Mergers And Acquisitions Explained - Part 3

Following on from Part I (overview of M&A) and Part II (mechanics and process of M&A), it’s now time to look out for where we’re going to see some M&A action in the near future.

It’s true to say that we haven’t seen a lot of merger and acquisition deals lately. Year on year, global M&A volume is down by 36%. Looking specifically at the UK, there’s been a near complete collapse. Excluding government activity, M&A deals in Q1 2009 were 84% lower than last year.

So the industry has been through a bit of a lean patch as of late. There could be a pickup soon. Shares are trading with single digit P/E ratios. They’ve rarely been cheaper in the past 40 years. True, earnings are under pressure but shares are still cheap. As the saying goes “when the going gets tough, the solvent get buying.”

Industries To Look Out For

Miners
The world’s biggest miner BHP Billiton (BHP) has been given support from its top investors to explore potential M&A deals. Going by their attempts to acquire the world’s third biggest miner Rio Tinto (RTP) last year, they are thinking big. Xstrata CEO Mick Davis has previously stated that one big acquisition will spark a wave of them. In total there are 11 mining companies in the FTSE 100 (^FTSE), so plenty of potential targets for. Vedanta, Xstrata or Eurasian Natural Resources Corporation (ENRC.L) would fit nicely into BHP’s portfolio. There’s also been talk that they may make a move for Dow Jones component Alcoa (AA).

There’s always the possibility of a tie-up between two of the mid-sized miners. Last year, when there were rumours that ENRC would make an offer for Kazakhmys, Kazakhmys’ share price rose 12.9%. Any talk of that deal being revived would likely have a similar effect.

Being specific inside mining, the gold subsector could see a flurry of takeover activity in the coming months. Rising bullion prices, but a shortage of internal growth projects for biggies makes takeovers a promising option. AngloGold (AU), Barrick Gold (ABX), Newmont Mining (NEM), Randgold (GOLD) and Freeport-McMoRan likely be amoung the big players in any moves. Hochschild, Avocet, Peter Hambro or even small Irish extractor Kenmare Resources could be targets.

Pharmaceuticals
Big Pharma has been the most active industry in the M&A sector with three big moves in the past few months. Pfizer’s (PFE) $68.1bn takeover of Wyeth started things off. The response to that was Merck’s (MRK) $48bn acquisition of Schering-Plough (SGP) and Roche’s $47 deal for Genentech (DNA.SW). And undoubtedly there’s more to come.

Pfizer, Merck and Roche have now bulked up their “pipelines” of products in various stages of testing and regulatory approval. Amgen and Gilead Sciences are two pharma companies with market caps over $40bn that could do with beefing up some more. Eli Lilly’s CEO said that they are looking for acquisitions of as much as $15 billion. And there are a number of mid-sized targets they could look at. Maybe Genzyme, Cephalon or Medivation.

Biogen Idec (BIIB) is already partnered with Élan and is a logical acquirer of them. Élan is definitely on the radar of many companies. Biogen Idec may not even be the acquirer as they could be snapped up themselves. Anything could happen in the next few months.

Last year, Intercell paid a 126% premium to acquire Iomai. With premiums as sky high as that in the pharma area, potential profits are huge if you correctly identify the next one to be targeted.

Carmakers
As the daily newsreels suggest, this is a beaten down industry that is in dire straits. Consolidation is a given and many of the biggest names are seeking quick tie-ups. The most prominent is Chrysler and Fiat with U.S. President Barack Obama giving Chrysler 30 days to make a deal or face bankruptcy.

General Motors are another automaker in big trouble but nobody is really looking to make a deal with them as bankruptcy looks like their destiny.

One problem with this industry is that none of the major players look strong enough or seem to have the will to make a big move… except for Porsche. Due to a €6.84bn gain from sneaky Volkswagen option deals, Porsche recently reported a six-month profit of €7.34bn at a time when most others are reporting losses. They boosted their stake in Volkswagen to a clear majority in the process. Porsche may possibly look for General Motors Opel brand.

