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By DENNIS K. BERMAN in New York, JASON SINGER in London and JOHN R. WILKE in Washington
May 8, 2007; Page A1One after another, the longstanding barriers that protected companies from takeovers are dissolving. The result: an unprecedented wave of deal making in which, it seems, few companies are entirely safe.
National borders and size used to be obstacles, but three banks from across Europe have assembled a nearly $100 billion offer to dismember Dutch bank ABN Amro Holding NV. It used to be unworkable for leveraged-buyout firms to buy finance companies and load them up with debt. Private-equity firms and banks broke through that roadblock when they proposed a $25 billion takeover plan for student lender Sallie Mae. Family-controlled companies, especially those with a special class of super-voting stock, were thought to be untouchable, but that hasn't stopped Rupert Murdoch's News Corp. from offering $5 billion for Dow Jones & Co., publisher of The Wall Street Journal.
BUYOUT BOOM
• The Situation: Obstacles that once protected companies from takeovers are dissolving.
• The Result: Companies such as Alcoa, Dow Jones and ABN Amro are among those involved in an unprecedented wave of deal making.
• What's Next: Investors brace for more deals in the coming year, but when the euphoria ends, a hangover could follow.
Even the biggest barrier -- the U.S. government -- doesn't seem insurmountable. Exhibit A: Alcoa Inc., which yesterday made a $26.9 billion unsolicited offer for Canada's Alcan Inc. That deal would recreate an aluminum giant that the U.S. government spent nearly 40 years trying to break up.
"Other than the biggest 10 or 15 companies in the world, nobody is off-limits," says Scott Barshay, a partner at the law firm Cravath, Swaine & Moore. "The debt financing is out there. The equity financing is out there. And the willingness of private-equity firms to make bets is out there."
Investors are bracing for still more combinations in the year ahead. Across Wall Street, there's a feeling that now is the time to strike, while stock valuations are buoyant, funding is freely available, and Democrats in Congress have yet to change laws in ways that would make deal making harder. Executives are often happy to do deals because they can get big payouts under change-of-control clauses in their contracts.
The most important engine remains the stock market, which continues to hit all-time highs. Higher stock prices give chief executives the confidence -- and currency -- to pursue bigger targets. The value of mergers in 2007 has already topped $2 trillion, higher than the level for all of 2004, and some 60% greater than the same period of 2006. U.S. volume is up 41% year-over-year, according to data provider Dealogic.
Optimistic Projections
The trend could quickly turn around if interest rates rise, increasing the cost of funds for acquirers, or if the U.S. and European economies turn south. Many of the acquisitions rely on optimistic growth projections that would be hard to justify in a slowing economy.
"There is a part of you that wants to ask how long it can keep going," says Robert Hotz, co-chairman at investment bank Houlihan Lokey Howard & Zukin. "What you worry about is some external event that impacts the credit markets, which I think could derail the buyout train."
The euphoria could leave a hangover if it turns out that buyers took on too much debt. Some private-equity firms could find themselves in bankruptcy, causing ripple effects in the broader economy. The cost-cutting needed to pay off the debt could mean more layoffs at companies.
Caught up in the excitement, companies are more likely to overextend themselves. That's apparent from the last merger boom. Time Warner Inc. is still dealing with the fallout of its 2000 merger with America Online.
For the moment, shareholders are generally blessing acquirers' proposals, especially when they put together businesses with significant cost savings. Shares in Thomson Corp. dropped just 40 cents after revelations last week that the financial-information company was mounting a $16 billion offer for Reuters Group PLC. And both Alcan and Alcoa shares jumped yesterday, in part because of investor expectations that a merged company could achieve some $1 billion in cost savings. In the past, an acquirer often saw its stock price drop sharply because investors feared an expensive acquisition would hurt its finances.
Some 43% of deals this year have some sort of cost savings built into the transaction, according to Standard & Poor's Corp., the highest level in 10 years.
