What the Spike in Mergers Means for the Economy

In late April, large mergers and acquisitions—friendly, hostile, cash, stock— blossomed like daffodils. On Monday, April 20, Oracle said it would buy Sun Microsystems for $7 billion. The same day, Pepsi bottled up two of its largest bottlers for $6 billion, and drug giant GlaxoSmithKline struck a $3 billion deal to acquire Stiefel Laboratories, a specialist in skin-care products. "The activity is very positive," said Steven Kaplan, a corporate-finance expert at the University of Chicago. "More deals means we are no longer falling." Companies don't make acquisitions unless they have some confidence in the future, he notes.

Deals are like Viagra for the stock market, especially hostile unsolicited offers—like the one chip-designer Broadcom made for Emulex, which makes network gear, on April 21. Traders and longtime stockholders love them because they can ignite exciting, profitable bidding wars. Analysts view acquisitions as excellent barometers for the level of testosterone and optimism in the markets, a gauge of what economist John Maynard Keynes called "animal spirits." Perhaps most important, deals throw off fees to all involved, from the investment banker (whose role consists largely of saying "Great idea, dude") to the companies that make the little gewgaws distributed when transactions close.

Since the fall of 2007, the markets have been in dire need of the mood elevator that dealmaking frenzy provides. When credit was cheap and plentiful and when stock prices were high (remember the halcyon days of 2007?), corporate empire builders had plentiful currency with which to conduct deals. Nine of the 10 largest leveraged buyouts in history were announced between July 2006 and July 2007. In the glory days, 11-figure deals were commonplace. But in the fourth quarter of 2008, U.S. deals announced were the lowest they had been since late 2003, and 75 percent below the high-water mark of mid-2007, according to Thomson Reuters.

While the volume of deals is rising, it might not augur a return to exuberance. During the boom, many of the biggest takeouts were offensive—pulled off by companies seeking to break into new markets, or by swashbuckling private-equity magnates with imperial designs. But today's deals seem more defensive. In early 2008, CEOs of blue-chip companies would acknowledge the U.S. was slowing, but would crow about their results in China, India or Brazil—markets that were growing by leaps and bounds. No longer. The International Monetary Fund warned in late April that the global economy would shrink by 1.3 percent this year. Rather than being decoupled from the U.S., the rest of the world is following America into recession. And when you don't have much hope of organic growth, the corporate playbook reads, you buy it.

By purchasing two of its bottlers, Pepsi Bottling Group and PepsiAmericas, Pepsi isn't looking to break into new markets or diversify. It's seeking to save money: the release described "annual pre-tax synergies estimated to be more than $200 million"—i.e., cost savings.

In addition, much of the rising volume of deals seems to be confined to a few sectors. "There's a resurgence in M&A if you confine it to tech and pharma companies with cash, and that's a very small universe," said Steven Davidoff, a law professor at the University of Connecticut perhaps better known by his nom de blog: the Deal Professor.

Multinational tech and pharmaceutical companies face a common dilemma—once you're huge, it's tough to consistently churn out new innovations that can add meaningfully to revenues. Larry Ellison, the CEO of Oracle, has evolved from enfant terrible into a sort of J. P. Morgan of the software industry (right down to the giant yacht)—a consolidator rather than an innovator. In the past four years, Oracle has purchased at least four dozen companies, including PeopleSoft and Siebel Systems, Silicon Valley high fliers that had been laid low. Now Ellison is presenting an encore with Sun Microsystems.

Drug companies face an even bigger challenge, as blockbuster prescription drugs continually lose patent protection, and as pinched consumers start to skimp on pills, creams and treatments. Mega-deals in the drug sector—the recently announced nuptials between Pfizer and Wyeth, and between Merck and Schering-Plough—have accounted for a big chunk of this year's deal volume. "The value driver for pharmaceuticals is new drug development, and there really hasn't been much lately," says Les Funtleyder, an analyst with Miller, Tabak and author of the book "Healthcare Investing."

And so, as with so much else in the economy at large, the news that comes out on Mondays isn't unambiguously good. (Dealmakers love to hash out agreements over the weekend.) The volume of deals is on the rise, but so far they're mostly defensive moves that don't require much in the way of financing from the still-dysfunctional credit markets. Many of them will bring job cuts. And yet optimists can take heart. With all the hoarding going on, many companies are in a position to purchase growth. Cisco Systems, for example, has $30 billion in cash on its books. The components of the S&P 500 had $654 billion in cash at the end of 2008. When they prove willing to spend it in larger chunks, rather than continue to sock it away for a rainy day, that might be a sign that the forecast is brightening.

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