Sunday, May 20, 2007

Mergers and Acquisitions

by Calculated Risk on 5/20/2007 11:34:00 PM

Another day, another deal. The WSJ reports: TPG, Goldman Acquire Alltel

TPG Capital LLP and the private-equity arm of Goldman Sachs Group Inc. Sunday night agreed to purchase wireless operator Alltel Corp. for about $27.5 billion, in the largest foray yet of private-equity money into the wireless business.
Research has shown that "merger waves", especially M&A activity involving stock transactions, happen during periods of market overvaluation (see Rhodes-Kropf and Viswanatan, Market Valuation and Merger Waves). The NY Times quoted Professor Rhodes-Kropf last December:
“Periods of high relative valuation are nearly always associated with high M.& A. activity, and the stock market has fallen after each major merger wave.”
Of course much of the current M&A activity is private equity LBOs using OPM (Other People's Money). Greg Ip writes in Friday's WSJ: Fed, Other Regulators Turn Attention to Risk In Banks' LBO Lending
Banks have been major players in the surge of takeovers, both as lenders to and investors in buyout targets. ... Regulators see signs of that in LBO lending, particularly in what is known as "bridge" financing, or the temporary credit that serves as a stopgap between the buyout and longer-term financing.

LBO loan volume hit $121 billion last year, compared with $31 billion in 1998, the peak of the previous cycle, according to Standard & Poor's Leveraged Commentary & Data. Volume this year has reached $88 billion, more than double the year-earlier period. Meanwhile, interest-rate spreads have fallen to their lowest levels ever, and loan restrictions have been loosened.

"There are some significant risks associated with the financing of private equity, including bridge loans, [and] we are looking at that," Federal Reserve Chairman Ben Bernanke said in response to questions at a Chicago conference [last Thursday].
Rhodes-Kropf addressed this issue in the NY Times article:
Professor Rhodes-Kropf cautions stock-market investors not to take solace in that difference [between stock and debt financing]. “To the extent the current merger wave reflects an overvalued debt market, it stands to reason that it will eventually correct — just as overvalued stock markets eventually correct,” he said. “And it can’t be good news for the stock market if money is destined to become much tighter in coming years.”
And Ip describes a prior case of "bridge" financing gone bad in the WSJ:
In a famous event dubbed the "Burning Bed," First Boston Corp. in 1989 made a $457 million bridge loan to the purchasers of Ohio Mattress. When the junk-bond market collapsed soon afterward, First Boston couldn't refinance the loan and ended up owning most of Ohio Mattress. Credit Suisse had to inject additional capital into First Boston, culminating in a full takeover.
I try not to comment on the stock market on this blog (just the economy), and this isn't to say I expect an imminent market correction in stocks or bonds. In fact the "merger wave" might still have legs. China just took a $3 Billion position in private equity firm Blackstone, so maybe there will be plenty more money for M&A investments. See the Financial Times: Beijing to buy stake in Blackstone

Yet, for some reason, all this activity reminds me of the ill-fated Time Warner-AOL merger that happened in January 2000. That merger never made sense to me. In this case, if debt is so "cheap", why are these LBOs using so much bridge financing?