Tags: Mike Caggeso

M&A Activity May Add Some Sunshine to the Gloomy Markets

By , Money Morning •

By Mike Caggeso
Associate Editor

Even though half of last year was plagued by a credit crisis, 2007 was the best year ever for worldwide merger and acquisition (M&A) deals.

Total global deal volume checked in at $4.5 trillion, up 24% from the previous high-water mark set in 2006. U.S. deal volume also hit record levels last year, jumping 9% to reach $1.61 trillion, according to Thomson Financial.

M&A also supplied much of the gas that fueled the Dow Jones Industrial Average Index and the Standard & Poor's 500 Index to record highs last year.

But with global markets feeling the pinch from dried-up credit, depleted financial firms, and rising inflation, it's easy to believe that M&A activity will slow in 2008.

Not true, says Louis Basenese, editor of investment newsletters Alpha Intelligence Alert and The Takeover Trader, the latter of which is dedicated to M&A. All the above economic troubles have benched private-equity firms, who over recent years have outbid public companies in the M&A arena. Now, the tables have turned. 

"What few realize is that M&A doesn't need cheap financing to continue. Corporations are sitting with almost near record amounts of cash on their balance sheets," Basenese said. And with that, they can "take advantage of [the] depressed stock prices of competitors without the fear of being outbid by overly aggressive private equity shops."

Vulnerable Sectors

Basenese believes technology companies should continue their rapid consolidation.

The best example is the deal nearly every investor is eyeing: Microsoft Corp's (MSFT) $44.6 billion offer for Yahoo Inc. (YHOO), a proposal that put Yahoo's shares at a 61% premium.

That offer looks especially tasty considering Yahoo announced "headwinds" and 1,000 layoffs in 2008, along with a 23% drop in profits in its fourth-quarter earnings report.

Interestingly, the Microsoft-Yahoo deal encapsulates several facets of the M&A process - compatible [and rival] companies, a generous premium and ego-fueled proposal refusals - the latter a vote of confidence to investors as well as a strategic, last-ditch effort to entice a higher bid. 

The same also applies to BHP Billiton's (BHP) $147 billion offer for Rio Tinto PLC (RTP), which was proudly rejected hours after it was proposed.

And with commodity prices skyrocketing, the extra money flowing into oil conglomerates and mining companies could entice them to open their wallets to smaller miners struggling to compete with industry giants such as BHP and Rio.

"As T. Boone Pickens is fond of saying, it's always easier to dig for oil on Wall Street than in West Texas," Basenese said. "We can expect commodity producers to adopt this adage en masse, preferring growth via acquisitions."

Media companies too, are vulnerable targets. Not only are they feeling the effects of the depressed economy, they are seeing massive declines in advertising revenues and readership/viewership nearly across the industry.

"As technology evolves and enables consumers to access content through various mediums, [media] companies will expand capabilities and acquire new platforms to attract consumers," PriceWaterhouseCoopers said in a recent report.

Again, Microsoft and Yahoo serve as examples. But an example that bridges the old-school information age with the present is Rupert Murdoch-run News Corp. (NWS) $5.6 billion [or $60 a share] pluck of Dow Jones & Co. The former is an aggressive mogul buying and/or upgrading assets - such as social networking site MySpace. The latter is an ink-stained newspaper stalwart losing readership and advertising to endless opportunities on the Internet.

Other recent high-profile buyouts include: The Sam Zell-led near $8 billion buyout of Tribune Co.; Apax Partners and Omers Capital Partners' $7.8 buyout of Thomson Learning; and the multi-firm $13.5 billion takeover of Univision Communication by Madison Dearborn Partners, Providence Equity Partners, Texas Pacific Group, Thomas H. Lee and Saban Capital, Forbes reported.

