Lessons from Adversity

The split personality of 2007 dealmaking, with its dramatic highs and lows, could teach a few things about M&A in the year ahead.

When London-based National Grid agreed in 2006 to a $12 billion deal for East Coast energy giant KeySpan, National Grid CFO Steve Lucas couldn’t have known that lending markets would collapse in mid-2007 — just a few months before his merger closed. But the design of the terms proved so prescient that he could be credited with a hint of omniscience.

As a hedge against the evaporation of then-prevailing easy credit, Lucas skipped the customary financing for such all-cash deals, which involves using bank credit facilities and issuing long-term debt to pay them off after the close. Instead, National Grid issued $7.5 billion in bonds ahead of time. “Not only did we minimize our risk, we also saved a ton of money,” says Lucas, estimating that between $300 million and $500 million was sliced from its interest rates and bank fees. Even now, he adds, “National Grid would like to do further value-enhancing deals in the U.S.”

Of course, deals did unravel — something that was sure to happen as the M&A landscape took acquirers “from Goldilocks to The Perfect Storm,” in the words of Lee LeBrun, co-head of M&A in the Americas at UBS Securities. If the confluence of problems started with the subprime-mortgage crisis and resulting tumble in credit availability, he says, the stock-market correction and the plunge in the dollar’s value quickly compounded the problem.

But in some ways the experience of buyers during the challenging 2007 M&A market — superheated at first, then severely chilled at midyear — bolsters the argument that many companies are doing deals better even as they face adversity. Through November, U.S. deals approached $1.5 trillion, leading some experts to suggest that when the economy slips, companies step up the quality of dealmaking. That could augur well.

“What we tend to see with the M&A market is higher returns for deals done in down markets,” says Jeff Gell, co-head of M&A for The Boston Consulting Group (BCG). Even LeBrun expects overall deal activity to fall less than 20 percent from last year, mostly reflecting the squeeze on private equity that won’t ease until the more than $200 billion in leveraged-buyout debt is sold. The heightened activity by cash-paying U.S. strategic buyers will continue to be augmented, he says, by foreign investors drawn to the weak dollar.

Indeed, a recent UBS report declared: “The current M&A wave is far from over,” as cash-paying strategic buyers step up, replacing some of the dealmaking done last year by private-equity players.

The New Advisers

The volume achieved in such a tumultuous year confirms that M&A has become an accepted tool for corporate growth. Such acceptance may have been in doubt as recently as 2000, when the AOL/Time Warner miscalculations and WorldCom and Tyco International scandals, among others, gave acquisitiveness a bad rap.

With improvements in corporate governance, though, certain “serial shoppers” — General Electric, Cisco Systems, and Oracle among them — have enhanced their reputations for doing value-producing deals. And internationally, companies like National Grid, which counted KeySpan as its sixth U.S. acquisition since 1999, refined systems for valuing deals, completing them cost-efficiently and integrating targets effectively.

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