Wednesday, October 21, 2009

The Debts of the Spenders: Is Corporate M+A Poised For a Comeback?

CFO magazine ( a great read by the way for those interested in knowing what's going on among corporate finance departments - warning wonk alert! ) reports that mergers and acquisitions, or M+A for short, may be poised for a return. But uncertainty about the macro level situation - especially credit - has dampened potential hopes of a sustainable recovery.

The author interviewed a Corning executive (manufacturer of industrial glassware) who was cautiously optimistic about the future but voiced concerns about extreme valuations. Such thoughts are directly connected to the months long run up in the equities market that have pushed many underlying stocks well above book value and historical valuations.

Corning's cash position makes the company less dependent on the credit markets for midsize deals. It also learned valuable lessons from the previous downturn in 2002, when the telecom bubble burst. "We decided then that we wanted to be prepared for the next downturn, whenever it came, by building up a significant amount of cash," Flaws explains. "We've done that, and have almost no debt coming due short-term. We're prepared to do deals now and we have the money to do them."

So what is he waiting for? "The valuations are higher than we think they should be," he says. "There were some companies we were interested in acquiring a few months ago, but the valuations were more than what we thought appropriate. Now they're lower and likely to get lower still."

This article was published before earnings season. Let's put his comments into context. The trend for the market has been a run UP into earnings only to be followed by an equally swift exit by profit takers (sellers) eager to cash out. . . . even though guidance has been for the most part positive. CFOs and other corporate finance personnel are patiently waiting for a return to more realistic levels.

The credit markets need to get revived as well. Despite the equity and bond rally (another source of financing for companies besides traditional bank loans), financing for deals is still hard to acquire - particularly for the debt fueled private equity market, including the sub-set of LBOs or leveraged buy outs (the "L" in leverage should tell you right away that there is a heavy reliance on financing).
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