Deal prices are at their highest level since 2000, according to FactSet Mergerstat, a provider of data on mergers. On average, buyers this year are spending about 12.1 times a target's cash flow, compared to 10.4 times during 2006, and 9.7 times in 2000.
Both corporations and private-equity firms are being lured to the negotiating table by hundreds of billions of dollars in financing, available at cheap rates with few restrictive terms.
"Your head is constantly spinning. Every single industry is being restructured," says Howard Wiesenfeld, a portfolio manager at DKR Ibex, a merger-arbitrage fund, who has been waking at 4 a.m. to start trading on stocks of companies that are part of European deals.
The deal for Sallie Mae, known formally as SLM Corp., suggests how the environment has changed. When a leveraged-buyout firm acquires a company, it usually loads its target up with debt to finance the transaction. Historically that made leveraged buyouts of financial-services companies difficult because these companies already have a lot of debt and their financial soundness is subject to regulation. Yet two private-equity firms, JC Flowers & Co. and Friedman Fleischer & Lowe LLC, plowed ahead in the Sallie Mae deal, backed by $30 billion worth of lending capacity from J.P. Morgan Chase & Co. and Bank of America Corp.
The reasoning: Sallie Mae can package its student loans into bonds to sell to eager investors, so the company isn't dependent on raising money in the credit markets. Even with Sallie Mae's debt rating heading toward junk territory, the company said it would have "no need to access capital markets during this time."
During the first quarter of 2007, companies and private-equity firms issued $183 billion in new debt, according to Standard & Poor's. The volume was nearly 25% greater than in the fourth quarter of 2006, and nearly four times the rate of 2004.
Banks, big institutions and hedge funds are willing to provide the financing for deals because the returns for safer investments such as U.S. government bonds are low.
Private-equity firms have been able to raise huge sums in a matter of weeks, often casting around for deals almost randomly. Just three weeks after abandoning its $20 billion bid for J Sainsbury PLC, CVC Capital Partners of Luxembourg approached cigarette maker Altadis SA of Spain with a $17.3 billion proposal. For a few weeks, Kohlberg Kravis Roberts & Co. was involved as a partner with CVC in the Sainsbury bid and, at the same time, pursued a $20 billion deal for Alliance Boots PLC.
"It's kind of like the wild West," says Mr. Hotz, the investment banker. "We're seeing much higher levels of leverage."
Regulation Eases
Beyond the abundance of cheap deal funding, economists and antitrust lawyers cite significantly eased merger-enforcement standards in the Bush administration. "Now's the time," says Carl Shapiro, a former Justice Department economist now at the Berkeley's Haas School of Business. "The line has clearly shifted in favor of big mergers between competitors, deals that would have been blocked" in earlier administrations.
The Bush Justice Department's rate of merger challenges between 2002 and 2005 was the lowest of the past 20 years, according to a new study by Mr. Shapiro and Jonathan Baker, a former Federal Trade Commission economist.
Thomas Barnett, the Bush administration's antitrust chief, says merger review standards haven't changed and the Justice Department remains vigilant. "We filed more complaints challenging mergers in the last fiscal year than in any year since the end of the merger wave in 2001," he said in an interview yesterday. The department brought formal challenges in 10 deals last year, he said, though none were blocked outright.
"Our approach is to aggressively protect consumer welfare and the competitive process," Mr. Barnett said. "That may sometimes mean blocking an entire transaction, but may also mean attaining more targeted relief that allows the beneficial aspects of a transaction to proceed."
Wall Street has benefited from the administration's light touch on taxes. With Democrats now in control of Congress, senior lawmakers are discussing taxing private-equity gains at a higher rate, prompting some financiers to try to rush to get deals done while taxes are lower.
In an interview last week, Sen. Max Baucus, the Montana Democrat who chairs the Finance Committee, said his committee is examining whether fund managers should pay higher taxes on the profits their funds generate for them. Committee aides have questioned whether it is appropriate that much of the managers' pay -- the cut of profits known as "carried interest" -- is taxed at the 15% long-term capital-gains rate, instead of ordinary income-tax rates of as much as 35%.
