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2012 Deals Hinge on Goldman Sachs' Idea of 'Fairness' (Update 1)

Updated to include additional M&A data, analyst research and closing share prices

NEW YORK ( TheStreet) -- Should investors beware of big takeover bids bearing a share premium? For Goldman Sachs (GS - Get Report), the answer increasingly signals an emphatic "yes."

A flurry of recent high-priced bids from big-league buyers such as Roche, Martin Marietta (MLM) and Carl Icahn have all been given the thumbs down by Goldman as the Wall Street bank offered less than favorable "fairness opinions" on the bids.

While shareholders are the ultimate arbiter of whether a bid is fairly priced, those deals reveal that Goldman Sachs is becoming more vocal on M&A prices and the management of the targeted companies are more than happy to use Goldman's word to scuttle a deal in hopes of a higher offer or an earnings recovery.

A fairness opinion is given by an investment bank as an independent analysis that should help shareholders sort between what is a fairly valued bid and what is opportunism.

So far, Goldman has seen a lot of opportunism. In three of the largest hostile offers of 2011 and early 2012, Goldman Sachs investment bankers have urged company managers and shareholders to turn down bids, with the expectation that either share price gains or a stronger offer would be available in the future.

The near $5 billion recent hostile offers for both genomics machinery maker Illumina (ILMN - Get Report) by Roche and construction aggregates giant Vulcan Materials (VMC - Get Report) by Martin Marietta were considered "inadequate" by Goldman Sachs.

The bank has also taken a dim view on premium priced offers from activist investor Carl Icahn for Clorox (CLX - Get Report) in 2011 and Commercial Metals (CMC) earlier in the year.

In each case, Goldman's opinion spurred management to reject an offer to often messy but still uncertain results.

With many hostile offers now coming toward an offer price nexus or previously announced negotiating deadlines, watch for bid boosts or deal breakups to be a strong indicator for both M&A activity and takeout premiums, which were a key to share gains for many investors in 2011.

Overall, the market for deals has slowed in 2012, even after Glencore's mega merger with Xstrata earlier in Feb. January was the worst month for M&A globally since Aug. 2009, according to Dealogic data.

Nevertheless, M&A premiums and markets are on the rise almost two months into the new year. Acquirers have paid a 42.9% premium for U.S. companies in 2012, according to Bloomberg data, a lift compared with the 31.1% premium paid in 2011. Meanwhile, the markets hit a major post-crisis milestone on Tuesday when the Dow Jones Industrial Average briefly eclipsed 13,000 for the first time since 2008.

For more on activist M&A, see 5 deal ready stocks loved by hedge funds and Carl Icahn's portfolio. For more on Goldman Sachs, see financial stocks bought and sold by hedge funds.

After German pharmaceuticals giant Roche offered Illumina $44.50 a share in January, analysts and investors reacted to the bid by signaling that a bidding war might emergy for the company among large players like Johnson & Johnson (JNJ) and Becton Dickinson (BDX), pushing shares far higher. Nevertheless, Roche maintained that its bid represented an over 60% premium to Illumina's shares prior to deal rumors and stated that it wouldn't increase the offer.

In February Illumina enacted a poison pill to thwart Roche from building a large share stake and it rejected the unsolicited offer, citing a fairness opinion from Goldman Sachs showing the underpricing of the takeover bid. Some shareholders are now suing Illumina for not further considering the bid, while reports indicate that Roche may extend the tender offer that's set to expire on Feb. 24.

Even with Illumina's aversion to a takeover, the company's shares are far higher than Roche's bid, signaling expectations of an offer increase, a competing bidder or a longer-term earnings boost. Illumina shares have maintained a near 15% premium above Roche's offer price, while consensus analyst estimates polled by Bloomberg give the company a $56.07 price target, signaling that Goldman and co-adviser Bank of America Merrill Lynch (BAC) are correct to advise management to hold out.

A similar dynamic played out in Martin Marietta's December all-stock offer for Vulcan Materials, which would give 0.5 Martin Marietta shares for each Vulcan share. Though the bid represented a 15% premium, Vulcan's management rejected the bid citing price opportunism that was confirmed by a bid inadequacy opinion from Goldman Sachs.

Analysts and investors seem to agree with Vulcan management and its bankers that the company will soon benefit from a construction recovery that will bolster its business of producing aggregates for buildings and roads, or that a more lucrative share offer is in store.

Currently, Vulcan Materials share prices of $46.12 indicate a higher than 0.5 share conversion, supported by a price target of $45.71, according to consensus estimates of analysts polled by Bloomberg.

Vulcan Materials' third largest shareholder Southeastern Asset Management with nearly 10% of the company's shares urged other investors to accept the takeover offer in January. The investment fund, which also owns over 13% of Martin Marietta's stock, said that if Vulcan doesn't resume merger talks, it will nominate a hostile slate of directors to move the bid forward.

To fight off a takeover, Vulcan Materials plans to sell $500 million in assets in the next 18 months to improve tis liquidity, balance sheet and restore its dividend, which was cut to 1 cent from 25 cents in 2011.
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