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Deals of the Year

It's a three-peat. Once again a new record is set for mergers in the United States.

1Jan

The year 2000 would seem to have presented enough obstacles to unsettle even the most daring deal makers. But it didn't. Neither careening stock prices nor rising interest rates nor the prospect of a slowing U.S. economy could shake the desire of U.S. corporate managers to merge with and acquire other companies.

Mergers and acquisitions in the United States totaled a record $1.81 trillion through November 28,

2000, according to Thomson Financial Securities Data. That's slightly higher than 1999's level of $1.75 trillion, and marks the eighth consecutive year of rising deal activity in the U.S. market. This is probably as good as it gets for Wall Street investment banks, however. Most analysts expect the volatile capital markets to quiet things down in the coming year.

Out of the Gates

The year started with a bang, thanks to America Online Inc.'s January engagement to Time Warner Inc. in an all-stock transaction then valued at $350 billion. The Federal Trade Commission has yet to give its blessing to the union. But if a settlement is reached between the company and the antitrust regulator, the deal will be the largest of all time, representing nearly a fifth of total merger volume for the past year.

The deal-making cooled off in the spring as the stock markets took a dive, slowing to a low of $78.7 billion in April. But it heated up again over the summer, with such deals as Deutsche Telekom AG/VoiceStream Wireless Corp. ($41.6 billion) and Chase Manhattan Corp./JP Morgan & Co. ($36.5 billion) topping the list. The September quarter ranked as the third most active in history, with more than $550 billion in announced deals. And the momentum continued through October, when 3 of the year's top 10 deals — Firstar Corp./U.S Bancorp, Chevron/Texaco, and General Electric Co./Honeywell International Inc. — were unveiled. The second half of the year was just as strong as the first, even as stocks — used as currency in 65 percent of merger transactions — dropped sharply in value.

The chief reason companies are so eager to merge, say experts, is the high premium that investors continue to place on growth. "The only way that larger companies can significantly accelerate their growth rates is to add to their capabilities," says Rick Escherich, a managing director at JP Morgan. "I don't think there's ever been as high a premium paid as this." A recent study by JP Morgan showed that small differences in projected earnings growth make big differences in market valuations. Large companies with projected earnings-per-share growth of 12 to 15 percent traded at an average earnings multiple of 13.7, while those with 16 to 20 percent projected growth enjoyed an 18.4 multiple. Projected EPS growth of 25 to 30 percent commanded an average multiple of 27.3.

Jack's Swan Song

GE's announced acquisition of Honeywell, originally valued at $45 billion, was a prime example of the drive to add growth engines. In fact, engines are a key component of the deal, with Honeywell's $10.5 billion in sales in the aerospace division expected to boost GE's aircraft engine offerings. In addition, Welch claims Honeywell's three other core business units — automated controls, performance materials, and microturbine technology — overlap neatly enough with GE to yield $1.5 billion in overhead savings within the first year.

Some analysts were dismayed by the price tag, especially given GE's usual finesse in acquiring companies at bargain-basement prices. But, according to Merrill Lynch & Co. first vice president Jeanne Terrile, the acquisition may help stem the slide of a price/earnings ratio that she expects will fall from 46.5 in 1999 to 33.8 in 2001. "Honeywell could provide earnings momentum of the old-fashioned kind, like better margins and more productivity, when more cyclical businesses such as Power Systems slow down two or three years from now," Terrile wrote in a recent report. Of course the deal has another fringe benefit. It's big enough and challenging enough to convince CEO Jack Welch to stick around for another year before handing the reins to recently anointed successor Jeffrey Immelt.

The pace of technology-related mergers cooled off in the second half, along with stock prices, but high-valued deals among Internet companies (like the $15 billion merger between VeriSign Inc. and Network Solutions Inc., and the Telefonica SA/Lycos Inc. deal, originally valued at $12.5 billion) boosted volumes in the first half. More traditional industries also saw consolidation trends continue. In the banking and finance sector, volumes were boosted by three deals valued at more than $20 billion each, and four more valued at between $5 billion and $10 billion. The oil and gas industry also saw another major merger, with Chevron Corp.'s $35.8 billion bid for Texaco Inc. putting it in league with the BP Amoco and Exxon/Mobil deals of previous years.

In some of 1999's hottest sectors, such as pharmaceuticals and telecoms, deal volume fell sharply, due to fewer numbers of large deals. For example, the telecommunications sector took a big hit in 2000, losing about 30 percent in volume over 1999, even as the number of deals increased by 18.4 percent, according to Thomson Financial Securities Data. Without the $41.6 billion Deutsche Telekom/VoiceStream deal padding the numbers, the drop-off would have been even more dramatic. "They don't have any money," explains Paul Hammer, head of the Tech Media Telco Group of Houlihan Lokey Howard and Zukin, a Los Angeles­based investment bank. "The telecom sector has gone into contraction mode now that they've discovered acquiring customers is a little bit more difficult than they thought."

