M&A's Long Road Back

Recent news from IBM, Amazon, and others suggests deals are being made, but conditions are still far from normal in the world of mergers and acquisitions

By Ben Steverman
July 28, 2009

Call it the merger muddle. If you wanted to buy a company in the past year, you had two big problems. First was simply trying to find anyone who would lend you the money. The credit markets were frozen and many banks that usually financed deals were on shaky financial ground themselves.

Second, good luck figuring out how much to pay. With the economy slowing rapidly, predicting a target firm's future profits or cash flow felt more like a wild guess than an educated forecast.

Those trends are starting to shift, say experts on mergers and acquisitions. That has been underscored by several recent deals. However, these M&A specialists warn, improvement in the M&A environment could be very slow—much slower than during a typical recovery.

Panic Seems to Be Gone

First, the good news. At least some investment bankers report being busy preparing deals that could be announced later this year. "The activity and tone has improved significantly this summer," says Howard Lanser, an investment banker at Robert W. Baird. Of course, everything is relative. M&A activity was near a standstill in late 2008 and early 2009.

With the economy in free fall, companies hesitated to make bold acquisitions. They're still skittish, says Robert Filek, a partner in PricewaterhouseCoopers' transaction services practice.

"We see continuing struggles to get back to a normal level of M&A," Filek says. "One of the biggest factors is CEO and board confidence." Without confidence in revenue or profit projections, companies focus more on bolstering their own balance sheets than making big bets, he says.

However, recently, some firms have been active shoppers.

On July 22, Amazon.com agreed to buy online shoe seller Zappos.com for $890 million in stock. On July 28, IBM agreed to buy software firm SPSS for about $1.2 billion in cash. On the same day, Virgin Mobile agreed to be acquired by Sprint Nextel in a mostly stock transaction valued at about $483 million.

"The panic seems to have left us," says Robert Profusek, head of M&A at law firm Jones Day. As conditions gradually improve, firms' outlooks appear more stable. "You're going to see more M&A, because you have more clarity for the future," he says. In relatively stable industries like technology or health care, large companies clearly have the ability to finance their own acquisitions—using either stock or cash.

Private Equity Largely Sitting Out

These large deals are "transformational acquisitions," launched to give the acquirers a big strategic advantage, Lanser says. "They're doing the deals that are going to position them for the next five years," Lanser says, citing recent deals by software giant Oracle and pharmaceutical firm Pfizer. "This is the opportune time because there aren't many buyers in the market."

The strongest corporate players can make bids, while private equity firms largely are sitting out. The problem for private equity—and for weaker, cash-strapped corporate buyers—is borrowing enough money to make deals work.

"Whether deals are getting done is dependent on whether the buyers have sufficient cash to purchase," says David Stone, a lead partner in law firm Neal Gerber Eisenberg's corporate and securities practice.

IBM—which had $11.7 billion in cash at the end of the last quarter—can afford to open its wallet. Other public companies can offer their stock in deals. But private equity firms need to borrow to make big purchases work.

Claire Gruppo of investment banking boutique Gruppo, Levey & Co. says private equity firms are active on smaller deals. "We're beginning to see a little bit of a shift," she says. They're looking at the companies they already own, and making adjustments: They either sell off firms in their portfolio, or they make small acquisitions that can be merged with existing holdings, she says.

Credit markets have undoubtedly improved in recent months, and stable, investment-grade companies are finding it easier to get financing. But, there are few signs that private equity is getting the same benefit of the doubt from lenders.

"A Different Paradigm"

In the boom years from 2005 to 2007, private equity could use lots of debt, or leverage, to make purchases. "Lenders are very hesitant to get involved in leveraged transactions," says Len Blum, managing partner at Westwood Capital, a boutique investment bank.

Now, private equity firms must put up much more of their own money, which makes deals less lucrative for them.

"The private equity community is adjusting to a different paradigm," Profusek says. In response, he says, private equity firms are trying new strategies, like seeking out troubled firms available at cheap prices, or coming up with creative financing schemes.

With the direction of the economy still uncertain, "these are dangerous waters," Filek says. "The rewards are great, but there is still a significant amount of uncertainty out there."

So while the deal flow may increase from a mere trickle to a steady stream in the months to come, don't expect the torrent of a few years ago.