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.

With PE deals having sharply receded in last year’s second half, strategic buyers may find a relatively open field for deals that advance the consolidation of their industries. Globally, Gell finds the regulatory environment more conducive to allowing such combinations, with antitrust concerns fading somewhat. And, he notes, industry-consolidating deals tend to generate substantial cost savings.

Certainly, global consolidation has been a theme in the natural resources sector. Fueled by an insatiable demand in China for raw materials, a range of commodities are now trading at all-time high prices. As 2007 ended, the world’s biggest M&A drama involved Australian mining concern BHP Billiton’s hostile $140 billion bid for London-based Rio Tinto, which itself had snapped up Canadian aluminum-maker Alcan for $43 billion during the year. (Experts suggest, by the way, that the larger the size differential between buyer and seller, the more the potential cost savings, but the harder the integration. That would augur less well for a BHP-Rio transaction, because the two companies have market caps of $206 billion and $136 billion, respectively.)

As 2008 unfolds, bankers also see more consolidation ahead for energy, financial, health care, information technology, and consumer-products companies. And much of it could involve overseas companies buying U.S. firms. “With the dollar down and the euro up, many of the large European players think power plants in Europe are overvalued. They see opportunity in the U.S.,” says Dean Maschoff, vice president at CRA International’s energy and environmental practice. Foreign acquirers like Iberdrola likely will compete with private-equity competitors for deals, he says.

For now, private-equity players are hampered by overhang of unsold LBO debt, which in addition to the weak credit markets is keeping them on the sidelines. If private buyers do regain their strength, they could target the utilities sector. Last year’s $44.4 billion purchase of Texas utility TXU by a Goldman Sachs–led investor group proved that such deals can be successful — if the buyer engages in early negotiations with legislators and environmental groups to bridge any divides that arise. Private buyers are likely to remain keenly interested. Indeed, private equity’s war chest is still enormous, at about $250 billion, according to some estimates.

In the near term, though, strategic buyers will continue to face less competition from financial players for targets, even if the amount of foreign money flooding into U.S. deals increases. Last year’s retreat by private equity was dramatic indeed. Because private investors left the field, deal volume fell 68 percent in the third quarter compared with the second quarter. But select fourth-quarter deals like IBM’s $5 billion purchase of Cognos suggested a renewed interest in software consolidation among cash-rich acquirers, and could kick off similar deals.

Says PwC’s Filek: “Sophisticated corporate buyers see this as a relatively limited time frame, when there are probably fewer competitors for properties, and they can make sensible, strategic acquisitions.”

Avital Louria Hahn is a senior editor at CFO.

Breaking Up Was Easy to Do

If private-equity buyers seemed to attack their acquisition prey with abandon as 2007 began, the midyear retreat from the market revealed evidence of a distinctly more cautious side: the low “reverse” breakup fees they wrote into their deals.

When Cerberus Capital Management withdrew its $4 billion buyout bid for United Rentals, for example, the target lost 37 percent of its stock value. Cerberus, meanwhile, was tagged with a $100 million fee that was a mere 2.5 percent of the deal’s value. If J.C. Flowers & Co. and the private-equity group it leads are allowed to withdraw from their deal with SLM Corp., as the private-equity firms propose, their payment to the Sallie Mae college lending operation would be $900 million — representing less than 4 percent of that $25 billion transaction. In the months after the bidders said they wanted to pull out, SLM lost 36 percent of its market capitalization.

The low breakup fees to the jilted target — called “reverse” because the normal fee is designed to remunerate the suitor when a target withdraws — were designed that way to allow an easy escape for conservative private-equity players.

But unhappy targets may have learned from these expensive withdrawals. Going forward, “reverse breakup fees may be larger because there is more downside for the public company to not get acquired than [for] the buyer being topped,” says Lee LeBrun, co-head of M&A, Americas, at UBS. — A.L.H.

To see a list of the top 20 deals of 2007 that targeted U.S. companies, click here.

U.S. M&A approaches record levels, 1998–2007

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