From Standard & Poor's Equity ResearchWith more than $630 billion in cash on the books of non-financial companies and utilities in the S&P 500, it's no wonder that share buybacks, dividend increases, and M&A activity have picked up in the past few years. Where might additional M&A activity come from? The most compelling comments I heard from S&P equity sector group heads concerned the Health Care and Information Technology segments.
Health Care: Robert Gold, who heads the sector group for S&P, says he and his team believe some investors will think interest in the health-care facilities group will be spurred by the proposed HCA (HCA
) leveraged buyout. He warns, however, that soft industry fundamentals will likely deter a flurry of activity.
Some of the private equity firms may become more aggressive due to the value in the facilities operators' real estate holdings, which could potentially be unlocked through sale/leasebacks or outright divestitures. Yet S&P believes any M&A activity in facilities would likely focus on small, one-off deals that add to an acquiring company's geographic focus.
S&P believes the medical device group will likely see some additional M&A activity, but here again it thinks deals will be small in nature, and focused on private companies with niche technologies in areas poised for growth, such as pain management, cardiology, specialized surgery, and oncology.
Orthopedics is probably the one area that could see some large deals emerge, due to recent shrinkage in key stock valuation measures, near-term pricing pressures, and favorable long-term demand drivers such as an aging, yet more active, population.
S&P also believes consolidation in biotechnology will probably occur, driven by rising cash hoards and a search for growth among the large-cap pharmaceutical names like Pfizer (PFE
; S&P investment rank 4 STARS, buy). S&P thinks deals will likely be focused on names with market caps around $10 billion and below, and expects that these companies will be very disciplined when exploring acquisitions.
Finally, S&P believes that M&A activity in the managed-care group will be minimal, since this segment has already consolidated to a large degree, and integration activities are continuing at most of the companies it follows. Still, S&P believes such regional players as Coventry (CVH
; 3 STARS, hold) and Humana (HUM
; 3 STARS) will eventually be absorbed by the larger HMOs. Some of the largest companies in the industry based on market capitalization and access to the financial markets include Aetna (AET
; 3 STARS), Cigna (CI
; 3 STARS), and UnitedHealth Group (UNH
; 4 STARS).
Information Technology: This sector has certainly seen its share of acquisitions. And more are on the way according to Scott Kessler, S&P IT sector group head. In semiconductors, since the analog segment is highly fragmented, S&P thinks small analog companies could be acquired by larger firms that are seeking veteran engineers.
The semiconductor equipment segment could experience consolidation in 2007 if an industry downturn begins, as S&P expects. Historically, this sub-industry has consolidated amid cyclical downturns.
In software, many smaller deals have been announced and completed. Acquisitions with sub-$500 million price tags, or of private point-solution vendors, will likely continue, in S&P's opinion. S&P believes Oracle (ORCL
; 4 STARS), which is a leading software consolidator, is largely finished, however, since the majority of the pieces needed to deliver on its Fusion platform are in place. Business intelligence could be a rich-target environment, with considerable overcapacity and rising competition. This can be broadly stated for software as a whole, in S&P's view.
The security software industry has been experiencing consolidation as customers are seeking all-in-one, best-of-breed security solutions from a single company. Currently, IT professionals use various software from several vendors to address security needs. This has complicated and cluttered security infrastructures at many companies.
Through acquisitions, security companies have begun diversifying their product portfolios by including various security technologies to simplify their customers' security systems. Furthermore, potential double-digit growth in the security market has attracted data storage, operating systems, and other software companies—some of which have already acquired security technology to complement their own products.
With the exception of Symantec (SYMC
; 3 STARS), which is undergoing a messy integration, in S&P's opinion, after acquiring Veritas, many security names are good targets for acquisition: Checkpoint Software (CHKP
; 3 STARS), Internet Security Systems (ISSX
; 3 STARS), McAfee (MFE
; 4 STARS), SonicWALL (SNWL
; 3 STARS), and Websense (WBSN
; 3 STARS). S&P thinks they have strong balance sheets, attractive share prices, and are leaders in their respective security technologies.
S&P sees many larger Internet companies focusing on Web 2.0 start-ups for technology, staffing, and unique offerings or brands. There has been talk that Microsoft (MSFT
; 5 STARS, strong buy) could be interested in Yahoo! (YHOO
; 3 STARS) or eBay (EBAY
; 5 STARS).
Given the recent share price declines in Yahoo and eBay, S&P thinks a takeover has become more possible. Yet Microsoft may be reluctant to commit additional cash for an acquisition after recently announcing $40 billion in stock buybacks. RealNetworks (RNWK
; 3 STARS) has a lot of cash, so it could play a role one way or the other.
So there you have it. The high level of M&A activity is likely to continue, according to S&P equity analysts, with many deals emanating from the Health Care and IT sectors.
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).