Four Sectors and Four Stocks Ripe For the Picking 

When it comes to M&A investing, investors should follow the consolidation trend. Long story short, deals in one industry encourage more deals in the same industry. It's a domino effect.
If you think about it, that theory actually makes a lot of sense. If one company in a sector goes out and doubles its size overnight via an acquisition, it ups the ante for the whole sector; the only way its sector rivals can remain competitive is to complete an acquisition of their own. Otherwise, they might as well sell out themselves.
Accordingly, the industries experiencing the most consolidation in 2007 will likely enjoy similarly strong consolidation in 2008 and beyond. And the three top industries last year were:

  • Financials.
  • Materials.
  • Energy.

Conditions also point to increased consolidation in the healthcare industry - specifically in the pharmaceutical space, as traditional pharmaceutical companies forgo the long-and-costly route for researching and developing their next "blockbuster" drug, opting to buy it instead.

Four specific stocks to consider include:

  • Ultra Petroleum Corp. (UPL): In early 2004, seven independent natural gas producers operated in the Western Rockies. Today, only Ultra Petroleum remains. Not that the others failed or went belly-up. Reserve-hungry suitors gobbled them up for an average takeover premium of 20%. The last deal, Western Gas Resources, fetched a 44% premium. Ultra Petroleum will likely be next because it finally sold its China drilling sites in late September. This divestiture officially eliminated the 6,000-mile operational divide that previously kept potential suitors at bay. Now, Ultra Petroleum represents one of the lowest-cost producers in the industry. And that makes it a hassle-free way for a suitor to add proven reserves and production. I don't expect it to remain independent much longer.

  • Colonial BancGroup Inc. (CNB): Investors were quick to bail out of this stock because of its focus on real estate lending in Florida. Ironically, Colonial dropped no subprime bombs to spark the sell-off. And after a thorough review of the company's financials, it comes up clean. Thanks to strict underwriting discipline, Colonial stopped lending into the overheated Miami condo market almost four years ago. Such foresight wasn't a coincidence. Management consistently demonstrates terrific acumen, and is an excellent judge of its local markets. A net charge-off level equivalent to only 0.25% of total loans for the past 10 years proves it. Put simply, Colonial is a classic case of "guilt by association," with investors throwing out the good with the bad - all in the name of "risk management." Colonial is an attractive buyout candidate because it represents an easy way to capture the wealth migration of U.S. banking assets into the Southeast, which we're seeing as more baby boomers retire there. Plus, Chairman and CEO Robert E. Lowder is nearing retirement age. With a 4.4% stake in the company, it's highly likely that he wouldn't mind dramatically boosting the value of his retirement package with a sale of the bank.

  • Genzyme Corp. (GENZ). Major pharmaceutical companies now embrace acquisitions as the easiest way to grow. And Genzyme represents an attractive asset. It focuses on rare diseases - a niche that lends itself to less competition and higher margins. Plus, many of Genzyme's drugs possess the ability to treat multiple diseases. And sales for its current drug lineup continue to accelerate. Not to be overlooked, of course, is its loaded pipeline, which includes several drugs in late-stage development, including the oncology drug, Mozobil. It has also worked to extract as much value as possible from its product portfolio by establishing key partnerships. In short, there's a lot of built-in value just waiting to be unlocked and released - enough, in fact, to pique the interest of billionaire activist investor Carl Icahn. And given his track record in the space, specifically with Maryland biotech, MedImmune Inc., a takeover of Genzyme shouldn't be far off.

  • Duff & Phelps (DUF) is a different kind of M&A play. It's neither a target nor a buyer. Instead, it's a firm that provides advice and services for M&A, restructuring, litigation and disputes. Buying corporations are already rolling the dice sweeping up assets in a gloomy market, and advisory firms like Duff & Phelps analyze whether a buyout or merger is economically feasible... for a fee, of course. "To capture this in layman's terms, we all know there's a push for greater transparency - for corporations, private equity shops, hedge funds, you name it," Basenese said. "Duff simply provides the services necessary to make such transparency a reality."

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