Magazine

Shake, Rattle, And Merge


Remember the urge to merge? Quelled since 2000, it's coming back. In the last quarter of 2004, deals for U.S. companies came at a trillion-dollar-a-year pace -- and more are in store. Companies are looking to mergers again to cut costs, boost efficiency, and extend their reach.

Although mergers dropped off starting in 2001 -- a victim of recession, corporate scandals, and a sluggish stock market -- the animal spirits have returned. The past month alone saw deals for Sprint (FON) to combine with Nextel (NXTL) for $39 billion, Johnson & Johnson (JNJ) to pay $25 billion for device maker Guidant (GDT), and Exelon (EXC) to acquire Public Service Enterprise Group (PKX) for $12 billion. And on Dec. 28, Blockbuster Inc., backed by financier Carl Icahn, threatened a hostile tender offer for No. 2 video-rental chain Hollywood Entertainment Corp. (HLYW).

DEAL GREASE

Behind the comeback: A robust economy and soaring corporate profits have boosted stock prices and cash. In other words, there's plenty of "deal grease" around. Other factors are at play, too. The weak dollar makes U.S. assets more inviting to foreigners. Stricter governance standards are forcing poorly performing CEOs and boards to entertain unwanted offers. And in a repeat of the 1990s, deals are spawning more deals as companies scramble to keep up in consolidating industries. While it's a good bet that at least some acquirers will overpay or make bad choices, few are holding back.

Little wonder that the rumor mill is spinning. There's talk SBC Communications (SBC) could buy BellSouth (BLS), uniting two giant Baby Bells; that a Chinese oil company like Sinopec might buy a U.S. energy outfit like Unocal (UCL); or that U.S. Steel (X) will be acquired by an Asian or European. The action could be fastest in cash-rich sectors such as tech, pharmaceuticals, and banking, says Jason Trennert, an analyst for International Strategy & Investment, a consulting firm.

Clearly, the rush is already on. There were $250 billion worth of mergers, including assumed debt, in the last three months of 2004. That brought the year's total to $809 billion, according to Thomson Financial (TOC). While a far cry from 1998 through 2000, when annual deal volume averaged $1.6 trillion, volume is up 49% over 2003. Execs at Lehman Brothers Inc. (LEH) and Bank of America Corp. (BAC) are prepping for a further 15% to 20% increase in 2005.

Partly driving the trend is deal psychology. One big merger in an industry tends to trigger more as companies scramble to stay a part of the pack. In steel, for example, "everybody's in play these days" in the wake of Mittal Steel Co.'s planned purchase of U.S.-based International Steel Group (ISG), says Karlis M. Kirsis, managing partner of World Steel Dynamics Inc., an information service in Englewood Cliffs, N.J. Even as U.S. Steel makes bids of its own, analysts say South Korea's Posco or Belgium's Arcelor might snap it up.

Consolidation is also on the table in utilities after Chicago-based Exelon Corp.'s Dec. 20 deal for Newark-based PSEG. "I think some of our colleagues will see this as a catalyst to make some negotiations come to fruition," says John W. Rowe, Exelon's chairman and CEO.

TELECOM TURMOIL

Nowhere is the urge to merge greater than in the once-fragmented telecom industry. In 2004, Cingular Wireless vaulted to No. 1 by buying AT&T Wireless Communications (AWE). Then Sprint agreed to buy Nextel to form a stronger No. 3. SBC Communications Inc. wants full ownership of Cingular, but BellSouth (BLS) isn't selling its 40%. So would SBC simply buy all of BellSouth? Says SBC COO Randall Stephenson: "I don't want to speculate, but who knows? This industry is going to continue to consolidate."

In financial services, too, big is beautiful. Bankers speculate that Citigroup (C), JP Morgan Chase (JPM), and Bank of America will keep shopping. Many also think someone, perhaps HSBC Holdings (HBC) PLC, may make a run at Bear Stearns Cos. The brokerage says it doesn't comment on market speculation. HSBC has said in the past it prefers to build up its own investment banking franchise.

In software, the motive for merger is to offer customers a fuller portfolio of products. So niche players are selling out to serial buyers -- like Oracle Corp. (ORCL), which snagged PeopleSoft Inc. (PSFT) after a long struggle, and security-software company Symantec Corp. (SYMC), which agreed in December to buy storage-software company Veritas Software Corp. (VRTS) for $13.5 billion.