The prospect of changes by a Democratic-controlled Congress and a possible Democratic victory in the next presidential election could affect the thinking of some sellers as well. The Bancroft family that controls Dow Jones is examining how an increase in capital-gains or dividend taxes might affect its decision on News Corp.'s offer, according to people close to some members of the family.
The maximum tax rate on capital gains and dividends is now 15%, but will rise in 2009 to 20% and 35%, respectively, unless Congress acts. Democrats are showing some resistance to President Bush's proposal to extend the lower rates. That could make it more lucrative for the Bancrofts to cut a deal now.
In Europe, governments take a more interventionist approach in corporate affairs, but that too seems to be fueling merger activity as officials seek to turn deals to their countries' advantage. Spain and Italy joined forces in defending electricity company Endesa SA from Germany's E.On AG, and a series of deals linking Spanish and Italian companies are in the works.
Shift in Boardrooms
Undergirding all of the activity is a deeper shift within corporate boardrooms. Boards are increasingly unwilling to resist demands from shareholders to spin off or sell businesses. Such resistance was common 20 years ago, when veteran merger lawyer Martin Lipton would counsel clients that they could use the "Nancy Reagan defense" of just saying no to takeover offers.
Following a series of corporate scandals earlier in the decade, shareholders have been pushing harder to exercise their rights of ownership -- even in Europe, where the activist investor is a relatively recent arrival.
In February, a London-based hedge fund sent a letter demanding a breakup or sale of Dutch bank ABN Amro. ABN at first thought the letter, sent by Children's Investment Fund Management (UK) LLP, would have only a limited effect. But the bank's shares rose as other hedge funds piled in, expecting the bank would be forced into a deal. Chief Executive Rijkman Groenink realized the long-term shareholders he had counted on in the past were abandoning him.
Mr. Groenink decided to sell his bank in a friendly transaction to Barclays PLC for $88.79 billion, including a sale of ABN's LaSalle Bank division to Bank of America for $21 billion. Shareholders likened it to a "crown-jewel defense" because, to protect a friendly deal with Barclays, ABN decided to sell LaSalle, a premier asset.
Hearing the shareholder complaints, three European banks teamed up to bid about $98 billion to wrest the deal away from Barclays. The three -- Royal Bank of Scotland Group PLC, Dutch-Belgian Fortis NV and Banco Santander Central Hispano SA of Spain -- plan to break up the sprawling ABN.
The consortium's move is even more audacious because it has completed limited due diligence. The group has spent just days poring over financial information and hours posing questions to a handful of top ABN executives. Its bid is valued $10 billion higher than Barclays, even though Barclays spent five weeks doing in-depth due diligence with ABN on a friendly basis.
The arrival of activist investors also makes management more willing to complete deals. Earlier this winter, American financier Nelson Peltz, who made a name for himself in the 1980s using junk bonds to buy aluminum-can companies, bought a stake in venerable Cadbury Schweppes PLC. Before he had even begun to agitate for change, the company announced a plan to break itself in two.
"This is an environment where people are open to deals," says Kenneth Jacobs, chief executive of Lazard North America. "There's a clear sense that if someone makes a compelling offer, that the just-say-no approach isn't going to work."
One reason for the openness: Executives stand to make millions when there's a change of control, as their stock options gain value and other payments kick in.
"It's all about incentives. Managements and boards of directors do well when companies go private," says William Ackman, who runs investment fund Pershing Square Capital Management. "They get change-of-control payments, their stock and options become fully vested, and they often get equity in the newly private company. Managements are using shareholder activists as an excuse to go sell the company."
But beneath the surface, some worry the merger boom can't sustain itself. With sardonic asides, Wall Street bankers joke about getting deals done before the music stops.
Wall Street has embraced exotic structures that in years past would have been dismissed out of hand. Chief among these was the buyout of publishing giant Tribune Corp., which relied on a highly leveraged employee-ownership plan to buy the company from its shareholders.
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