Soft in the Middle

While blockbusters abound, the next tier of deals shrinks a bit. That could be a good thing.

The headlines leave little doubt that multibillion-dollar U.S. mergers and acquisitions are back, led in the first months of 2005 by the sale of Unocal to ChevronTexaco, May Department Stores to Federated Department Stores, MCI to Verizon, and Storage Technology to Sun Microsystems. Mix in private-equity deals for giants like SunGard Data Systems and Toys “R” Us, and predictions for a third straight annual rise in deal flow seem solid.

Except for one thing: both the number and overall value of acquisitions below $1 billion — the vast middle market — have slipped, knocking the total count of domestic acquisitions off by more than 8 percent, according to a tally through April 30 by Thomson Financial and Robert W. Baird & Co.

Does this softness suggest that, beneath the blockbusters, the structural basis for an extended M&A upturn has yet to develop? That well could be, says Peter Falvey, co-founder of Boston-based Revolution Partners, a four-year-old investment-banking boutique that specializes in midmarket technology mergers. “The economy is a little stagnant and the stock market is meandering somewhat,” he says, while concerns linger about the additional responsibilities that Sarbanes-Oxley brings to acquirers. “People are very cautious, and I don’t think many smaller companies are superaggressive in feeling that now is the time to grow through acquisition.”

But Alan Alpert, a managing partner at Deloitte Tax LLP, sees the recent middle-market slide as something of an aberration. “I would consider the middle market to be strong, even if it’s not growing quite as much as it was in 2003 and 2004,” he says. Alpert expects an uptick later this year. “Acquirers start selling off pieces, and that could generate deal flow down the line,” he says. Under that scenario, more caution in doing deals is a healthy development.

If middle-market deals do bounce back, the software industry is likely to lead the way, acknowledges Falvey, noting that Oracle Corp.’s purchase of PeopleSoft is already stirring new pressure for consolidation. “In technology, the market has matured a bit,” he says, “and to justify higher multiples and market caps, you’re going to have to use M&A as a strategic weapon.” Software has remained the busiest area for M&A, according to consultancy FactSet Mergerstat LLC, even though software is among the 34 sectors for which middle-market activity has slipped so far this year.

A Charming Acquisition

This cautious, strategic brand of middle-market deal-making is hardly limited to technology, though, as the experience of Charming Shoppes Inc. shows.

The parent of Lane Bryant and other women’s “plus-size” specialty stores announced a $218 million cash acquisition of the Crosstown Traders catalog operation on May 19 from private-equity firm JPMorgan Partners. Morgan had pieced Crosstown together around the Federated mail-order properties that Morgan acquired in 2002. Charming’s acquisition of Crosstown marks its first move into catalogs, and allows it to initiate a “tri-channel mode” of online, catalog, and in-store selling that Charming sees as a key to its future.

At the same time, says Steven R. Wishner, senior vice president of treasury, investor relations, and business development, Charming will be able to leverage its 29 million–person database in mail-order business beyond the plus-size apparel market. Further, the mail-order acquisition prepares the company for the 2007 exercise of its option to buy the Lane Bryant catalog, which wasn’t part of Charming’s 2001 purchase of Lane Bryant.

Why make the Crosstown deal now? The economy was right, answers Wishner. Also, Charming had “fully digested” its Lane Bryant acquisition and was ready for new ventures, he says. With the addition of Crosstown Traders, “we are now back in the mode of accelerating our growth, but in a strategic, well-defined way,” including through possible acquisitions of smaller retailers, says Wishner. Charming’s stock has climbed since the Crosstown acquisition, which he says did not surprise the management team, because “the synergies were so compelling.”

One lesson the deal taught him, though, is not to expect a lot of publicity in an era of big-deal domination. Charming’s announcement came the same day the proposed US Airways Group-America West merger was reported. As a result, says Wishner, “they got top billing, and we didn’t even get a mention.”

Roy Harris is senior editor of CFO.

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