Those deals raise questions about whether such Silicon Valley stalwarts as McAfee, BEA Systems (BEAS), and Siebel Systems (SEBL) are big enough to survive on their own. "This is going to be a big boys' game. They're going to move very aggressively and quickly," says Joseph M. Tucci, president and CEO of data-storage giant EMC Corp. (MC), which recently announced a $260 million cash deal for SMARTS Inc., a network-management software company. "The fast-moving, well-capitalized companies are going to be the winners in this round."

There's plenty of money for deals. The Standard & Poor's 500-stock index companies, including financial companies, have a record $2 trillion in cash and other short-term assets, according to S&P Compustat. Close to 60% of the U.S. deals in 2004 were paid for with cash, vs. around 35% in 2000, estimates Stefan M. Selig, vice-chairman of Banc of America Securities, the investment banking arm of Bank of America Corp.

Not all the cash is coming from corporate coffers, though. Hedge funds, which traditionally focused on short-term speculation, are getting into the act. Buyout shops are putting to work about $100 billion they raised in the late 1990s. And private investment funds such as Edward S. Lampert's $9 billion ESL Investments Inc. are picking up marquee companies. In November, Kmart Holding Corp. (KMRT), which was 53% owned by ESL, said it would buy Sears, Roebuck & Co. (S) for $11 billion.

With so much money to deploy, "some private equity guys are falling...all over themselves to get deals done," says Robert A. Profusek, a senior partner at the law firm Jones Day who advised Nextel Communications Inc. on its Sprint Corp. (FON) deal. "That could be where the action really is next year."

Not only are there tons of cash floating around, but the recent fall of the dollar makes U.S. assets look cheap for foreign investors. A Russian firm, Severstal, already has taken over a bankrupt U.S. steelmaker and is bidding for Canada's Stelco Inc., a big U.S. auto supplier. In banking, London-based HSBC Group and the Royal Bank of Scotland are seen as bidders. "We'll probably see more cross-border deals," says Wilbur L. Ross Jr., chairman and CEO of WL Ross & Co., a New York private investment bank. But the fit has to make sense. In Germany, potential buyers are still haunted by the poor results of Jürgen E. Schrempp's hasty merger of Daimler Benz with Chrysler Corp.

ACTIVE BOARDS

The shareholder rights movement, ignited by executive-suite scandals, also contributes to the rebound in M&A. Institutional Shareholder Services Inc. says that 66 companies repealed their staggered boards in 2004, and 25 eliminated poison pills. "What's happening is a reversal of all the work that started from the '70s, when companies adopted shark repellent and poison pills," says Michael E. Tennenbaum, senior managing partner of Tennenbaum Capital Partners, a private investment firm.

What's more, the legal environment for mergers has rarely been friendlier. Jeffrey N. Gordon, a Columbia University law professor, says the Oracle-PeopleSoft trial in Delaware Chancery Court likely unnerved corporate directors by making it clear that they could be forced to explain on the stand why poison pills and other defenses are good for shareholders. Also, judges in the Oracle case and in Arch Coal Inc.'s (ACI) purchase of rival Triton Coal disregarded as irrelevant some testimony from customers worried about postmerger price increases. That setback could rob trustbusters at the Justice Dept. and Federal Trade Commission of a crucial weapon in future cases.

Some investment bankers say the new deals will fare better than past ones because acquirers are paying smaller premiums. Managers and boards, under closer scrutiny, are less likely to overpay, says Jack Levy, co-chairman of mergers and acquisitions at Goldman, Sachs & Co. (GS) What's more, adds BofA's Selig, "People are quite chary about getting out of their areas of expertise" in the wake of late-'90s deals that flamed out.

Then again, that's the reassuring stuff that people always say early in a merger boom. As M&A gets going, takeover premiums could rise as vows of caution get thrown to the wind. Still, whether the merger surge ends well or badly, there's little doubt that it will be a busy 2005.

By Peter Coy and Emily Thornton in New York, with Michael Arndt in Chicago, Brian Grow in Atlanta, and Andrew Park


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