Companies are paying record premiums on takeovers, a sign execs are growing more bullish about profits and stocks
By Rita Nazareth
(Bloomberg) — American companies are paying the biggest premiums on record in takeovers, a sign executives are growing more bullish about profits and stocks even after the biggest rally for the Standard & Poor's 500 Index in 73 years.
When Dell (DELL) agreed to buy Perot Systems Corp. for $3.9 billion in September, it offered 77 percent more than company's stock price during the 20 days before the deal was announced. Xerox Corp. paid 38 percent more than market value when it purchased Affiliated Computer Services Inc. for $5.8 billion. The average premium in mergers and acquisitions in which U.S. companies were the buyer and seller rose to 56 percent this year from 47 percent last year, data compiled by Bloomberg show.
Chief executive officers are so sure the economy will keep recovering they're agreeing to prices that are 37 percent higher than the average since 2001, when Bloomberg started compiling data. While stocks in the S&P 500 are trading at the most expensive valuations in seven years compared with profits in the last 12 months, buyers are looking out to 2011, when analysts say earnings will have risen 52 percent.
"M&A activity is a sign of confidence in the future of the country," said Bill Gerber, chief financial officer at Omaha, Nebraska-based online brokerage TD Ameritrade Holding Corp. "Companies have to look two, three, four, five years ahead."
Adding to Earnings
TD Ameritrade acquired Thinkorswim Group Inc., a New York options brokerage, in January for $606 million, paying a 48 percent premium. The company will add 3 percent to 7 percent to profits during the fiscal year ending in September, Gerber said.
The price-earnings ratio on U.S. equities climbed as the S&P 500 surged 63 percent from a 12-year low on March 9, pushing its annual return in 2009 to 22 percent, the biggest since 2003. The index slipped 0.4 percent last week after New York-based bank Citigroup (C) sold shares at a discount and investors speculated Federal Reserve Chairman Ben S. Bernanke is preparing to raise interest rates in 2010. The measure added 0.9 percent at 9:33 a.m. in New York today.
Higher takeover premiums may help drive gains in the stock market. A Deutsche Bank AG index of potential U.S. targets has advanced almost seven times more than the S&P 500 since Dubai's debt crisis roiled global markets last month.
Driving the Rally
The total value of deals involving U.S. buyers and sellers has plunged 57 percent from its all-time high three years ago to $306.9 billion in 2009, data compiled by Bloomberg show. Record M&A in 2006 helped drive the S&P 500 up 17 percent between mid- June and mid-December, part of a five-year rally in which the index doubled to a record 1,565.15 in October 2007. The measure finished last week at 1,102.47, rebounding from 676.53 in March.
Takeovers picked up this year after the price of corporate assets fell to the lowest level since at least 1994 in March and the financial crisis eased.
S&P 500 companies traded for 1.52 times book value, or assets minus liabilities, on March 9 and now cost 2.22 times, still cheaper than the day before New York-based Lehman Brothers Holdings Inc. collapsed in September 2008, according to data compiled by Bloomberg.
Executives say they're finding bargains based on projected earnings. Analysts predict per-share income for companies in the S&P 500 will jump to $94.98 a share in 2011 from $62.52 this year, according to the average estimates in a Bloomberg survey.
Once Since 1990
While the S&P 500 trades for 22.2 times its companies' profits over the last 12 months, the price-earnings ratio falls to 11.6 when measured against analysts' 2011 forecast, according to data compiled by Bloomberg. The multiple using reported profit has fallen to that level once since 1990, in March 2009 on concern $1.7 trillion in bank losses and writedowns would spur a global depression, data compiled by Bloomberg show.
Dell acquired Perot to expand in the market for health-care information technology. The takeover gave Round Rock, Texas- based Dell a partner to boost sales of computer services as companies reduce PC purchases.
The second-largest personal-computer maker agreed to pay $30 a share in cash for Plano, Texas-based Perot, whose stock had already jumped 31 percent in 2009. It valued the company at 29 times the average analyst projection for 2010 profit.
Dell, whose shares have dropped 18 percent since the deal was announced, paid twice as much relative to sales as Hewlett- Packard Co., the biggest personal-computer maker, gave shareholders of Electronic Data Systems Corp. in its takeover last year, data compiled by Bloomberg show.