Past the Great Wall, Beijing is encouraging its biggest carmakers - Shanghai Automotive Industry, FAW, Dongfeng and Changan - to lead consolidation of its industry. If this happens, they will probably start to look westward to boost their international presence. Geely, Dongfeng and Changan have all stated an interest in Ford’s Volvo brand. Any deal, especially if it included a bidding war, would probably see Ford’s share price rise.

Big Oil
In the late 1990’s, when oil prices last plummeted, there was a huge wave of consolidation in the industry. Giants such as Exxon Mobil (XOM), Chevron Texaco (CVX), BP Amoco (BP) and TotalFinaElf were all born. Now, as we all know, oil prices have collapsed again. This makes oil exploration less profitable due to the lower price, but makes preying on rivals easier, thanks to the depressed share prices.

Kicking off a possible wave of acquisitions, Suncor recently agreed to buy rival Petro-Canada for $15.1bn. Exxon Mobil is likely to be hungry for cheap prey. They have billions stashed away, so they don’t even need to go to the capital markets to raise money. Also watch out for the Chinese and Indian state-owned oil firms who have become much more acquisitive in recent years and would love to increase their international presence with large Western acquisitions.

Regional Newspapers
Action is urgently needed here after a long list of famous US papers, including the Chicago Tribune and Los Angeles Times, declared bankruptcy in recent months. Even the national iconic paper, the New York Times, would have possibly gone to the wall without a recent bailout by Mexican billionaire Carlos Slim.

There’s a belief that regional UK newspapers will follow the same path in the next few months unless drastic action is taken, including consolidation to obtain sufficient scale to survive. A lot of analysts believe that the “big four” UK regional newspaper groups - Trinity Mirror, Johnston Press, Newsquest, owned by Gannett of the US, and Northcliffe Media, the regional arm of Daily Mail & General Trust - should become a big two.

The Future Impact On The Buyer?
Throughout my ramble on mergers and acquisitions, I’ve constantly talked about identifying potential targets and going long on them before they get picked up. What about the acquirers’ share price? After all, they are the ones who are left when the target has been gobbled up and untradeable.

Well, as mentioned in Part I, about 65% of acquisitions don’t work out too well. But when they do succeed, the acquirers’ share price often booms. Traders must attempt to distinguish between those deals that will create value and those that won’t. It’s not cut and dry what to look out for, but here are a few characteristics of M&A deals that help to create value:

1. The acquirer is strong. Acquirers with earnings and share price performance that outperform their industry stand a better chance of making the deal work. A strong cash flow position is also important.
2. The premium price paid is relatively low. A low premium price increases the likelihood that the acquirer got a bargain. High premium prices can lead to a “winner’s curse” which is often punished by the market.
3. The number of bidders is low. This increases the likelihood that the acquirer got a bargain. There’s a negative relation between stock returns and number of bidders.
4. The initial market reaction is favourable. This initial reaction gives a good indication of where the share price will go in the medium term.

Impact On FX
To finish off, as strange as it might see, M&A also affects the FX market. The key here for traders is to look at cross-currency flows rather than every large M&A transaction. For example, the AOL takeover of Time Warner is useless in this instance because both companies trade in US Dollars. However RBS acquisition of ABN Amro is prefect because RBS had to convert their GBP into EUR to pay ABN’s shareholders.

In the RBS-ABN Amro deal, RBS had to sell GBP and buy EUR to pay ABN Amro’s shareholders. If the deal involves cash, instead of equity, the significance and potential impact is far greater. Keeping all else equal, this deal would cause EURGBP to rise.

By how much? In a study entitled “FX impact of cross-border M&A“, it was found that immediately after a $1bn deal is announced, there is generally a strong upward movement in the target’s currency relative to the acquirer’s. Fifty days after the announcement, the target currency is, on average, 1% stronger, with most of this move happening in the first week. The bigger the deal, the bigger the move.

So that’s it. I’m finally finished on mergers and acquisitions. I hope that you got from the start to the finish in one piece. And if you have any hot tips, don’t be shy…

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