Cash-Rich Firms Snare Rivals In Flurry Of Deals

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A lack of financing from skittish banks continues to keep a lid on private equity deals. But cash-rich firms are willing to make strategic buyouts where they see value.

Germany's Merck said Sunday it will pay around $6 billion to buy U.S. biotech equipment maker Millipore (MIL) and expand the German firm's presence into life sciences.

Meanwhile, British insurer Prudential (PUK) said Monday it will buy the Asian unit of bailed-out American International Group (AIG) in a transaction worth $35.5 billion. That will let AIG pay back some of the money it owes the government.

Prudential's shares tumbled on the huge deal, which will require a $20 billion rights issue, but the acquisition will turn the British firm into Asia's top life insurer.

As of March 1, global M&A dollar volume for the current quarter was $374 billion, says Thomson Financial (see chart). Last year, total Q1 dollar volume was $515.4 billion, helped by three blockbuster deals in the pharma sector. In 2008, first-quarter volume was $528.2 billion.

Private Equity Subdued

But there continues to be a dearth of large-scale private equity deals. A rare exception was the recent announcement that Thomas H. Lee Partners will buy CKE Restaurants (CKR) for about $619 million in cash. CKE owns the Carl's Jr. and Hardee's franchises.

Private equity deals began to drop off during Q4 2008, when the global financial crisis froze up capital markets.

"Private equity needs financing from banks, and that really hasn't thawed out," said Roger Aguinaldo, CEO of M&A Advisor. "The credit markets are still frozen for the most part. The banks aren't lending on large transactions unless there's a lot of equity in the deal."

Last year the dollar value of private equity deals ranged from $10 billion to $25 billion a quarter, according to data from mergermarket, an industry tracker. That compares with $50 billion to $200 billion a couple of years earlier.

Aguinaldo, a former investment banker with Merrill Lynch, says the current environment leans much more heavily to strategic buyouts.

"You're seeing a lot of companies with plenty of cash on their books, and they need somewhere to put the cash," he said. "You're going to see a lot of players go out and buy companies now, when valuations are more reasonable."

I'll Take Manhattan

An example is Walgreen's (WAG) recent acquisition of New York-based smaller rival Duane Reade. The $1.08 billion deal, announced Feb. 17, will give Walgreen a quick, easy and not terribly expensive route to market leadership in the Big Apple.

The deal includes $618 million in cash and the assumption of $457 million in privately held Duane Reade's debt.

Duane Reade has 257 stores in the Big Apple. It logged $1.8 billion in sales last year. Most of its stores are in Manhattan. Walgreen, the No. 1 U.S. drugstore operator, has only 13 stores in Manhattan.

In a report following the buyout, Morningstar analyst Matthew Coffina noted that the acquisition price was around 60% of Duane Reade's 2009 sales and 11 times its adjusted EBITDA.

"These multiples seem rich relative to Walgreen's current market value, but are reasonably consistent with our fair value estimate for Walgreen," Coffina wrote. "We also expect Walgreen to achieve meaningful distribution and purchasing efficiencies and back-office synergies through the acquisition."

Duane Reade found a way to get out from under its debt load.

"Duane Reade might have gotten ahead of itself in terms of expansion," Aguinaldo said. "Remember, growth is not cheap. You need the fuel to grow, and if you don't have it you need outside capital from banks, equity investors, etc. If that's not coming in, you may be forced to sell."

Liquid Deals Solidify Dominance

Similar to Walgreen, Schlumberger (SLB) is looking to solidify its top spot in oil-field services with its recently announced plan to buy Smith International (SII) for $11 billion.

With around $23 billion in annual revenue, Schlumberger already ranks well ahead of No. 2 Halliburton, with about $15 billion in yearly sales. Smith, renowned for its drill-bit technology, has around $8 billion in annual sales.

The deal might face close regulatory scrutiny because of rapid consolidation in the oil-field services sector. That includes Baker Hughes' (BHI) buyout of No. 4 oil-field services firm BJ Services (BJS).

On a conference call with analysts, Schlumberger CEO Andrew Gould said he had been mulling the acquisition "for some time." He also conceded that his firm paid "a significant premium."

Wall Street seemed to agree. Schlumberger shares fell more than 4% during the days after the announcement. Smith shares shot up almost 9% during the first session.

Strategic buys have also been on the minds of PepsiCo (PEP) and archrival Coca-Cola (KO).

Last week Coca-Cola surprised Wall Street by announcing it will buy the North American operations of bottler Coca-Cola Enterprises(CCE). That followed previous moves by Pepsi to buy bottlers Pepsi Bottling Group and PepsiAmericas.

The most high-profile takeover of 2010 has been Kraft Foods' (KFT) $19.5 billion Cadbury buy. That deal was finally struck on Jan. 19 after months of haggling.

Other announced deals include Yara International's $4.1 billion offer for fertilizer maker Terra Industries (TRA). Earlier, CF Industries (CF) pursued a hostile takeover of Terra before backing off in January.

Meanwhile, real estate developer Simon Property Group's (SPG) $10 billion bid for General Growth Properties, announced Feb. 16, has run into problems. General Growth officials rebuffed that offer.

They later struck a $2.6 billion equity deal with Brookfield Asset Management that will allow General Growth to exit Chapter 11 bankruptcy. Simon reportedly has not abandoned its pursuit of General Growth.

Recent news reports also suggest that United Airlines (UAUA) and US Airways (LCC) might be open to a merger.

The year's first big deal came Jan. 4, when drugmaker Novartis (NVS) announced plans to take control of Alcon (ACL), which makes eye-care products. Novartis paid more than $38 billion for the 77% stake it didn't already own in Alcon.

Fewer Big Pharma Deals Seen

That deal raised hopes in some quarters of another robust year of M&A in the drug industry. The first three months of 2009 saw three blockbusters: Pfizer's (PFE) $63 billion buyout of Wyeth, Roche's (RHHBY) $44 billion buy of Genentech and Merck's (MRK) $43 billion takeover of Schering-Plough.

Industry watchers expect to see much less action in 2010.

"The Big Pharma merger wave is over until 2012 or 2013," said Les Funtleyder, analyst at Miller Tabak. "A lot of what happened last year was related to depressed valuations, and they're not so depressed anymore. So things are kind of in a holding pattern right now."