Merger activity to show tepid recovery in 2010

Last year’s move by Exxon Mobil Corp to buy XTO Energy Inc for $30 billion in stock may be a harbinger of activity to come in 2010 as companies flex their stronger share prices and release pent-up deal demand.

The XTO takeover followed other corporate mega-deals, such as the US$26 billion cash-and-stock deal for Burlington Northern Santa Fe by Warren Buffett’s Berkshire Hathaway, and Comcast Corp’s US$30 billion planned purchase of NBC Universal.

“We’re encouraged by the current activity. The pipeline for the early part of 2010 is improving —— 10 to 15 per cent growth for the year is possible. Both engines of activity —— private equity and corporates —— are now active,” said Bank America Merill Lynch Global Head (mergers, acquisitions, financial sponsors and corporate finance) Jeffrey Kaplan.

“You need a sustainable economic recovery,” he said. “You cannot expect the M&A market to flourish without favorable economic conditions. The best deals often are done at the beginning of a recovery. Post-bubbles create opportunities to get great values but are not always the best times for sustained M&A activity.” M&A total in 2009 was $1.968 trillion, down 32 per cent from full-year 2008 and down 53 per cent from the record high in 2007, according to data from Thomson Reuters.

The United States, which suffered a six-year low in mergers and acquisitions, still squeaked ahead of Europe for the first time in three years.

Flat growth

“If you look deeper into 2009 and you back out rescue financings, which were counted as M&A transactions, we’re closer to US$1.6 trillion in traditional M&A. So much of this year has been nontraditional M&A and a few mega healthcare deals,” said Paul Parker, head of global M&A at Barclays Capital.

“We expect US$2.1 trillion in 2010, but with more traditional M&A playing a larger role,” he said. “The numbers may look flat on paper, but when you take out a lot of the noise of this year, it really indicates more traditional merger transactions and a healthier market,”Swiss Bank Co-Head (America’s M&A) Lee LeBrun said, “There are a number of factors which create a tailwind for M&A volumes to rebound: CEO confidence is high, capital markets are accommodative, balance sheets are stronger with high levels of cash. And given the interest rate environment, cash hasn’t ever had a lower opportunity cost.”

Joseph Frumkin, a partner with law firm Sullivan & Cromwell, said the market remains quite cautious, with deals taking months to assemble, rather than mere weeks for some deals during the M&A peak.

In 2009 Morgan Stanley topped the global M&A league table for the first time since 1996, benefiting from working on each of the five largest deals this year. Morgan’s win is a big upset for Goldman Sachs, which until this year held the No 1 ranking on the list of announced M&A deals for the last 12 years without interruption. Advisory fees generated by M&A deals totaled US$18.9 billion, down 46 per cent from 2008 —— the worst annual level since 2003. For the first time in six years, M&A was not the main source of fees for investment banks, representing just 27 percent of all fees earned this year, according to Thomson Reuters. The energy and power sectors generated the most fees of all industries, followed by financials. Still, the biggest deal of the year was in the pharmaceuticals sector: Pfizer Inc’s US$64.6 billion acquisition of Wyeth.

Energy and healthcare were the only two industries that showed gains in deal volume this year. The worst performing sectors were consumer staples and consumer products and services. Energy and raw materials, as well as industrials, financial institutions, healthcare services and technology will likely take the spotlight next year, bankers said.

“M&A activity in 2010 will be driven by strategic buyers who have access to capital and the strategic vision to capitalise on some of the best values we have seen in recent times,” said Bob Filek, a partner with PricewaterhouseCoopers Transaction Services.
“Companies have taken aggressive actions on costs; the low hanging fruit is gone, and to drive further efficiency they will look to combine with similar players to drive scale and enhance productivity. The ‘merger of productivity’ will be a driving force in 2010 as companies look to drive revenue growth and enhance margins,” Filek said.

Global buyside financial sponsor activity dropped 45 percent in 2009, hitting a seven-year low of US$130 billion. There were only two financial sponsor deal over US$5 billion this year —— the takeover of Delphi Corp by creditors, and the acquisition of IMS Health Inc by TPG Capital and the Canada Pension Plan.

Private equity is sitting on US$400 billion in dry powder, or cash, while Fortune 1000 companies have more than US$1.8 trillion of cash on hand, an increase of US$271 billion over last year, according to Ernst & Young’s Transaction Advisory Services.

Hostile deals to increase

Extra cash on companies’ balance sheets, buoyed stock prices and rising corporate boardroom confidence points to an increase in hostile deal activity in 2010, bankers said.

“In a corporate governance environment with fewer staggard boards and poison pills, hostile activity continues to be relatively robust. However, despite a number of high-profile bids, completion rates remain low,” LeBrun said. Kraft Foods Inc’s US$16 billion hostile offer for British confectioner Cadbury is typical of the move toward hostile deals, according to data from Thomson Reuters. Hostile bids represented only 0.9 per cent of the M&A market in 2009, but that was still the highest rate of the past five years, the data showed.

“When you have a disconnect between market valuations and sellers’ expectations, that tends to make buyers go hostile. It’s exactly this kind of environment that is ripe for hostiles, though it’s somewhat constrained by bank lending. With hostiles, there is no chance to do due diligence, and banks tend to be risk averse,” Frumkin said.