Consolidation - Mergers and acquisitions could boom again next year

LIKE every other business activity nowadays (except bankruptcy-advisory work) merging and acquiring companies (M&A) is in a deep slump. Last week BHP Billiton, a mining giant, withdrew from its planned hostile acquisition of Rio Tinto. This is part of a trend of corporate grooms abandoning their would-be wives at the altar. According to Thomson Reuters, that takes the total value of cancelled mergers so far in this quarter to $322 billion, a two-year high and almost as much as the value of completed mergers in this quarter ($362 billion). Read original article.

Another study, by UBS, found that one-third of the deals announced in America this year have been terminated before consummation. And the number of proposals is down overall this year. Worldwide, the value of mergers and acquisitions completed so far in 2008 is $2.8 trillion, down by 27% from the same time last year.

Shares in Rio Tinto plunged by 37% after BHP withdrew its offer, which suggests it was a wise decision to pay whatever break-up fees it will incur. The general plunge in share prices will cause many bidders to rethink offers that seemed reasonably priced only a few months ago.

Although BHP had secured the necessary debt—a luxury available to few would-be bidders now—it was concerned that taking it on would worry its investors, especially given the uncertainty about when credit markets will be liquid enough to allow existing debt to be refinanced. Moreover, to please antitrust regulators, BHP would have had to sell off various bits of the combined business, and in the current climate it had no confidence that it would be able to find buyers (at least not at anything resembling a decent price). Since calling off the acquisition, the price of insuring BHP against default has fallen sharply.

There is now speculation that two other multi-billion dollar deals will be called off. The acquisition of BCE, a Canadian telecoms giant, by private-equity firms seems in extreme peril, following “preliminary” comments by its auditors that the amount of debt the buyers intended to impose on the firm would render it insolvent. Roche, a big drugs firm, insists it will complete its $43.7 billion acquisition of Genentech, but this claim is being met with increasing skepticism.

That is now. But what will happen when confidence returns to the financial markets and good deals can get funding? At current share prices, attractive targets abound. Industry troubles will likely make private-equity firms more enthusiastic sellers than buyers, creating a big opportunity for companies to do “strategic” M&A—buying their weaker rivals, cutting costs and so forth. This was much harder when private equity could borrow as much as it wanted and so pay often daft prices.

At the same time, the economic downturn will make weaker firms more willing to accept offers than they were in good times. Jumping into bed with a strong suitor is a more appealing prospect than lonely bankruptcy.

In short, when the M&A business re-opens, which, given the speed of mood changes in financial markets, may be sooner than the current gloomy consensus thinks, it will be a buyer’s market. Do not be surprised if many buyers are those firms that recently called off their proposals, only to find themselves delighted to rekindle an old flame.