'A Little More'
The $13 billion price Palo Alto, California-based Hewlet-Packard (HPQ) agreed to was about half EDS's annual revenue, compared with the 1.4 times sales that Dell offered, according to data compiled by Bloomberg. Hewlett-Packard has gained 10 percent since the takeover was announced in May 2008, compared with a 6.4 percent retreat for computer companies in the S&P 500.
"Given historical acquisitions we've seen in terms of H-P, what they paid for EDS based on revenues, it just seems like you're paying a little more," JPMorgan Chase & Co. analyst Mark Moskowitz said on a conference call with Dell's management after the buyout was announced.
The transaction will start adding to earnings in the fiscal year that begins in February 2011, the company projects.
"Our investors have to trust that we'll manage those decisions effectively," Dell Chief Financial Officer Brian Gladden said in a Dec. 16 interview. "There may be other cases where we have to pay what would be considered above-market premiums for special assets. I would put Perot in that bucket."
Shift to Services
Xerox, in Norwalk, Connecticut, agreed to pay $63.11 a share in cash and stock for Affiliated Computer in September to shift to technology services as sales of printing equipment drop. Dallas-based Affiliated Computer trades at 12.8 times projected 2010 earnings.
Shares of Xerox, the largest maker of high-speed color printers, have fallen 7.2 percent since the purchase announcement. Xerox is paying 0.96 times ACS's annual sales. When Armonk, New York-based International Business Machines Corp. bought PricewaterhouseCoopers LLP's business-consulting unit for $3.5 billion in 2002, it paid 0.7 times revenue.
IBM has advanced 78 percent since the takeover was announced in July 2002, compared with a 61 percent gain for a gauge of technology companies in the S&P 500.
'We Don't Overpay'
"We don't overpay for any properties," Larry Zimmerman, chief financial officer at Xerox, said in an interview on Dec. 16. "The discussion you have with shareholders is that not only are you more competitive, not only do you have a stronger business model, the returns for the longer-term shareholder are going to be better than if you didn't do it."
Cheap valuations aren't enough to spur mergers and acquisitions, according to Sanford C. Bernstein & Co.'s Brad Hintz, a New York-based securities-industry analyst who was CFO at Lehman Brothers a decade ago. Gross domestic product growth and confidence in the economy are also necessary, he said.
"What's the easiest way for a CEO to lose his job?" he said. "He does a bad M&A deal. You see M&A activity picking up when the markets become more attractive with the likelihood that if I buy a company today, an improving economic environment will help that acquisition."
Economists say U.S. GDP will rise 2.6 percent in 2010 after shrinking 2.5 percent this year, according to the median forecasts in a Bloomberg survey. Confidence in the world economy held near a record high this month as reports showed the U.S. recovery is gaining momentum and more banks repaid government bailout funds, according to a survey of Bloomberg users on six continents.
Buffett's 'All-In Wager'
Warren Buffett is so confident about U.S. growth prospects that the controlling shareholder of Omaha, Nebraska-based Berkshire Hathaway (BRKA) agreed in November to pay $26 billion for the 77.4 percent of Fort Worth, Texas-based Burlington Northern Santa Fe Corp. his company didn't already own.
Buffett, the world's most successful investor, paid 23 percent more than the railroad's stock price during the preceding 20 days in an "all-in wager on the economic future of the United States."
Takeovers increase the value of shareholders' stakes 30 percent to 55 percent of the time, according to a 2003 review by Paul A. Pautler of the U.S. Federal Trade Commission's Bureau of Economics. Although deals may cut costs for the combined company, they erase value when buyers pay too much, he said.
Mergers may rise 35 percent in 2010 and 23 percent in 2011, according to Sanford C. Bernstein. The forecast is based on an analysis using data since 1980 that incorporates growth in GDP, corporate earnings and commercial loan volume, which it said are about 72 percent correlated to takeovers.
"M&A is back," said James Paulsen, who helps oversee about $375 billion as chief investment strategist at Wells Capital Management in Minneapolis. "It shows improving confidence as companies are willing to pay up to get those deals done. It also reflects the strong liquidity position in corporate America right now, which is a positive for future growth in equity values."
To contact the reporter on this story: Rita Nazareth in New York at firstname.lastname@example.org.