Watch for a Different Kind of Merger in 2008
Editor's note: Falling home prices and subsequent defaults on mortgage-backed securities led to a credit and liquidity crisis that's seized up financial markets since mid-2007, and it's only getting messier in 2008. This is the fifth installment in an occasional series about how the tumult in the credit markets will affect the economy and the markets throughout the year.
Finally, a big tech merger deal has come along to break the glum M&A mold on Wall Street.
Until news broke Wednesday morning that Oracle (ORCL) will buy BEA Systems (BEAS) for $8.5 billion, none of the deals or capital infusions announced thus far this year produced much of a boost for the target company's stock price or for the stock market as a whole.But while the market shrugged at major capital injections for mortgage- and credit-hammered banks like Citigroup (C) and Merrill Lynch (MER) earlier this week, BEA's strategic deal news was aiding the stock. Shares were rising back to near their price when Oracle first said it would buy BEA, which could, perhaps, signal that corporate strategic deals could supplant credit-reliant private-equity buyouts as the deal of choice in 2008. The blasé attitude toward M&A in 2008 marks a far cry from 2007's bullish merger Monday rallies and buyout betting. A toxic combination of trends converged to stall the M&A freight train since the subprime mortgage debacle spawned a credit crunch that gripped markets last summer. Banks have tightened up their lending standards as a backlog of leveraged buyout-related debt remains hung on their balance sheets alongside unsavory mortgage-backed securities and derivatives. Risk premiums in the high-yield debt markets have also more than doubled since last summer, making borrowing costs expensive for companies that may need to leverage themselves in a buyout. And, profit declines and expectations for economic weakness have meant some of 2007's blockbuster deals fell through, leaving a bad taste for investors who'd done well betting on the underlying M&A "bid" that kept stocks on the rise in 2006 and 2007. "The trend of slowing M&A activity will continue into 2008," writes Brad Hintz, financial sector analyst at Sanford Bernstein. He expects that M&A advisory revenues for Wall Street firms will fall 20% in 2008. Last year's worldwide M&A volume reached a record $4.5 trillion, according to Thomson Financial. BEA's acceptance of $19.38 a share from Oracle helped the market buck the trend Wednesday morning, as the company's shares jumped more than 19% to $18.60 and were climbing toward the takeover stock price. That's a far cry from the recent stock price declines by Citigroup and Merrill Lynch, despite Tuesday's international capital infusions that are to provide $12.5 billion to Citi and $6.6 billion to Merrill. Of course, both firms are raising the capital to shore up balance sheets decimated by billions of dollars in writedowns to the value of their portfolios of mortgage-related securities. Countrywide Financial's (CFC) stock price likewise languished, despite Bank of America's (BAC) decision late last week to buy the threadbare mortgage lender in a deal valuing shares at $7.16 apiece, or $4 billion. Even a less controversial target like Bright Horizons Family Solutions (BFAM), a child care and education provider that private equity shop Bain Capital agreed to buy for $1.27 billion, remains 7% below the takeover price. The deal, announced Monday, values Bright Horizons at $48.25 per share, but the stock is down slightly at $44.87 per share Wednesday.
Strategic Deals Poised for a ComebackThe BEA deal not only strikes a hopeful tenor in the market, but also may point to a resurgence of strategic dealmaking taking the place of leveraged buyouts as the more dominant force in a year when M&A activity is expected to slow dramatically. According to Hintz, LBO activity is expected to drop by 30% in 2008, as poor economic conditions pressure highly leveraged companies. Indeed, amid a possible recession, the corporate default rate is expected to rise to 4.8% this year from a near-record low of 0.9% in December, according to Moody's Investors Service. Corporate strategic deal volume, on the other hand, is likely to fare better, with only a 10% decline in 2008.
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