Pool or Purchase

The pooling-of-interests accounting method, slated for the regulatory guillotine in 2001, seems to be dying a natural death. Contrary to predictions that companies would rush to make acquisitions before year-end in order to qualify for pooling treatment, only 9.1 percent of this year's deals employed the method, down from 22.3 percent in 1999 and 53 percent in 1998. "The thinking is that analysts and investors are sophisticated enough to discount goodwill [charges] and focus on cash earnings," says Lehman Brothers Inc. managing director Robert Willens. He also notes that with pooling off the table next year, companies are now deciding they don't want to be held to the restrictions that come with the accounting method, such as stock buybacks, the disposal of certain assets, and changes in capital structure. Furthermore, the Financial Accounting Standards Board recently decided that companies might not have to amortize goodwill to earnings after all. "...some of what is recorded as a goodwill asset does not decrease in value," said FASB chairman Edmund Jenkins in a December 6, 2000, news release. The new approach will make the purchase accounting method far less onerous to companies making acquisitions.

The Euros Are Still Coming

Despite the fact that the euro lost about a quarter of its value during the year, European firms continued to be major buyers on this side of the Atlantic, spending a total of $299 billion, or 21 percent more than last year, for U.S. firms. "The European firms saw their own currency weakening, and just felt they had to get
involved here," says Tom Burnett, president of Merger Insight Inc., a New York­based institutional research service firm. Financial service firms were particularly popular targets, with Zurich-based Credit Suisse First Boston acquiring Donaldson Lufkin & Jenrette, Geneva's UBS Warburg taking Paine Webber Inc., and Italy's Unicredito paying cash for asset manager Pioneer Group at a 40 percent premium.

The flood of foreign companies listing on the New York Stock Exchange last year suggests their buying spree isn't over yet. U.S.-denominated stocks, while not inherently more valuable, make a more attractive currency for U.S. shareholders, because there's greater visibility and access to data about the stock, says Burnett. "They want to have an acquisition currency they can use." European firms, however, were among the few willing to pay cash for acquisitions. Unilever Plc, the Netherlands-based food company, forked over $20 billion in cash to purchase Englewood Cliffs, New Jersey­based Bestfoods. And Deutsche Telekom included $6.4 billion of cash in its $46.6 billion offer for VoiceStream. Most of the large deals last year involved stock swaps. Overall, 46 percent of transactions were stock-only, while 65 percent involved at least some stock.

U.S. firms, on the other hand, clearly shied away from the Old World. As such large corporations as Gillette Co. and DuPont reported weak sales abroad, and huge losses due to foreign currency translation, the pace of U.S. acquisitions in Europe slipped by more than 10 percent over the previous year, to $87.7 billion. "If you take a look at the change in the dollar, a lot of executives are focusing on their export volumes declining," says Frederick M. Shepperd, managing partner of Akron-based Quadral Group Ltd., an international consulting group. "Rather than increasing market share through acquisition in Europe, they're actually closing down their offices and heading home."

Would-be U.S. buyers may be worried about more active European Union regulators. Led by Mario Monti, who took office in September 1999, the EU's Competition Department sifted through more than 50 U.S.-based deals, forcing such companies as Sara Lee Corp., The Dow Chemical Co., and Alcoa Inc. to divest assets in order to complete acquisitions. For example, Time Warner was forced to give up on its acquisition of British music concern EMI Group to gain clearance for its merger with AOL. Some companies, notably Sprint and MCI WorldCom, abandoned their deals altogether because of regulatory demands.

"The FTC and the Justice Department, combined with the EU, played a much more meaningful role last year," says Richard Leaman, a managing director at UBS Warburg. "The marquee deals are getting an enormous amount of scrutiny." As this issue of CFO went to press, the EU was reviewing the GE/Honeywell deal.

As for next year, neither the EU nor the FTC is expected to regulate the air out of this astounding M&A market. The problem is the capital markets. Stock prices are down, and the corporate bond market is still deteriorating, making deals much harder to finance. And with investors ever more skeptical about merger-related synergies, selling those deals could prove a lot more difficult this year. "With the markets as jittery as they are, we're anticipating a smaller number of transactions and lower aggregate volume," says Merger Insight's Burnett.

The party couldn't last forever.

Alix Nyberg is a staff writer at CFO.

Top 10 Deals for 2000

"Value" is based on base equity price of offer at announcement.
Source: Mergerstat (as of 11/27/00)

BuyerSeller Value ($ bill.)
America OnlineTime Warner$165.9
General ElectricHoneywell International$44.2
Deutsche TelekomVoiceStream Wireless$41.6
JDS UniphaseSDL$38.1
Chase ManhattanJP Morgan$36.5
ChevronTexaco$35.7
CitigroupAssociates First Capital$30.7
FirstarU.S. Bancorp$20.99
UnileverBestfoods$20.2
JDS UniphaseE-Tek Dynamics$17.4

Top 10 Sectors for U.S. Deals

"Aggregate value" is based on base equity value at time of announcement. The figure for the leisure and entertainment sector includes AOL/Time Warner, valued at $165.6 billion.
Source: Mergerstat

Sector Total Deals ($ bill.) Aggregate value
Leisure & Entertainment254$182.2
Computer Software, Supplies, & Services2,362$151.3
Banking & Finance277$125.1
Electronics217$98.2
Communications (including telecom.)445$82.7
Brokerage, Investment, & Mgmt. Consult.485$79.1
Food Processing101$66.1
Oil & Gas82$63.6
Electric144$51.7
Electrical Equipment276$50.8

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