Cash M&A still lifeless

August 14, 2009

Bond sales are at a record, equity markets are at year-highs, private equity firms are sitting on huge cash piles — Blackstone alone has $29 billion — and banks are lending to each other again.

The ingredients should all be there for a resurgence of cash-driven mergers and acquisitions. But instead, the market is in hibernation.

So far the value of all M&A deals completed this year totals $990 billion. You have to go back to 2003 — when the total for the year was $1.23 trillion — to find a figure this low, according to Thomson Reuters data.

Of this, some $364 billion — just 37 percent — were cash deals, marking a dramatic shift in the mix of recent years when cash has dominated.

The main spanner in the works is the still dire state of banks’ balance sheets and the crippled syndicated loan market. This has kept a tight lid on cash bids of any size, with the mega merger or takeover a distant memory.

Most banks are doing all they can to shrink their balance sheets, guard against problem exposures and to lend to their best clients. As a result, global syndicated loan volumes hit their lowest monthly volume since 1993 in July.

True, corporate bond issuance is booming and companies are raising equity, but this is not going to be enough to fill the void. And even if companies are confident of being able to fund their purchases with bonds, they first need to find a bank to give them a bridge loan.

The absence of debt finance has all but killed off fully-funded hostile cash bids. One consequence has been a shift to the type of bear hug Xstrata is attempting on Anglo American, where a attempts to win shareholder support for a deal before launching an offer.

Meanwhile, other companies are assembling warchests to give them the opportunity to move quickly when they spot a bargain. German chip-maker Infineon, for instance, recently raised equity to repay borrowings and prepare a stash of dry powder for acquisitions.

Another approach is to raise equity by partially listing subsidiaries. Spanish bank Santander is seeking to float part of its Brazilian unit and British insurer Aviva is doing the same with its Dutch operation, Delta Lloyd. Not only does this raise some fresh capital to bolster the parent’s position, but gives the unit concerned an acquisition currency without drawing on its cash-strapped parent.

An alternative is to buddy up with a cash-rich financial investor. Germany’s Bertelsmann, for example, teamed up with KKR to form a music rights management company designed to prey on distressed competitors.

One area where buyers don’t always have to put up that much cash for control is in distressed companies. In some cases, banks are willing to hand over the keys so long as the acquirer is willing to inject some more cash into the company to put in on a stable footing. One example is the acquisition of Pearl by special purpose acquisition company Liberty International, where Liberty put in fresh cash, and the banks wrote down some of their debt.

Vulture investing isn’t going to spur much of a recovery in overall volumes, however. That’s probably a good thing. A great deal of the hyperactive M&A of recent years was wasteful and left businesses saddled with too much debt. Moreover, many businesses are more concerned about bolstering their balance sheets and steering a steady course through the recession rather than empire-building.

There remains another problem with distressed M&A: the relative shortage of targets. Banks have been reluctant to get too tough with troubled borrowers for fear of realising further losses — so rather than foreclose they have often been prepared to amend debt terms and relax covenants. This has allowed many to ride out the storm so far. And for less distressed sellers, market volatility has made it harder to agree on value.

Like the banks, CEOs are being equally cautious about what they do with their cash. Those who have survived the financial crisis aren’t about to be caught napping a second time. They may be tempted into share offers to grab assets they think worth acquiring if they see greater market and economic stability returning, but most will be keeping their cheque books deep in their inside pockets for now.

— By Neil Unmack and Alexander Smith

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