These are bleak times for deal-makers. The value of global merger & acquisition (M&A) deals transacted last year is barely a third of its level three years ago, when world stock markets came thundering to earth.
According to research by JP Morgan, global M&A activity for 2003 was flat at US$1,3 trillion, against 2002's $1,2 trillion. However, the number of deals transacted was down 25%, according to KPMG. The picture is little different in SA. According the latest Ernst & Young Review of Mergers & Acquisitions, the number of deals is on a par with 2002, but the value of these deals has fallen for two consecutive years.
There was an encouraging turnaround in the second half of 2003, when deal activity increased, boosted by rising equity prices, low interest rates and a rush by white business to secure empowerment partners.
The rebound in global equity prices last year brought deal-makers out of hibernation, prompting the Financial Times to trumpet the return of the megadeal. The scale of some of these deals brings back fond memories of the 1990s. JP Morgan Chase put in a $59bn bid for Bank One in January; Bank of America offered $47bn for FleetBoston last year; and Comcast recently lodged a $66bn bid for Walt Disney.
The three-year global economic downturn left many companies in financial distress and others with spare capacity - conditions ideal for M&A. All that was required to set the ball rolling was a recovery in equity prices.
Though global M&A activity showed signs of convalescence last year, no-one expects a prompt return to the giddy levels of 2000. The world has changed since then. Weaker equity markets devalued the universal currency of deal-makers, and a string of accounting scandals, from Enron to WorldCom, stirred regulators into action. The Sarbanes-Oxley Act in the US enjoined a clear separation of audit and consulting practices among accounting firms to prevent the kind of conflicts that sunk Enron's audit firm, Arthur Andersen.
In SA, the King code on corporate governance establishes guidelines for separating audit and consulting functions within the accounting profession, but stops short of recommending a complete unbundling.
It's not just regulators who are applying the brakes on M&A activity. Shareholders, too, are losing patience with deal-happy executives. In the 1990s investors asked few questions about executive remuneration and corporate governance so long as they were getting rich on the back of the M&A frenzy. They cared little that many of these deals were structured to enrich the executives so long as they got to share in the spoils.
All that changed with the collapse of Enron. Many of the deals of the 1990s have since been unwound, and many more failed to deliver the promised synergies. Given the public outrage over Enron, investors are understandably suspicious of mergers promoted by their sponsors on the basis of earnings growth.
Buyers are not willing to pay excessive premiums for acquisitions, according to Ernst & Young Corporate Finance director Dave Thayser. There is far greater scrutiny of potential liabilities in the target company, some-thing eager buyers have been accused of overlooking in the past.
Institutional shareholders, particularly, have taken a more direct role in vetoing boardroom excesses.
A case in point is Nedcor, where 53% parent Old Mutual engineered a boardroom reshuffle as the price for stumping up its share in the bank's upcoming R5bn rights issue. This comes after a catalogue of ills were laid bare in the bank's latest results, including revelations that it had overpaid by about 10%, or R700m, for BoE.
One positive outcome of the Enron saga is the tightening of accounting and corporate governance standards. Directors are being held to account for their boardroom lapses, as shown by the fallout at Nedcor.
RMB corporate finance head Herman Bosman says portfolio managers place a much higher premium on corporate governance than they did a few years ago. "There's been a flight to quality among institutional investors, so those companies paying attention to corporate governance issues enjoy a higher market rating, making it easier for them to do deals."
Undoubtedly, one reason for the slowdown in local M&A activity is the thicket of regulations companies must negotiate before a merger. Investec SA joint MD Andy Leith says competition commission approval can take three months, long enough to expose a transaction based on relative share prices to a high degree of market risk. "Where the deal is settled in cash, these delays often mean the buyer has difficulty obtaining institutional commitment before the transaction's approval. Many deals don't even get out of the starting blocks. We're in favour of competition legislation, but would like to see quicker decision making, and we've also seen it used to frustrate transactions that have merit."
A notable feature of the M&A market over the past year was the emergence of private equity players as deal-makers. According to KPMG, in Western Europe private equity now accounts for 13% of M&A activity by value (3% in 2000) and 11% by volume (6% in 2000). Globally, the proportion of private equity-backed deals is also rising and now accounts for 10% of M&A deal value from 2% in 2000. Private equity funds with spare cash pounced once the price of listed target companies fell within range. In SA, many of the large delistings of recent years - among them Foodcorp, Fedics, Waco and Logical Options - were engineered by private equity funds such as Ethos and Brait.
More than 200 companies delisted from the JSE over the past three years, many of them small companies that failed to attract investor interest after the rout of the small-cap sector in the late 1990s. This is good news for deal-makers, who make money advising companies on whether to list or delist. They have been criticised for overpromoting IPOs when conditions are favourable, and then encouraging these same companies to delist when conditions turn sour. The larger corporate finance houses say most of the failed listings were promoted by small boutiques, many of which have since disappeared. Telkom was the most notable addition to the JSE in 2003, and its 160% appreciation since then made it one of the exchange's best performers of the year.
As part of a strategy to attract companies back to the exchange, the JSE last year launched AltX, a separate market targeting small, start-up and empowerment companies. Though no profit history is required and listing fees are lower than for a main board listing, AltX companies must comply with rigorous corporate governance standards, one of the lapses that contributed to the poor showing of the development capital and venture capital boards, both of which will be phased out this year.
AltX companies must appoint a designated adviser to ensure compliance with JSE rules and other regulations. These advisers must adopt a more hands-on approach than required for main board company sponsors. For example, they must appoint a financial director, attend board meetings and sign off official announcements.
Two companies have so far listed on AltX and several more are in the pipeline, according to JSE CEO Russell Loubser.
