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Good Kindling Fires-Up M&A Activity: Verizon Deal Provides the Fuel

November 2013
Financial Executive Magazine - for the online version go HERE.

When Verizon Communications Inc. Chairman and CEO Lowell McAdams spoke with analysts via a conference call on Sept. 3, 2013, he said his company was acquiring Vodafone Group plc’s 45 percent interest in Verizon Wireless “after a decade of anticipating.”

It was paying Vodafone $130 billion, consisting primarily of cash and stock, with about $49 billion of that total coming from the sale of bonds, marking it the largest corporate sale ever. Sitting in a studio at Verizon’s operations center in Basking Ridge, N.J., McAdams explained, in general terms, why the anticipation could now end: “The timing of this transaction is right from both the strategic and financial perspective.”

The timing appears to be right for many companies. “Many corporations have trimmed all the fat they can from their businesses and are now realizing their cost of capital is likely to rise. That’s one of the reasons we have been witnessing more M&A activity,” says Kathleen Gaffney, vice president and co-director investment grade fixed income, Eaton Vance Investment Managers. “If companies are going to finance a deal, there may be no better time than the present with rates still close to record lows.”

Microsoft Corp. announced its $7.2 billion purchase of Nokia Corp.’s mobile phone business at about the same time Verizon scooped up Vodafone’s share in Verizon’s wireless business. The Verizon and Microsoft deals overshadowed Koch Industries Inc.’s $7.2 billion purchase of Molex Inc. one week later.

Though the Koch acquisition was the same size as Microsoft’s, mention of its significance disappeared in the press the day after it was announced. As if acquisitions in the billions had suddenly become de rigueur. Deals continued to roll off the assembly line throughout the fall. On Sept. 18, Packaging Corporation of America acquired Boise Inc. for $1.995 billion.

Recent acquisitions have been both sizeable and smaller in dollars but still stunning. Amazon.com Inc.’s CEO Jeff Bezos’s $250 million purchase of the The Washington Post Co. in August is a prominent member of the latter category, although Bezos is making the purchase with his personal fortune, and for cash, so interest rates aren’t an issue there. US Airways Group’s merger with bankrupt American Airlines (AMR Group), announced last December, was perhaps less of a surprise, but no less significant, as two of the top five U.S. airlines could dissolve into one.
Conditions Driving M&A
The soil has been fertile for these kinds of deals for the past year, according to Greg Lemkau, co-head, global mergers and acquisitions, investment banking division, Goldman Sachs Group. Speaking in a webcast in July, Lemkau said, “Conditions driving M&A are as good as they have been in a long time.” He was referring to historically low interest rates, record corporate cash balances and relatively low corporate organic growth opportunities.

Given the current climate, Lemkau said it was “fascinating” that there had not been, up to that point in July, no big recovery in M&A. He cited as the reason “risk aversion by CEOs,” who had become gun shy because of big macroeconomic shocks such as the fiscal cliff and the euro crisis. But he noticed a big sentiment change over the past year. “CEOs of the biggest companies are much more forward leaning and much more confident than they were six or 12 months ago,” he said.

“They are thinking about big industry-changing transactions. Conditions are too good and all that is needed is a period of sustainable stability in the market,” said Lemkau. The Verizon, Microsoft, Koch and PCA deals were announced a few months later.

The pickup in M&A pace seems likely to continue barring any major economic shocks in the U.S. or elsewhere. KPMG issues its M&A Predictor, which bases predictions on two measures: predicted forward price to earnings ratios (P/E),its measure of corporate appetite, and the capacity to transact, as measured by forecast net debt to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The July issue of M&A Predictor included data on 362 large U.S. companies, which were among 1,000 corporations worldwide included in the survey.

The model concluded the U.S. continues to outperform the market, even when times are tough. Forward P/E ratios were 4 percent higher than six months ago — modest but positive in an uncertain market — and 14 percent up year-on-year. The U.S.’s capacity to transact is robust, with an expected improvement of 20 percent over the next year. The U.S. market for mergers and acquisitions is in better shape than most other world markets, though Japan scored well, too.

Companies involved in this recent surge of M&A activity do not appear to be concerned about the Obama administration’s attempt to block some recent mergers, nor intimidated by the U.S. Department of Justice’s (DoJ) publication of new merger guidelines in 2010. “The changes in the 2010 merger guidelines were pro-enforcement because they expanded the theories and the types of evidence that the government could use to challenge mergers raising substantial competition issues,” explains Spencer Weber Waller, professor and director of the Institute for Consumer Antitrust Studies at Loyola University Chicago School of Law.

Those new merger guidelines might have been one factor in persuading the DoJ and six state attorneys generals to federal district court in August to block the US Airways/ American merger. Justice stepped in to force changes to a couple of big proposed mergers since 2010, including AT&T Inc.’s takeover of T-Mobile USA, which AT&T then dropped, and Anheuser-Busch InBev N.V’s merger with Grupo Modelo, which Anheuser-Busch subsequently revised in order to gain the Justice department’s approval.

Just one month prior to Justice flashing a red light to US Airways and American, the Federal Trade Commission (FTC), which is bound by the DoJ merger enforcement guidelines issued in 2010, issued an administrative complaint challenging Ardagh Group S.A.’s proposed $1.7 billion acquisition of Saint-Gobain Containers Inc.

The proposed acquisition would combine the second-largest manufacturer of glass containers (Saint-Gobain) and the third-largest (Ardagh). Owens-Illinois Inc. is the largest. Together, the three companies dominate the approximately $5 billion U.S. glass container industry. The next step in both cases is scheduled for this fall. An administrative law judge will hear the Ardagh case in early December.
Legislative Roadblocks
Verizon, Microsoft, Koch, PCA and any other purchaser or merger instigator is subject to the Hart-Scott-Rodino (HSR) law, which requires the Federal Trade Commission (FTC) or DoJ to review details of any large, proposed merger to insure it will be pro-competitive.

