DealZone

Former New York Governor Eliot Spitzer at a September 2009 conference

Seems like old times. 

Eliot Spitzer, who rose to national prominence in 2002 when he forced a sleepy S.E.C. to crack down on conflicted analyst research,  is none too pleased to hear that his old rivals recently joined 12 Wall Street banks in seeking to knock big holes in that wall.

Asked for his thoughts on this Wall Street Journal article that broke the news, this is what he had to tell Reuters in an exclusive interview:

“For the S.E.C. to join with the banks to diminish consumer protections with respect to the quality of advice and research is absolutely and fundamentally violative of their duty to the public.  This one more example of the S.E.C. being in in the tank.”

It’s almost as if we turned the clocks back seven years. Spitzer gained his crusading “Elliot Ness” reputation in 2002 when he took the unprecedented step of probing banks and threatening to prosecute Wall Street executives, stepping around a passive S.E.C.

Yet even after Mary Schapiro replaced the ineffective Christopher Cox as the agency’s chairman, the Feds still appear reluctant to get tough, he said.    

Across the different bits of financial services – such as fund management, broker-dealers, insurance, and trading systems – mergers and acquisitions fell sharply in 2009. But Freeman & Co outlines 10 drivers that should make this a busier year for dealmaking:

“1. Banks and insurance companies continue to assess whether their asset management units
are core to their business, especially those that have stand alone brands or are in non-core
markets

2. Large transformational asset management deals will diminish, but deals in the $3-30 billion
AUM range will increase from current lows

A poll from UBS and the Boston Consulting Group finds a “surprisingly healthy” one in five European companies is likely to make a significant (EUR 500 mln+ in sales) acquisition in 2010. Some of the other key findings:

“Corporates are seeking growth: Strategic and growth-related considerations such as expansion of product offering, access to new geographies and access to new customers and distribution channels were the three most cited drivers of M&A activity, from a choice of 12 drivers.

“Lack of attractive targets and company valuations are main M&A barriers: Lack of attractive targets (cited by 40% of respondents) and, reflecting the speed and extent of stock markets’ recovery, high valuations (cited by 39% of
respondents) were the most commonly cited barriers to M&A.

The year-long ban BHP Billiton has had on revisiting a takeover of rival miner Rio Tinto will soon end, but it seems as if the moment has passed. Liberum and Investec said earlier this week that most of the synergies were captured anyway by the duo’s iron-ore joint venture.  If regulators nix that deal, analysts say a full takeover could be back on — but how that would pass muster if a JV doesn’t is not clear. On Friday, Credit Suisse joined the chorus of disapproval, saying a takeover would cut BHP’s return on equity (ROE) in half. From the CS note:

“We have re-run the numbers on an all scrip BHP Billiton takeover of Rio Tinto at a 30% premium (2.3 BHP shares for each RIO share). We see such a deal as materially EPS dilutive (by 12% even after year 3) and would significantly decrease BHP’s return on equity (from 25% to 12%).

“We do not see BHP making another takeover offer for RIO because: (i) The iron ore JV should capture many of the synergy benefits expected from the possible merger. (ii) If the iron ore JV fails on account of not passing regulatory hurdles similarly then we do not see a takeover receiving regulatory passage. (iii) We do not foresee shareholder support for the deal (and any such deal would use BHP script) with the potential EPS dilution and ROE erosion significant. (iv) Non-availability of sufficient credit facilities.

Richard Bove at Rochdale says JPMorgan is in pole position to benefit from a surge in dealmaking:

“A core theme in our banking thesis is that “Merger Monday” is back.

“There could be a surge in merger and acquisition (M&A) activity that may last two to three years. The dollar is weakening, the yield on junk bonds has plummeted, and the stock market is quite strong. The money is available. No company is better positioned to take advantage of this development than J.P. Morgan.”

Bove says JPM has tens of thousands of middle-market clients as well as long-standing relationships with the biggest U.S. companies, such as Mars and Black and Decker.

Like UBS and Societe Generale, Deutsche Bank’s researchers are now forecasting a resurgence in M&A and say investors should “prepare to ride the wave”.

They concede that “picking actual as opposed to potential M&A targets is a notoriously difficult exercise” but have come up with 30 potential European targets, based on strategic and financial criteria. While bank lending remains a problem, they say that is not always an insurmountable hurdle, and should spur more stock-based deals (see graph below).

In a note dated Nov. 4, the DB team writes:

“Following two years of below-normal levels of merger and acquisition (M&A) activity in Europe, we believe the conditions are in place for deals to return to the fore as a major driver of returns: Public markets are well and truly open for financing, low organic growth should spur expansion by acquisition, rising equity markets and sub-peak valuations make stock an attractive acquisition currency, and confidence is returning to boardrooms and executive offices.”

Like SocGen before them, UBS strategists are looking forward to a pickup in M&A next year.

From a note published on Monday:

“We expect 2009 to mark the trough in global M&A transactions and for activity to pick up in 2010 and beyond. For FY2010, globally we expect M&A activity in the region of $2.5-2.7trl, an increase of 15% on current annualised run rate for 2009 and close to levels last seen in mid 2004-05. The biggest driver of an increase in activity is likely to be the increase in risk appetite in equity markets and in the boardroom, a return to earnings growth and profitability by World Inc and a backlog of pending asset disposals.”

“Credit conditions are also supportive and we expect private equity and bank lending to pick up at some point next year.”

Could buying the undervalued Dutch retailer Ahold, which operates U.S. brands including Stop & Shop, make sense for Tesco?

ING analysts Peter Brockwell and John David Roeg think there is a “compelling strategic logic” for a deal.

The pair say buying Ahold’s established U.S. business would be a way of quickly turning round Tesco’s fledgling, and loss-making, business Fresh & Easy, with Tesco funding a deal with cash, shares and disposals.

Societe Generale’s asset allocation team reckons cash-rich corporates are going to start ploughing money into deals as the economy recovers, and that spells a brighter future for stocks than bonds. The graph above is lifted from a note published earlier this week, in which the French bank shows how equities tend to outperform bonds as M&A becomes proportionally more important (they measure it as a percentage of GDP).

The Paris- and London-based team adds:

“Beyond share buybacks, we believe three main factors will trigger a strong M&A cycle: equities are still cheap versus bonds, productivity gains should continue to be a priority for corporates and the primary credit market has reopened, with access to cheap financing. Furthermore, higher industrial concentration leads to stronger pricing power.”

“M&A is currently a massive source of alpha for stock pickers as control premiums are above 40% in the U.S. and above 25% in Europe.”

Interesting detail in a research note on Thursday from Credit Suisse, highlighting how it pays for bankers to sweat the small stuff in these lean times.

The bank’s own research and Dealogic data shows that deals worth less than $100 million have generated average success fees equivalent to nearly 1.2 per cent of the value of the transaction this year. Deals worth $1 billion or more have yielded just 0.2 percent.

As I wrote earlier, Credit Suisse also says that M&A may replace fixed income as a driver of investment banking revenues in coming quarters as the high-grade bond bonanza draws to a close.