Big Merger Deals Signal Restored Confidence

By ANDREW ROSS SORKIN
The corner office is getting a bit more bullish about the economy.

While investors have been bidding up shares in the stock market for months, many chief executives and boards had privately remained skittish about their own businesses — until recently.

In a signal that confidence — and perhaps a bit of executive swagger — may be returning to the business world, two large mergers were announced on Monday, adding to a flurry of deals in the last month. First, Abbott Laboratories, the drug maker, agreed to acquire a unit of Solvay of Belgium for $6.6 billion, and then Xerox agreed to buy Affiliated Computer Services, an outsourcer, for $6.4 billion.

Neither merger compares in size to the double-digit billion-dollar deals that took place just two years ago at the height of the buyout boom.

But taken in the context of what has been a merger drought — in the wake of the financial crisis, deal-making is still off by more than 50 percent from last year — the transactions suggest that the most senior ranks of corporate America may now have a more optimistic outlook on the economy than some people thought.

“Will you see us move with a lot of acquisitions over this next year? You betcha,” John Chambers, the chief executive of Cisco Systems, said in a recent meeting. “Especially if it plays out economically the way that I think.”

For nearly two years, mergers plunged along with the markets as executives grappled with trying to understand how best to survive. At this time in 2007, $1.28 trillion in takeovers in the United States had been announced; so far this year, only $491.8 billion have been announced, according to Thomson Reuters.

And with stock prices fluctuating sharply after falling for many months until the spring, buyers were anxious about overpaying and sellers were nervous about shortchanging themselves. But as the markets have rebounded and leveled off, companies are more confident about their prospects, so they are dipping their toes into the deal waters. The takeovers, in turn, helped lift the stock market on Monday, which had stalled recently.

“The psychology has changed. This is sign that things have stabilized,” said Boon Sim, Credit Suisse’s head of mergers and acquisitions for the Americas, who suggested that deals were a lagging indicator to the stock market. “I don’t think the floodgates are opening up,” he continued, “but C.E.O.’s are now beginning to say, ‘If I don’t buy it now, it’s only going to get more expensive in the next 12 or 18 months.’ ”

What Wall Street hasn’t seen, of course, is the return of the biggest buyers in recent years — the private equity firms that propelled much of the merger mania during the debt-fueled bubble.

And that may be good news. The big deals announced recently are strategic deals, in which one company buys another to make it an integral part of its business, and they do not require the buyer to take on mounds of new borrowing to pay for the acquisition.

In contrast, many of the takeovers for the last five years were based on little more than financial engineering, with lax lenders providing low-interest debt to help private equity firms buy companies that they often planned to resell quickly in hopes of pocketing a fast profit. That has left many companies struggling to make interest payments, making it harder for them to invest in new products or more efficient manufacturing methods.

A number of those takeovers are already underwater and some have turned sour. Just one example: Simmons, the mattress maker, was bought by the private equity firm Thomas H. Lee Partners, or THL, in 2003, largely with borrowed money. Last week, THL said that Simmons — whose immense debt burden from the takeover was hampering its prospects — would be put into bankruptcy proceedings and sold. But the sale price for Simmons is so low that bond investors will lose around $500 million.

At Xerox, Ursula M. Burns, the company’s chief executive, said that she pursued the deal for Affiliated Computer Services only because she finally felt more comfortable with the performance of her own business. “We’re confident that our base business will rebound when the economy does — and in Q2 saw the right trends in this direction,” she said. “So, all factors played to our favor. At the end of the day, in tough times, strong companies look to invest in their future.”

While the recent mergers may represent a positive sign for the economy, Alexander Roos, a partner at the Boston Consulting Group, is less inclined to believe that we are about to see a burst of activity. In a study to be published on Tuesday, he said, his analysis of a sample of companies in the Standard & Poor’s 500-stock index shows that about 20 percent are “predators,” ready to take on the risks of a deal, while another 20 percent are “prey.”

“We expect a window of opportunity offering attractive takeover prospects to open soon,” Mr. Roos said. “We have already seen some of our smarter clients making preparations in recent months.”

The greatest concentration of deal-making appears to be in the health care and technology sectors. Warner Chilcott made a $3.1 billion deal for Procter & Gamble’s drug business last month, for example, and Dell bought Perot Systems, a technology services company, for $3.9 billion. But deals are also being made in other sectors, like food; Kraft’s $16.7 billion unsolicited bid for Cadbury, which was rejected but remains a possibility, is the largest outstanding offer to date.

“If you’re healthy, it’s a great time to acquire inexpensively,” adds Ted Rouse, a Ahead of Bain & Company’s global mergers and acquisitions practice. “But it’s an awful time for two weak companies to merge.”

While the return of corporate mergers may be a good sign for the economy, a bigger question may be whether it is such a good thing for companies. Most deals sound great at the time, but in the end, not all of them work out as well as planned.

Mr. Rouse said, “Before the recession, Bain’s research on M.&A. showed that approximately 55 percent of acquisitions failed to deliver expected shareholder returns after one year — worse than flipping a coin. The odds only get worse as the size of the acquisition increases and the target is further from the acquirer’s core business.”

Let’s hope the odds are better this time around.