January 31, 2005--A strong economy, rising stock prices and stockpiles of cash fueled mergers and acquisitions worth more than $800 billion last year. Similar factors exist this year, leading many to be bullish about 2005.
During the height of the late-90s tech-boom, merger activity averaged $1.6 trillion a year; companies were virtually buying one another with inflated pieces of paper. After the bubble-burst of 2000, however, the urge to merge subsided. Then things got worse. The nation was attacked and corporate malfeasance ran amok. Stocks, in reaction to these events, plummeted-- between 2000 and 2004, the Dow, the S&P 500 and the NASDAQ fell 9%, 25% and 109% respectively. Merger transactions, which are correlated to the stock market, fell as a result. In 2003, for example, there were $570 billion worth of mergers, a third of the activity three years earlier, according to Thomson Financial.
But those dark days had their dawn last year. U.S. merger activity reached $833 billion in 2004, up 46% from the year before, according to Thomson Financial.
Leading the resurgence was the growing stock market, said Lawrence J. White, an economics professor at New York University. Last year, the Dow rose 3.15% and the S&P 500 gained 9%, thanks to a robust economy and soaring corporate profits. Because of the merger-bust, added White, "we had a bunch of itchy CEO's eager to go out and buy up other companies."
Adding to the activity was the need to remain competitive. Historically, mergers beget mergers, and this was certainly the case last year. Cingular's $41 billion acquisition of AT&T Wireless, for example, led Sprint and Nextel to combine for $39 billion.
Two not-so-typical factors played a role in the flurry of mergers. For one, the weaker dollar attracted foreign investors, like the Russian firm Severstal who paid $140 million for a Wheeling-Pittsburgh Steel Corp production facility. Secondly, the heightened regulations created after the collapse of Enron, Worldcom, and Tyco increased investor's confidence, said Jeffrey Gordon, a professor at Columbia University's Law School.
"There has been enough time now, and enough work by the accountants under the new Sarbanes-Oxley regime, that essentially most of the bad news about prior breaches have been washed out of the system," Gordon said.
Robert A. Profusek, a senior partner at Jones Day, called the short-term effects of Sarbane-Oxley "significant."
"Director's are more conservative now than in the 90s," Profusek said. "But that's because the 90s were so easy," he added.
Professor Gordon also points to Oracle's bid for PeopleSoft, which landed in a Delaware court, as a potential turning point in merger activity. In the PeopleSoft case, board members were called to testify as to why they activated a poison pill, marking the first time such a case has been litigated. "The procedural precedent that the PeopleSoft case set could potentially have a significant impact on M&A activity," said Gordon.
Low interest rates propelled mergers in 2004, but not as much as good credit, said Robert Filek, a partner in PricewaterhouseCooper's transaction services division.
"It's not until banks really loosen the purse string, and say 'we're willing to loan money' that you really see a growth in M& A. You saw that in '04," said Filek.
Credit ratings improved for two reasons: Companies have reduced costs and revenues have started to come back. "Those two things combined really improve the operations and balance sheets of companies," Filek said.
According to PWC, credit ratings will continue to be healthy. Also, companies are predicted to remain awash in cash, the ultimate deal grease. This bodes well for mergers activity in 2005. Indeed, Proctor & Gamble's purchase of Gillette last week, along with the Rayovac and United Industry merger earlier in January is testament that 2005 will be an active M&A year.
But mergers are beginning to get expensive, potentially because of an abundance of cheap financing available to private equity firms, warned Profusek.
Filek doesn't believe that private equity firms will exceed 20% of next year's deals. He is, however, wary of overpriced transactions.
"M&A have actually gotten very expensive, very quickly in 2004, and we don't expect that to subside," he said.
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