Merger mania gets Wall St buzzing again

Deals: banker Bruce Wasserstein, Kraft’s Irene Rosenfeld and Bob Iger of Disney

10 April 2012

Merger mania is back in America and Wall Street bankers who have spent the last year wandering in a fruitless and miserable wasteland are clamouring for a piece of the action.

Back in 2007, when US markets were at their peak, the start of the week was known on Wall Street as "Merger Monday", such was the proliferation of M&A deals announced on that day.

Since then, of course, Wall Street has shrunk in size by about a third and the idea of investment bankers being paid fees for advising anybody about anything seemed, until very recently, almost laughable. After all, aren't these the same guys who blindly lead us into the worst recession in 70 years?

But in the past few weeks some rather interesting deals, with some hefty price tags attached, have been blazoned across the front pages in America to mark a welcome return to the sort of business Wall Street is famous for. On a recent couple of Mondays deals totaling more than $37 billion (£23 billion) were announced. It almost felt like the Great Recession had never happened.

Disney's $4 billion acquisition of legendary comic book publisher Marvel was the first multi-billion-dollar deal to really turn heads. Not only was Disney able to get its hands on the biggest blockbuster movie franchises of recent decades — like Spiderman, the X-Men and The Fantastic Four — but also the House of Mouse was able to do so for $50 a Marvel share, a pretty good price for such a valuable stable of assets.

It is staggering to imagine the possibilities for Disney as it toys with introducing each of the 5,000 or so characters that have been created by Marvel in the past 70 years.

The value in this deal for shareholders of both Disney and Marvel is fairly plain to see and highlights one of the principle drivers of M&A activity in a market such as this.

Assets, whether we are talking repossessed homes in California, or vast tracts of intellectual property like Marvel, are priced very competitively indeed.

The 2006 to 2007 M&A boom was fuelled in large part by the lowest share price to earnings ratios of companies in the Standard & Poor's 500 index in more than 15 years. Today the S&P 500 is trading close to its lowest level relative to profit since 1989, meaning the market is lousy with bargains.

And seeing as even those economists with the bleakest of outlooks like Nouriel Roubini are calling the end of the recession, those prices are not likely to stay in the bargain basement for much longer.

So corporations like Disney that have the cash and the balance sheet to fund a big acquisition are doubtless running their slide rules over any number of seemingly undervalued prizes now.

Not long after the Marvel deal was announced food giant Kraft took a big swing at Britain's Cadbury with an offer of $16.7 billion for the maker of Creme Eggs and Dairy Milk chocolate. Kraft CEO Irene Rosenfeld was disappointed though when her Cadbury counterpart, Todd Stitzer, rejected the deal out of hand.

And so she should be, as her shareholders will doubtless be banging on her door before long to ask why earnings growth seems to be eluding her.

The potential Kraft-Cadbury deal is very different from that hatched by the superheroes at Marvel and Disney.

While the Hollywood wedding was all about the endless possibilities of introducing Marvel's characters to Disney's massive studio and distribution resources to extract lots of value down the road, Kraft wants Cadbury simply to help it bulk up in lean times. By consuming all the chocolate Cadbury can pump out of its Birmingham HQ Kraft believes it can automatically add a few pounds to its cheese-filled girth. This sort of lumpy and old-fashioned growth by bolt on acquisition strategy rarely delivers what it promises.

For this principle of M&A to work the deal must include lots of cost cuts — or synergies as the advisers on Wall Street call them. And indeed, Kraft believes there are synergies aplenty to be had in acquiring Cadbury. Even Stitzer, who is still officially opposed to a deal with Kraft, admitted last week that there might indeed be some significant overlaps between Kraft and his sweety business. But it should not be forgotten that there are endless studies showing that CEOs always over-estimate the supposed efficiencies to be had in a merger. In fact Hay Group produced a study recently that showed close to 90% of the mergers struck in Europe in 2007 fell short of their goals.

Last Monday saw Dell announce a $4 billion deal to buy Perot Systems, the information technology company chaired an founded by former US
presidential candidate Ross Perot. This deal reveals yet another driver of the resurgent M&A market as the recession fizzles out.

As companies fired employees, shuttered factories and generally cut costs like crazy over recent months they accumulated hoards of cash on the balance sheet, thinking they might need it for a great many rainy days to come.

Indeed, US Commerce Department data show that American companies posted annualized cash flow of more than $1.5 trillion in each of the last three quarters, the highest level on record.

With overheads still shrinking, many analysts believe that these great piles of cash make US corporations more attractive to buyers who plan to fund acquisitions either fully or partly with debt.

Whatever the reason for a merger or acquisition, or indeed whether a deal succeeds or fails, Wall Street is the certain winner. Even though Kraft has yet to make a formal bid for Cadbury, the investment bankers are already lined up, ready to advise the US company on how best to proceed.

Bruce Wasserstein, the portly CEO of Lazard in New York is said to be in pole position to advise Kraft should the deal go ahead. If he is hired, Wasserstein can expect to earn as much as $42 million for passing on his pearls of wisdom.
Wall Street banks have seen a big dip in their fees from advisory work. So far in 2009 the big firms have been paid $11.58 billion of advisory fees, according to Thomson Reuters data,
the lowest annual take in more than a decade.

Last year the same firms made $35 billion and in 2007 when M&A was really booming they made $49 billion.

The reason Wall Street loves M&A advisory work so much is that there is absolutely no downside, it takes very few resources, and the best bit — the fees are almost 100% profit.

So for those who thought the last year of economic hardship was a bit like the 1970s, take heart, with all this M&A activity it seems like the 1980s are just around the corner.

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