For those rooting for a revival of buyout activity, the merger of the two pharmaceutical giants, announced Jan. 26, showed that corporate dealmakers are still on the prowl and the financing is still available for some big transactions.
But the Pfizer-Wyeth merger is also a unique case. The M&A market has become moribund, with deal volumes battered by first the credit crunch and then a sharp slowdown in the economy.
Credit is Still an Issue
Most bankers and M&A experts expect the recession to eventually spark waves of consolidation in many industries. Weakened companies will need buyers to survive, while strong firms will take advantage of low stock market valuations to buy troubled rivals at discounts.
But a revival in M&A won't be simple or easy. First, there is the credit issue. Banks and other lenders have made it tough to finance deals, making loans, especially for big deals, scarce and more expensive.
Pfizer did get promises of $22.5 billion in financing for its Wyeth buyout, but other firms are unlikely to get the same financing terms. Pfizer, a company with strong cash flow and lots of cash on its balance sheet, was likely seen as a good credit risk. The drug company has a rare, stellar "AAA" credit rating from Standard & Poor's—even if, after news of the merger broke, S&P placed Pfizer's rating under review "with negative implications."
Looking for Stability
Furthermore, says Howard Lanser, an investment banker at R.W. Baird, lenders are favoring "sectors where there is the most stability" in earnings and revenue outlooks. Health-care stocks like Pfizer fall into this category, as do some education and technology firms, Lanser says. But others such as retail don't.
Most of the Wyeth deal is being funded by cash and Pfizer stock. That will be a common trend in 2009, as even buyers with financial strength must make acquisitions with less debt than in the past, says Mark DeGennaro, managing director at investment bank Gruppo, Levey & Co.
A second barrier to a revival in M&A is fear. Firms are storing up cash, holding onto it as insurance against a nasty economic downturn. "It takes a little courage to step forward and pursue M&A in this environment," Lanser says. "To spend that cash can be a big psychological hurdle."
Betting on the Future
Amid a broad economic slowdown, no sector or industry is immune from these worries. "Who is left standing that is so comfortable that their boards and CEOs are willing to take a risk and do an acquisition?" asks David Stone, a lead partner in the corporate and securities practice at the law firm Neal Gerber Eisenberg. "You're seeing a lot of risk-aversion."
An M&A move is a bet on the future, and it's hard to make those bets when the outlook is so cloudy. "Everybody is trying to figure out what the new economic order is going to be," says Steven Blumreich, president of BKD Corporate Finance.
In such a gloomy environment, what will persuade dealmakers to take risks on M&A bids? Ironically, the recession and credit crunch—the very things constraining M&A activity for the time being—could spark a revival in M&A in the future.
Driven by Necessity
Tough times can make companies desperate. Outfits with falling sales figures and credit trouble may have no choice but to find buyers—often at very low prices, says DeGennaro. "There is going to be a need for a lot of companies to consolidate to survive," he says.
Other companies may be forced to repair balance sheets by selling off assets or profitable divisions, says independent market strategist Doug Peta.
While M&A may revive out of sheer necessity, it will be a buyers' market, Peta says. Typically, buyouts offer stockholders a premium to the target company's current share price. But Peta expects more "take-unders"—deals where the bid is less than shares are priced in the market.
Retail Will be Hard Hit
Bankers say that, eventually, this sort of environment will force buyers back into the M&A market. Some buyers will be trying to solve their own problems through acquisitions. Analysts say one reason Pfizer is buying Wyeth is its concerns about the expiration of drug patents.
Strategic buyers make "buy vs. build decisions," Lanser says. Companies may want to expand into new markets, exploit new technologies, or develop new products. In this environment—with the stock market way off 2007 peaks—it is often much cheaper to accomplish those goals by buying out a rival than by doing them yourself.
Not every firm will find a buyer. Retail may be the hardest hit, as consumers slow their spending. "That's a sector that is really in free fall," says DeGennaro. "There is way too much supply for demand in the foreseeable future." For example, bankrupt electronics retailer Circuit City failed to find an acquirer and was forced to liquidate its U.S. stores this month.
Getting to the Right Price
When the revival in M&A activity actually does occur, it could be swift. That's been the experience after previous recessions of Hiter Harris, co-founder of investment bank Harris Williams & Co.. "When the green light comes on, there's a lot of volume waiting to happen," he says. "When it comes back, it comes back with a vengeance."
But when will that be? The first hurdle for the M&A activity to clear is a revival in credit conditions. Pfizer's $22.5 billion in financing provides some hope.
But the second may be trickier: Getting to the right price. Buyers and sellers must agree on valuations for firms with difficult prospects in an uncertain economy. "It all comes down to when acquirers feel like they're getting a good enough deal," Peta says. "It's a game of chicken between a distressed seller and a buyer that isn't necessarily in a hurry."
Watching and Waiting
Occasionally, a buyer like Pfizer will be in a rush to make an acquisition, to assure investors that its future plans are on track. But for now, potential buyers have the luxury of watching and waiting for better deals.
Steverman is a reporter for BusinessWeek's Investing channel.