A company such as Verizon submits a notification to both agencies, which decides which one of the two will conduct the review. That decision is made based on which agency has expertise in that particular industry area, on staff availability and other factors. Both agencies can go to federal court to obtain an injunction to prevent a merger from taking place.

The FTC has the additional option of forcing a company like Ardagh to submit to a hearing by an administrative law judge, who makes a decision. Going that route can be much faster than going to court and it also allows the FTC to build a factual case that judge rebuffs the commission.

FTC Chairwoman Edith Ramirez told the Senate Judiciary Committee last April that fiscal 2012 saw twice as many HSR filings as FY 2009. In fiscal 2013, the FTC stepped in to block 16 mergers, in the energy, manufacturing, pharmaceuticals, health care and automotive industries. In a number of those cases, the mergers or acquisitions were approved when the dominant partner agreed to divest some of the assets of the purchased or merged company.

The Justice Department attempt to ground the US Airways/American deal could be viewed as a little perplexing given that the George W. Bush and Barack Obama administrations allowed six major airline industry mergers since 2005: U.S. Airways/ America West in 2005; Delta/Northwest in 2008; Republic Airlines’ acquisitions of both Midwest and Frontier Airlines in 2009; United/Continental in 2010; and Southwest/ AirTran in 2010.

But when Justice and six attorneys general filed the US Airways lawsuit on Aug. 13, Bill Baer, assistant attorney general, said the US Airways/ American combination would lessen competition for commercial air travel throughout the United States. “Importantly, neither airline needs this merger to succeed,” he added. “We simply cannot approve a merger that would result in U.S. consumers paying higher fares, higher fees and receiving less service.”

The two airlines argue the merger is “pro-competitive.” In testimony before the House Judiciary Committee last February, Gary F. Kennedy, senior vice president, general counsel and chief compliance officer, American Airlines Inc., called the merger a combination of two complementary networks that will offer consumers more service at more times to more places.

“And because this will be a merger of complementary networks, these benefits come with virtually no loss of competition,” he explained. “Of the more than 900 domestic routes flown by the two carriers, there are only 12 overlaps. This is one reason we are convinced that this merger is consistent with good public policy.”

Clifford Winston, senior fellow, economic studies program, The Brookings Institution, has studied the U.S. airlines industry. “I don’t see the basis for DoJ opposition and they have not clearly and persuasively articulated it,” he says. He explains that carrier competition would continue to be intense and low-cost carriers would continue to put downward pressure on fares.

Entry and exit would continue to be fluid in airline markets as a merged American and US Airways would optimize its network by exiting some routes and entering others, while other carriers would adjust their networks by entering some of the routes that American exited and exiting some of the routes that they entered.

Of course, Justice’s attempt to scuttle the US Airways/American merger has raised concerns over whether it will do the same in the case of the Verizon merger with Vodafone.

Robert Doyle, Jr., a partner with Doyle, Barlow & Mazard PLC and former deputy assistant director in the FTC’s Bureau of Competition, says: “Given that Verizon Communications had a preexisting 55 percent controlling interest in Verizon Wireless, buying its remaining 45 percent from Vodafone doesn’t seem to change the competitive dynamics in the industry, since it won’t change the controlling interest in Verizon Wireless.”

Verizon Communications controlled Verizon Wireless before the Vodafone deal, he says, and will control it after the deal. Nothing changes, he says, “I don’t see any change post acquisition that should raise any DOJ antitrust concerns with the deal.”

A Justice challenge to Verizon would be a lot more surprising than its challenge to US Airways, which itself elicited some head scratching. Whatever the level of anti-trust enforcement from the Obama administration, it is not impeding the announcement of M&As, which continued to appear through the fall, including some big ones, such as Applied Materials Inc.’s merger with chip-equipment rival Tokyo Electron Ltd., a $10 billion deal.

Barring the U.S. falling off some fiscal cliff or Federal Reserve Chairman Ben Bernanke turning off the cheap money faucet, other blockbusters seem certain to follow.

U.S. Approval of Chinese Acquisition of Smithfield Sends ‘Open Door’ Message
The U.S. government’s approval of a Chinese acquisition of one of America’s leading food processors may have opened the door to a broader range of foreign buy-ups of U.S. companies. In September, The Committee on Foreign Investment in the United States (CFIUS) green lighted Shuanghui International Holdings Ltd.’s acquisition of Smithfield Foods Inc., the world’s largest pork producer and processor. The acquisition represents the largest-ever purchase of an American company by a Chinese company.

CFIUS reviews potential purchases of U.S. companies that could threaten national security. Its review of the Smithfield deal was the first time the committee had looked at a potential acquisition in the field of agriculture.

Some members of Congress questioned the thoroughness of the CFIUS review. Sen. Debbie Stabenow (D-Mich.), chairwoman of the U.S. Senate Committee on Agriculture, Nutrition and Forestry, was unsure, given CFIUS’s non-public process, whether issues such as the potential impact on American food security, the transfer of taxpayer-funded innovation to a foreign competitor or China’s protectionist trade barriers were considered.

“It’s troubling that taxpayers have received no assurances that these critical issues have been taken into account in transferring control of one of America’s largest food producers to a Chinese competitor with a spotty record on food safety,” she said.

Larry Ward, a partner at international law firm Dorsey & Whitney, notes that “Within the last year, at least two deals where the acquirer was ultimately owned by a Chinese state-owned entity were effectively prohibited by CFIUS and so clearance of this transaction may ease concerns so such entities may feel comfortable again in investing in  the United States.”

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