For the Journal Register Co., a $400 million, publicly held newspaper chain with operations in the northeastern U.S., the opportunity that presented itself this past spring to buy 21st Century Newspapers, a private chain with publications in and around Michigan, was exciting–and at the same time, worrisome. True, 21st Century might fit nicely into Journal Register's expansion plans, but the challenge of bringing the acquired firm into compliance with the Sarbanes-Oxley Act's reporting requirements by the Journal Register's Dec. 31 yearend close was daunting, to say the least.
SEC ACCOMMODATION
Fortunately, the staff at the Securities and Exchange Commission (SEC)–which has been swamped with complaints and questions from companies looking to acquire and seeking clarification about just this issue–rode to the rescue in late June. The SEC posted on its Web site a staff opinion stating that acquiring firms can have a grace period of up to a year to get the acquired firms' books in compliance, whether or not the acquired firm is private. The Public Company Accounting Oversight Board sent out a companion notice. "We would typically expect management's report on internal control over financial reporting to include controls at all consolidated entities," the SEC staff wrote. "However, we acknowledge that it might not always be possible to conduct an assessment of an acquired business's internal controls over financial reporting in the period between the consummation date and the date of management's assessment."
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That's all Journal Register executives needed to hear. The Trenton, N.J.-based company struck a deal on July 3 to pay $415 million in cash for 21st Century. The new deadline will still be a challenge, says Journal Register CFO Jean Clifton, since as a private company, 21st Century has never had to comply with GAAP standards or meet SEC reporting requirements. "If the SEC hadn't added this grace period, it would have been a tremendous burden and effort for us to do everything by the deadline," says Journal Register General Counsel Mark Goldfarb. "Obviously, we were prepared to go ahead with the merger, but this is a great relief."
And that about sizes up the state of the mergers and acquisition market these days. Not even Sarbanes-Oxley can stop the burst of acquisitiveness that was unleashed at the beginning of this year–although SOX, plus a newfound post-Enron caution, will definitely slow it down.
While not nearly as bustling as the last boom in 2000, M&A activity is still hopping, with $398 billion in deals during the first half of this year in the U.S. This is more than double the $159 billion in deals during the same period in 2003. "A lot of things are driving this M&A wave," says Paul Gibbs, head of M&A research at JPMorgan Chase. "A recent period of restructuring has given companies strength to expand and profits are comfortable."
SWIMMING IN GREENBACKS
Among other major factors driving the current merger trend is the state of corporate cash flows, which are extremely high. According to John Lonski, chief economist at Moody's Investors Service, corporate cash is $75 billion greater than cash outlays over the 12-month period ended March 31 of this year. All that black ink explains why 60% to 70% of acquisitions these days–particularly the smaller ones like the Journal Register-21st Century deal–are cash transactions, or involve a high proportion of cash. Only the really large mergers are stock deals, says Gibbs.
Besides that, companies are simply ready to expand, and with a lot of companies faced with excess capacity and slow internal growth potential, mergers can offer another avenue to growth. "For the past two years or so you had a preoccupation with risk and governance," says Bob Filek, partner for transaction services at PricewaterhouseCoopers. "Now, you're seeing a shift of focus back to growth."
Filek predicts a wave of mergers focused on geographic expansion of core businesses or on deals that will enhance core business competitiveness. "I think you'll see a lot of firms trying to expand their footprints, both within the U.S. and globally," he says.
The consensus forecast is for the heaviest activity to take place in financial services, healthcare, telecom and the oil and natural gas companies. This is no surprise since that's where a bulk of the M&A to date has already occurred. While activity is up, expectations are for much lower premiums than the 45% nosebleed heights hit in 2000, although you wouldn't necessarily know it from some trophy deals, such as Cingular Wireless' purchase of AT&T Wireless at a whopping 118% premium and Bank of America's purchase of Fleet Bank at 45%. In fact, JPMorgan's Gibbs puts the average premiums at closer to 30%. "That's still a lot of value to have to create on top of the company you buy," he adds.
NOT AS GOOD AS THEY LOOK
In fact, John Purcell, adjunct professor of finance at the Wharton School, argues that finance officers and their investment banker advisers are underestimating those seemingly attractive premiums. "Companies tend to use discounted cash flow to evaluate M&A deals," he explains, "but unless they factor in higher interest rates in the future, they may not be recognizing the real premium they are paying." Buying a company, he notes, is not like buying a piece of machinery. "It's amazing to me how infrequently companies adjust their required rate of return when interest rates are rising."
So while it may be a boom of sorts, such cautionary words provide a theme for the current M&A market as well. While acquirers are hungry, they are also quite choosy and extremely careful. Why not? The nation is at war. Oil prices are close to all time highs. Terrorists are lying in wait. And interest rates are on the rise. All of these factors could further dampen consumer spending and slow the economy. None of these factors are conducive to closing big deals. But companies are also suffering from a hangover post Enron et al. Investors are much more skeptical about mergers, and executives considering acquisitions seem intent on responding by being more careful than in prior boom times–particularly when Sarbanes-Oxley forces them to attest to all the numbers. On the plus side, this extra effort is paying off for those deals the market views favorably, with acquirers' stocks uncharacteristically rising post deal. On the negative side, it makes the process go much slower. "Due diligence is taking twice as long," says JPMorgan's Gibbs, "and costing twice as much, these days as it used to."
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