Going Fishing for Cheap Companies


In recent weeks, there has been a flurry of high-profile acquisitions. Warren E. Buffett snapped up distressed assets in the energy sector. Texas Pacific Group, a takeover giant, announced it was leading the acquisition of Burger King (DEO). Then, a deal that caught everyone's attention: IBM's July 30 announcement that it would buy PwC Consulting for $3.5 billion. Gregory D. Brenneman, the man PricewaterhouseCoopers brought in to sell its consulting arm, says the time was right -- for both IBM (IBM) and PwC. In the 1990s, "clearly you had some major-league dope smoking, [with] multiples you just couldn't explain," he says. Now, "market values are coming down to reality."

As a result, the bottom-fishers are starting to troll. Cash-rich companies such as IBM are looking to plug holes in their businesses. Private equity firms, many of which have sat on the sidelines for the past 18 months, seem to be gearing up for action, too. Morgan Stanley estimates that such outfits have $125 billion at their disposal and some are beginning to spend it. Beaten-down stock prices also have some companies, such as Charter Communications (CHTR), pondering whether they would be better off taking themselves private -- and off the market. "The field is wide open," says Stephen A. Schwarzman, president and CEO of the Blackstone Group, an investment bank with $14.5 billion for private-equity investments.

To be sure, no one is predicting a full-fledged rebound in mergers and acquisitions -- certainly nothing close to the frenzied levels of 2000. In all, some 3,849 U.S. companies have announced M&A deals this year, worth $296 billion, according to Thomson Financial/First Call. By comparison, there were some 5,048 deals

announced, worth $497 billion, in the same period last year, and far more in 2000. "There's a steady, though much-diminished, flow of deals," says Jack Levy, co-chairman of M&A at Goldman, Sachs & Co. in New York. "It is by no means an avalanche, and there is no prospect of that happening soon."

REAL VALUE? Indeed, it is not yet clear whether the current round of dealmaking has legs. With the economy flailing, many corporate executives and leveraged-buyout chieftains are taking a wait-and-see attitude. Even those who have taken the plunge say they aren't sure if the economy and the market for corporate assets have hit bottom. In the prevailing environment, says Jim Coulter, a partner at Texas Pacific, would-be buyers

require "intestinal fortitude."

Still, the conditions have improved enough that many are willing to take a look for the first time in a while. For starters, sellers have finally gotten real about what their companies will fetch. In the past 18 months, Francisco Partners, the nation's largest tech-focused buyout firm, didn't even bother to go shopping. Not anymore. Thanks to more reasonable prices, Francisco has done three deals in the past month,

including paying $800 million for General Electric Co.'s (GE) electronic-data division.

With prices coming back down to earth, some companies are gambling that buying strategic assets will put them in a good position if the economy rebounds next year. IBM is a case in point. The PwC Consulting deal made little sense at $18 billion, the price in stock that Hewlett-Packard Co. (HPQ) broached in late 2000. But it's a golden opportunity for IBM at the current cash-and-stock price. Such

"bolt-on" deals are aimed at filling holes in a company's core businesses, a far cry from the growth-at-any-cost takeovers that were the hallmark of, say, Tyco International Ltd. (TYC) and WorldCom Inc. in the late 1990s.

READY TO POUNCE. Even in the battered telecom sector, cash-rich companies think things may have fallen far enough to begin snapping up distressed assets. Level 3 Communications Inc. (LVLT), shored up with a $500 million investment from Buffett and others, has been bottom-fishing. Earlier this year, CEO James Q. Crowe paid $200 million for two software companies that will attract new customers interested in digital delivery of software. Now, Level 3 is looking into buying network units of such bankrupt competitors as WorldCom and Teleglobe Inc. on the cheap. It's also eyeing the pipelines of such distressed telecoms as Qwest Communications International Inc. (Q) and Genuity Inc., according to Vik Grover, a telecom analyst at Kaufman Brothers LP.

For private equity firms, the calculation is somewhat different from the method used at their corporate counterparts. While the likes of Kohlberg Kravis Roberts & Co. and Bain Capital have amassed massive war chests, they continue for the most part to tread carefully. These firms are not looking for strategic assets to fill holes as much as cheap companies they can restructure and sell at a profit. That means the price must be sufficiently low.

Some buyout firms -- even those attached to publicly traded banks -- have begun to pounce on distressed assets. One Equity Partners, which manages $3.5 billion in capital for Bank One Corp. (ONE), has been on a tear lately, for example. It paid just $255 million on July 31 to help buy Polaroid Corp. out of bankruptcy, a price so low that Derek Jarrett, a former vice-president for international operations at Polaroid, says he was "horrified" at the sale. One Equity Partners, trolling for

more such bargains, declined to comment.

BAD PRECEDENTS. Still, many of these firms believe the bottom is a ways off. Even if the economy improves, many analysts figure the big private equity firms won't plunge in until next year. "It's a difficult market because of a fundamental lack of confidence," says John R. Willis, managing partner at Willis Stein & Partners, a $3 billion leveraged buyout firm in Chicago.

Indeed, the question now is whether the flurry of deals will keep gathering speed. Even if asset prices continue to soften, other factors could make it tough to complete some deals. In the troubled telecom and energy sectors, worries over accounting, regulatory challenges, and the possibility that legal liabilities would be transferred to new owners are casting a pall over the sale of assets. Just ask Qwest. The company is desperate to sell its $1.6 billion-a-year Yellow Pages unit to help it pare back $26.5 billion in debt. But ever since Qwest revealed that the sale would require regulatory approval in four states, buyers have melted away.

At the same time, the failure of acquisition-fueled growth strategies of such '90s players as Tyco and WorldCom have made many execs queasy. "Today, you get whacked on Wall Street if you announce a large acquisition," says Mark A. Ernst, CEO of H&R Block Inc. (HRB), which is adopting the "lower-risk proposition" of buying back its own shares. Indeed, Gregg Polle, managing director and co-head of the M&A Group at Salomon Smith Barney, argues that "company-defining" deals will be avoided until their stock prices rise and until target companies get through the next audit cycle, perhaps by next spring.

Still, for those with cash, the moment to go shopping may be approaching. "This is a terrific time to have liquidity," says Rodney L. Goldstein, managing partner of the $600 million Frontenac Co. equity firm in Chicago. "In the third and fourth quarters, we're going to see a material upturn in acquisition activity." Nestle (NSRGY) certainly thinks the time is ripe. On Aug. 6, it announced it would buy Chef America Inc., maker of Hot Pockets frozen sandwiches, for $2.7 billion. Like IBM, Nestle clearly felt this was an opportunity it couldn't pass up. By Joseph Weber in Chicago, with Emily Thornton in New York, Linda Himelstein and Jim Kerstetter in San Mateo, Calif., Wendy Zellner in Dallas, Roger O. Crockett in Chicago, and bureau reports


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