Investing

A Renaissance for Big Acquisitions

A large part of the money that was made by banks and investment banks from 2004 through most of 2007 was made from mergers and acquisitions. When the credit markets fell apart, the financing for these deals disappeared. Then the economy got so bad that buying companies became secondary to staying in business through the downturn

A few very large deals have been done recently. Most were first proposed several months ago. They were likely to work because they were what investment bankers call “strategic.” Usually that means that the two companies involved are in the same business. They see “synergies” which involve things like taking the R&D geniuses from the acquiring company and putting them in the same room with their counterparts from the firm being acquired. Working together may set off the creative sparks that drive new discoveries. Or, they may not. The real but hidden definition of the word “synergy” is firing lots of people. The recently closed marriage between Dow Chemical (DOW) and Rohm and Haas (ROH) was about firing people. Pfizer (PFE) bought drug company Wyeth (WYE) for the same reason. Being in the pharmaceuticals business is not what it used to be. Blockbuster drugs face competition. Keeping hundreds of research scientists around is expensive.

Roche recently bought Genentech (DNA), a company in which it was already the largest shareholder. That deal was not just about firing. Biotech operations like Genentech are the next generation of pharma companies. Roche wants in on that action. It had the tremendous advantage of only having to buy part of the shares in Genentech. Aside from getting customers and new products, Roche got control of the whole company and merely had to acquire 44% of the shares.

M&A may be coming back. Not the kind of M&A that is about firing but the kind where the excuse for the buyout is more positive than layoffs. And, the impetus for the move up in M&A activity is probably that the stock market has been going higher recently.

IBM (IBM) is in talks to buy server company Sun (JAVA). Sun has had a difficult time making it all alone. It sits in fourth or fifth place in terms of market share. Giants like Hewlett-Packard (HPQ) top that list. Sun has no chance of ever making it to one of the top three spots. The company has already fired thousands of people, so it is lean, maybe too lean to grow. IBM has been watching Hewlett-Packard become a more formidable competitor. And, Cisco (CSCO) recently said it would get into the high-end server business. The number of huge companies that want a piece of IBM’s business seems to be growing.  IBM gets new technology by buying Sun, but, more importantly, it gets Sun’s market share.

Sun’s stock is way down. Before the rumor about an IBM deal hit the news, Sun traded at $5, less than a third of its 52-week high. What was lost in the commotion about the buyout was that Sun’s shares had moved from $3.84 to $5 in just six trading days. Most of that increase was due to the rally in the overall market. And, if the market keeps going up, the price of potential acquisitions is going to get more expensive, even if the underlying businesses of the targets has not changed.

Companies that want to get bigger or round out their portfolios of businesses have probably been on the phone with their investment bankers in the last two weeks. It may be the first time that some bankers have gotten a client call in a year. There is a rush to look at targets now, because if the market moves up another 10% or 15%, a lot of companies that were cheap will get expensive.

Time Warner (TWX) may not be planning to buy CBS (CBS), although it would make some sense. If a deal like that was on Time Warner’s mind, CBS has gotten 29% more expensive in the last five days. If Exxon Mobil (XOM) wants to buy Chevron (CVX), the price is up 9% in five days.

Cheap is getting expensive. The environment for M&A may not be as safe as it was two years ago, but the targets have begun to cost more.

Douglas A. McIntyre