M & A; Activity Mutes as Share Prices Fall, but Firms Find Other Ways to Make Deals
Technology companies clustered in Irvine and Newport Beach thrived during America’s longest-running bull market, which went on for almost nine years. As their stock prices reached dizzy highs, companies such as Broadcom Corp. and Conexant Systems Inc. used their stocks as currency to buy other companies and strengthen their position in the technology industry.
“Broadcom did what any smart company would do,” which is use its stock to buy companies, said Kimberley Valentine, managing director of corporate finance at Deloitte & Touche LLP.
Last year, Broadcom was by far the busiest Orange County-based acquiring company, making 11 of the 20 largest acquisitions for which financial details were disclosed. According to Mergerstat, the fabless chip designer was involved in acquisitions totaling more than $7.5 billion in 2000.
By issuing stock for its acquisitions, Broadcom and other technology companies were able to position themselves strategically against their competitors and at the same time not have to carry any loans on their balance sheets. For Broadcom, it was sort of like printing money.
Such acquisitions tend to fuel growth because the buyer adds assets more quickly and cheaply than it could internally. In fact, a key acquisition strategy for a large publicly traded company is to buy up firms that have lower price to earnings ratios than the acquiring corporation. In doing so, companies buy growth for a lower valuation than that of their own earnings and growth.
Acquisitions are very important in the technology industry and firms such as IBM Corp, Sun Microsystems Inc., Intel Corp. and Microsoft Corp. acquire companies on a regular basis for strategic reasons and to fill holes in their product segments.
But now that the share prices of many tech companies in Orange County are down, and in some cases have collapsed, technology, media and telecom,or TMT,companies face their biggest challenge in recent times: growing without acquisitions.
Irvine-based Broadcom has seen close to a 90% drop in its stock price, while Conexant is down by almost 95%.
“As long as you have strong currency, you can make acquisitions without much problem,” said Valentine. But “the moment you see a sharp decline in stock price you have to look at alternative sources.” Valentine said that with stock prices for some companies collapsing, they will need to look at debt to make future acquisitions.
“As the markets come down, deals are getting more complex,” said Ronald Speyer, founder and president of Costa Mesa-based Emerge Corp., an online M & A; service provider and consultant. He said that previously, deals were one-layered,simple equity swaps.
“In a market like this, M & A; deals have up to seven layers,” he said.
One of those layers is an increase in the debt component. That has made acquisitions more expensive for companies,and only few companies can acquire through borrowing from banks.
“Acquisitions today are more dilutive and more expensive because of increasing debt component,” said Speyer.
Most technology companies in Orange County and in the United States, including Conexant and Broadcom, are losing money, depending upon how one defines a loss. The interest payments on borrowed money only compound the losses for cash-strapped companies.
“The key is that companies will need to go to their banks and convince them that a particular acquisition is very important,” said Speyer.
“Acquisitions by large public companies will have to be very strategic,” agreed Valentine.
So, as stock prices have fallen and as debt components in M & A; transactions have risen, companies in Orange County and the U.S. have started focusing more on getting their existing businesses on track rather than partying with acquisitions.
To start with, the value of M & A; in the U.S. fell last year to $1.325 trillion, down 7.1% form the 1999 record of $1.425 trillion. But the annual figures mask the fact that the first half of 2000 had more M & A; activity than the second half.
“When stock markets fall, M & A; activity by larger companies usually comes down,” said Michael Morris, CEO of GMA Partners Inc.
“It looks like the decline in M & A; activity would continue,” said Roger B. Palley, national director of value strategies for Wells Fargo Private Asset Management.
The recent fall in their share prices has debased the currency of most TMT companies. A company has to issue more shares to make an acquisition and that means that the management of the acquiring company will have lower stake and less board control after the acquisition,a no-no for most acquiring companies.
Last year’s drop in value of M & A; deals was the first in nine years, which clearly shows that the M & A; activity is linked to the performance of the stock markets. As the Dow Jones Industrial Average rose from it lows in 1991, so did the value and the number of M & A; deals. While the Dow Jones tripled in these eight years, the value of M & A; deals grew 20 times, from $71 billion in 1991 to $1.425 trillion in 1999.
OC technology companies, too, have seen a decline in their M & A; activity along with a fall in their stock prices. In the first quarter, for instance, Broadcom made only one acquisition. That is down from five acquisitions in the fourth quarter last year and seven in the third quarter.
Even the total deal value fell for Broadcom. In the first quarter of this year, the chip maker’s one acquisition was valued at $2.2 billion, down from $3.4 billion in deals in the fourth quarter and $4.7 billion in the third.
“For a public company like Broadcom or Conexant, acquisition activity will slow down because of the fall in their stock prices,” said Valentine.
“For large companies, the volume of deals is slightly lower so far,” said David Barnes, director in the M & A; group of Houlihan Lokey Howard & Zukin. Barnes said the fall in the volume is because of the fall in stock price and also valuations in M & A; deals.
“I think it’s going to be harder to raise money, period,” said Palley.
According to Mergerstat, total deal values in the U. S. were sharply down in January and February. In the first two months of this year, the value of M & A; deals is lower by 62% to $103 billion from $277 billion for the same period last year. Even the number of deals is lower this year. In the first two months, companies were involved in 1,448 deals, down 15% from the 2000 level.
Certainly, the outlook is now bad enough to justify asking if America’s fifth merger wave is on its last legs. “This is my fourth recession in the past 20 years,” said Speyer, “and during each, deals have dropped maybe 10% to 12%.”
Investment bankers say that the main reason for the decline in the value of deals is that valuations in M & A; transactions have fallen. Barnes said in 1999, companies were getting acquired or merged at 12.4 times their earnings before interest and tax. That number was lower at 11.2 times in 2000.
“There has been a relative decrease in valuations,” said Stephen Fillet, director of the Technology Investment Banking department of CIBC World Markets.
“Maybe Broadcom is going to make fewer acquisitions this year,” Fillet said.
But Speyer said where there’s a will there’s a way.
“Broadcom has to re-examine its currency,” he said, “but there are other tools for acquirers to use. If Broadcom really wants to acquire somebody, it has the wherewithal and the talent to do so.”
Many analysts said that the decline in valuations is positive for the industry.
“Its back to reality,” said Valentine. “We will have a year of focus on fundamentals,” she said.
Valentine said that companies such as Broadcom and other TMT companies would use the next year or so to consolidate the acquisitions they carried out last year.
“M & A; won’t be dead but will slow down,” said Palley. He said that companies will consolidate whenever there are too many players in an industry. “M & A; will continue because there is lot of stress in the system and hence there is the possibility of a lot of consolidation.”
Valentine said that, although the M & A; numbers are down, there is still lot of activity in the private market. She said that larger publicly traded companies will continue making acquisitions for strategic reasons. For that, she said that companies will need either cash reserves or credit.
But Palley said that until the stock markets revive, M & A; activity will continue to drift to lower levels.
“The high level of M & A; in 1999 was another bubble,” he said.
Also, recent concerns about the slowdown in the U.S. economy have altered boardroom attitudes. At times of uncertainty, firms tend to focus on their core businesses, rather than explore possible new investments, such as acquisitions.
Any revival of merger activity is likely to hinge on a rebound in economic optimism and the stock prices. n
