M&A to Decline 30% in 2009 as Government-Forced Deals Dominate

By Ambereen Choudhury and Jonathan Keehner

Dec. 8 (Bloomberg) -- Forced sales demanded by creditors and government-brokered transactions may provide the only consolation for bankers in what promises to be the slowest year for mergers and acquisitions since 2004.

Bankers at Barclays Capital and Nomura Holdings Inc. say the value of deals may decline 30 percent in 2009 to about $2 trillion. Takeovers so far this year are down 36 percent from the same period in 2007, reducing the fees paid to banks by 34 percent to an estimated $63 billion, according to data compiled by Bloomberg and New York-based research firm Freeman & Co.

“These are the worst conditions for many years, as bad as or worse than the early 1990s, perhaps as bad as the mid-1970s,” said Philip Keevil, 62, senior partner in London at Compass Advisers LLP and former head of European mergers at Salomon Smith Barney Inc. “There will be a flood of strategic deals in the new year out of necessity, including government-forced mergers among banks and insurance companies.”

More than a third of the 20 biggest acquisitions announced in the fourth quarter were government-induced, Bloomberg data show. The Dutch government took control of Fortis’s assets in the Netherlands after Belgium’s largest financial-services company ran out of short-term funding in October. Paris-based BNP Paribas SA, France’s biggest bank, acquired units from Brussels-based Fortis in Belgium and Luxembourg. The Kremlin is pushing for banks to merge, including the possible combination of MDM Bank and Ursa Bank to form Russia’s second-largest private lender.

“Governments will be acting as arbitrators and twisting people’s elbows if necessary,” said Frederick Lane, 59, a former co-head of mergers at Donaldson, Lufkin & Jenrette who now runs Boston-based Lane Berry & Co.

Gloomy Forecast

American International Group Inc., the New York-based insurer controlled by the U.S. government, is under pressure to sell about $60 billion of assets. New York-based Citigroup Inc., which has received $45 billion in federal cash, plans to find a buyer for its Japanese trust-banking unit. And Royal Bank of Scotland Group Plc, 58 percent-owned by the U.K. government, may shed its insurance operations and a stake in Bank of China Ltd.

“In Europe, any major consolidation is likely to come from government-sponsored rescues,” analysts led by Stefan Slowinski at Paris-based Societe Generale SA wrote in a note to clients last week. “Banks that can think about expanding outside of government rescues will do so on a piecemeal basis.”

The Societe Generale analysts offered an even gloomier forecast than the ones from London-based Barclays and Nomura in Tokyo: They say completed deals next year may drop to 4,000 from 8,000 this year, the lowest level since 1995.

Circuit City, Woolworths

A combination of declining revenue and rising borrowing costs may drive companies to shed assets at low prices. Buyers are picking over the remains of Circuit City Stores Inc., the second-largest electronics retailer in the U.S., and century-old London-based Woolworths Group Plc after both collapsed in November. Three U.S. automakers seeking $34 billion in federal funds also may have to sell units.

The collapse of New York-based securities firm Lehman Brothers Holdings Inc., which in September filed the largest bankruptcy in U.S. history, raised corporate borrowing costs to the highest level since at least 1999, according to indexes compiled by Merrill Lynch & Co. That has limited the appetite of companies for mergers and acquisitions and jeopardized the ability of some to repay debt maturing next year.

Borrowing has never been so expensive for U.S. companies with non-investment-grade ratings -- below Baa3 at Moody’s Investors Service and BBB- at Standard & Poor’s -- Merrill indexes show.

Record Borrowing Costs

Bond buyers increased the extra yield they charge non- investment-grade companies to 2,054 basis points, or 20.5 percent more than government debt last week, the highest level since Merrill started collating daily data almost a decade ago. Investment-grade companies are paying a record 655 points more than similar-maturing government debt, the indexes show. A basis point is one-hundredth of a percentage point.

“In this environment, it isn’t unusual to see an otherwise strong company be crippled by both a downturn in its business, and a liquidity crisis,” said Paul Parker, the New York-based head of M&A at Barclays Capital, which bought Lehman’s North American investment-banking unit in September. “Default rates will continue to rise over the foreseeable future and will lead to meaningful restructuring of many companies.”

That may provide an opportunity for leveraged buyout firms. Blackstone Group LP and Apollo Management LP, both based in New York, are among the companies investing in distressed debt.

‘Turing to Distress’

“Everyone is turning to distress and proffering that it may be one of the best opportunities,” said Thomas Barrack, founder of Los Angeles-based investment firm Colony Capital LLC. “The problem is that everyone who has invested on that basis during the past 12 months has been wrong.”

Prices for high-risk, high-yield loans in the U.S. dropped to 67 cents on the dollar in December from about 90 cents in April, when firms including Apollo and Blackstone negotiated to buy more than $12 billion of debt from Citigroup, the fifth- biggest U.S. bank by market value, and Deutsche Bank AG, Germany’s largest bank, according to New York-based Standard & Poor’s.

As many as 135 companies were in danger of breaching targets set by their banks as recently as October, S&P reported. With newspaper and TV advertising revenue declining, Sam Zell’s Tribune Corp. may not garner enough cash from asset sales to avoid violating loan covenants, S&P said last month.

Abandoned Takeovers

Appetite for the large takeovers that fueled the boom of the past two years has vanished. Australia’s BHP Billiton Ltd., the world’s biggest mining company, abandoned its $66 billion offer for London-based Rio Tinto Group on Nov. 25, and BCE Inc., Canada’s largest phone company, said on Nov. 26 that the economic slump may stop its $42 billion takeover from closing.

“You are less likely to see deal sizes beyond the $20 billion mark in 2009,” said Larry Slaughter, the London-based co-head of European M&A at JPMorgan Chase & Co., the biggest U.S. bank by market value. “The balance-sheet capacity of the banking system will make it tough to finance much bigger” transactions, he said.

That may help drive smaller deals, as robust companies buy competitors weakened by the tight credit markets.

“Every sector will have a handful of acquisitive companies that can take advantage of relatively strong equity and credit positions,” said Michael Boublik, co-head of Americas M&A at New York-based Morgan Stanley, the fifth-ranked mergers adviser in the U.S. this year.

JPMorgan Rising

Chinese and Japanese companies may be the most active buyers in 2009, bankers said. Japanese companies will use their cash and take advantage of the strong yen to make purchases abroad. Tokyo- based Mitsubishi UFJ Financial Group Inc., Japan’s biggest bank, invested $9 billion in Morgan Stanley, the largest outlay made by a Japanese company outside the country this year, according to Bloomberg data.

“Japan is likely to continue to feature highly in outbound M&A, as it benefits from a lower cost of borrowing and a stronger yen, while China remains a key draw for investors and a source of outbound M&A,” said Richard Griffiths, Hong Kong-based managing director at Royal Bank of Scotland’s M&A unit.

As the collapse of the subprime mortgage market roiled Wall Street, it has also moved the rankings of advisers on takeovers. JPMorgan, which purchased Bear Stearns & Cos. in a government- brokered takeover, climbed from fourth place last year to second this year behind New York-based Goldman Sachs Group Inc., the world’s No. 1 M&A adviser since 2000.

“We are bullish about our ability to pick up market share,” said Hernan Cristerna, London-based co-head of European mergers and acquisitions at JPMorgan. “We are hoping to continue to outperform the market.”

To contact the reporters on this story: Ambereen Choudhury in London at achoudhury@bloomberg.net; Jonathan Keehner in New York jkeehner@bloomberg.net.