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M&A: Second Wave, or No Wave Ahead?

By Ed Zwirn on Sep 15, 2011

There has been a recent slowdown in the architectural, engineering and construction-company sector with Morrissey, managing principal at Boston-based Morrissey Goodale,  talking about a good storm, with merger and acquisition volumes first making up for the last two recession-plagued years of lost ground, and then heading sharply up.

It's only "the calm before the storm," Mick Morrissey says of the recent M&A slowdown in the architectural, engineering and construction-company sector, where his consulting firm specializes. And Morrissey, managing principal at Boston-based Morrissey Goodale, is talking about a good storm, with merger and acquisition volumes first making up for the last two recession-plagued years of lost ground, and then heading sharply up.

Waiting for the return has been a hot-and-cold affair. In this year's Q1, sector volumes rose 15% year over year, then leveled off, with the overall first half coming in flat, and things staying quiet in the face of the recent volatility in the financial markets. While there's now "a lot more caution in this sector," though, he sees a second wave developing, spurred by foreign companies moving to acquire the U.S. companies they expect to benefit from increased infrastructure spending lying ahead.

High Cash, High Expectations

Across the wider M&A horizon, Morrissey's expectations are being heard more and more in recent weeks, in part reflecting the solid growth that at year-end seemed almost inexorable.

Globally, over 21,000 deals were announced in 2010, worth more than $1.9 trillion in total, according to Bloomberg News research. That represented a 12% increase over 2009, and a sharp reversal in the two-year decline that began in 2008. Further, a Bloomberg report last December showed "tempered optimism" on the part of over 1,000 financial market professionals for continued growth of dealmaking in 2011.

The optimism certainly seemed warranted as 2011 began, with mega deals such as AT&T's embattled proposed $39 billion acquisition of T-Mobile USA propelling things. So when deal volumes seemed to peter out in Q2 -- with announced M&A totaling $611 billion, off 23 % from Q1 -- many saw it as temporary. And they have been expecting other sectors to begin catching up with technology, where deals like Hewlett-Packard-Autonomy and Broadcom-NetLogic have set a steady pace.

Underlying much of the optimism: the unusually high amounts of cash sitting on the sidelines since the financial meltdowns of 2007-2008. Driven by lack of confidence, increased borrowing and other factors, the 1,000 largest U.S. companies had $853 billion in cash reserves at the end of 2010, up more than 6% from 2009, and up 33% from 2008 and nearly 75% from 2005, according to REL Consultancy.

Post-Summer Pickup?

"There was definitely a recovery of M&A up to a few weeks ago," says Edward Schultz, a partner at the Tatum executive outplacement firm. "There seems to be less M&A going on right now, and when it does go on it tends to spark interest. A lot of (clients), they're holding up buying right now. There's a lot of wait and see."

Schultz has performed the finance function at several companies over the past 12 years, including at Hanson Industries, a $3 billion manufacturing, consumer products and services company, where he integrated five corporate acquisitions, and acted as CFO/COO of a foreign consumer products subsidiary.

"Valuations may be down," he says. "But by the same token one has to do more due diligence when the economy is questionable. Nothing substitutes for good, strong financial due diligence. It can't just be a P/E of so-and-so implies a valuation of so-and-so."

In most industries, M&A is dominated by specific opportunities and needs, of course.

David McGirr, CFO of Cubist Pharmaceuticals expects M&A in general to pick up a bit now that summer's over. "It's a bit like back to school," he says. "But I don't see any particular wall of pressure building up."

Cubist in the past has purchased companies to help fill its pharmaceutical pipeline, tends to be less affected by short-term market fears, according to McGirr. "If we look at buying a molecule that is going into Phase 3 trials in three or four years, the outlook is much longer," he says.

"We've bought a few companies that have interesting molecules," the most recent being Calixa, a San Diego-based company in the R&D stage, in December 2009. Cubist purchased that company to get a hold of CXA-201, an intravenous drug to be used to treat serious Gram-negative infections in hospitals. His company paid $92.5 million in cash up front for Calixa, agreeing to additional payments of up to $310 million as CXA-201 passes through regulatory hurdles and eventually starts to make money.

Taxi-Driving Architects, Take Heart

Speculation continues to suggest that the chain of recent technology deals will lead to a new level of purchases, and perhaps kick off that broader second M&A wave.

But in each individual sector, like engineering and architecture, the analysis takes a more-directed tack.

For Mick Morrissey, expectations of more M&A are propelled in part by today's "commodity-rich environment," which is seeing increasing cross-border activity as engineering firms expand to take advantage of mining sector opportunities, such as the August acquisition by San Diego-based Tetra Tech, a $1.1 billion market cap company, of Metalica Consultores, a Chilean mining and engineering firm, and the purchase of 60% of Portland, Ore.-based Otek by South Korea's HamniParsons.

That could get the second wave started, in Morrissey's view, as more foreign companies see U.S. infrastructure-based opportunities. He expects cash-strapped state governments to boost this spending on the cheap, through "public/private" initiatives that allow for the investment of private capital into projects like highways and bridges. "Politically, that makes a lot of sense. The states can't do it themselves and there's trillions of dollars waiting on the sidelines." he argues.

"Canadian firms and firms from Asia and Australia" are all familiar with the "public/private" model, and are "looking to purchase platform firms in the U.S.," he says. "They're willing to pay seven to eight times earnings or one to 1.2 times revenues."

And there are plenty of potential targets, given the economic slowdown. "There are," he adds, "more architects driving taxis in New York than working."


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