since 2009. The U.S. equity benchmark’s price-earnings ratio has increased to more than 16 from 14 in January. The Stoxx Europe 600 Index has gained 11 percent.

The rising stock prices also mean there’s no penalty to small buyers to stay on the sidelines, said Chris Ventresca, global co-head of M&A at JPMorgan Chase and Co.

“You had a free pass because the stock has gone higher without any meaningful revenue growth,” he said.

Economic Recovery

The big deals could continue, as activist investors who have had success spurring sales by smaller companies have set their sights on larger targets, said Citigroup’s Kochman. Activists now have positions in large companies including Procter & Gamble Co. and Pepsico Inc.

Looking ahead, economic recovery in Asia and Europe should spur more deal activity next year, said Paul Parker, head of global finance for Barclays Plc. Chinese retail sales and industrial output accelerated in August amid government stimulus measures while the Euro zone exited an 18-month recession.

“We are beginning to see improvement in deal activity in the U.S. and in Europe,” Parker said in a phone interview. “In the second and third quarters of next year, you’ll see Asia kick in and the U.S. and Europe continue to improve.”

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