KEY POINTS:
Forced sales demanded by creditors and Government-brokered transactions may provide the only consolation for bankers in what promises to be the slowest year for mergers and acquisitions since 2004.
Bankers at Barclays Capital and Nomura Holdings say the value of deals may decline 30 per cent in 2009 to about US$2 trillion ($3.46 trillion).
Takeovers so far this year are down 36 per cent from the same period in 2007, reducing the fees paid to banks by 34 per cent to an estimated US$63 billion, according to data compiled by Bloomberg and New York research firm Freeman & Co.
"These are the worst conditions for many years, as bad as or worse than the early 1990s, perhaps as bad as the mid-1970s," said Philip Keevil, 62, senior partner in London at Compass Advisers and former head of European mergers at Salomon Smith Barney.
"There will be a flood of strategic deals in the new year out of necessity, including Government-forced mergers among banks and insurance companies."
More than a third of the 20 biggest acquisitions announced in the fourth quarter were Government-induced, Bloomberg data shows.
The Dutch Government took control of Fortis' assets in the Netherlands after Belgium's largest financial-services company ran out of short-term funding in October.
Paris-based BNP Paribas, France's biggest bank, acquired units from Brussels-based Fortis in Belgium and Luxembourg. The Kremlin is pushing for banks to merge, including the possible combination of MDM Bank and Ursa Bank to form Russia's second-largest private lender.
"Governments will be acting as arbitrators and twisting people's elbows if necessary," said Frederick Lane, 59, a former co-head of mergers at Donaldson, Lufkin & Jenrette who now runs Boston-based Lane Berry.
American International Group, the New York insurer controlled by the US Government, is under pressure to sell about US$60 billion of assets.
New York-based Citigroup, which has received US$45 billion in federal cash, plans to find a buyer for its Japanese trust-banking unit. And Royal Bank of Scotland Group, 58 per cent-owned by the British Government, may shed its insurance operations and a stake in Bank of China.
"In Europe, any major consolidation is likely to come from Government-sponsored rescues," analysts led by Stefan Slowinski at Societe Generale in Paris wrote in a note to clients last week.
"Banks that can think about expanding outside of Government rescues will do so on a piecemeal basis."
The Societe Generale analysts offered an even gloomier forecast than the ones from Barclays in London and Nomura in Tokyo. They say completed deals next year may drop to 4000 from 8000 this year, the lowest level since 1995.
A combination of declining revenue and rising borrowing costs may drive companies to shed assets at low prices.
Buyers are picking over the remains of Circuit City Stores, the second-largest electronics retailer in the US, and century-old London-based Woolworths Group after both collapsed in November. Three US carmakers seeking US$34 billion in federal funds may also have to sell units.
The collapse of New York securities firm Lehman Brothers Holdings, which in September filed the largest bankruptcy in US history, raised corporate borrowing costs to the highest level since at least 1999, according to indexes compiled by Merrill Lynch.
That has limited the appetite of companies for mergers and acquisitions and jeopardised the ability of some to repay debt maturing next year.
Borrowing has never been so expensive for US companies with non-investment-grade ratings - below Baa3 at Moody's Investors Service and BBB- at Standard & Poor's - Merrill indexes show.
Bond buyers increased the extra yield they charge non-investment-grade companies to 2054 basis points, or 20.5 per cent more than Government debt last week, the highest level since Merrill started collating daily data almost a decade ago.
Investment-grade companies are paying a record 655 points more than similar-maturing Government debt, the indexes show. A basis point is one-hundredth of a percentage point.
"In this environment, it isn't unusual to see an otherwise strong company be crippled by both a downturn in its business, and a liquidity crisis," said Paul Parker, the New York-based head of M&A at Barclays Capital, which bought Lehman's North American investment-banking unit in September. "Default rates will continue to rise over the foreseeable future and will lead to meaningful restructuring of many companies."
That may provide an opportunity for leveraged buyout firms.
Blackstone Group and Apollo Management, both based in New York, are among the companies investing in distressed debt.
"Everyone is turning to distress and proffering that it may be one of the best opportunities," said Thomas Barrack, founder of Los Angeles investment firm Colony Capital.
"The problem is that everyone who has invested on that basis during the past 12 months has been wrong."
Prices for high-risk, high-yield loans in the US dropped to US67c on the dollar in December from about US90c in April, when firms including Apollo and Blackstone negotiated to buy more than US$12 billion of debt from Citigroup, the fifth-biggest US bank by market value, and Deutsche Bank, Germany's largest bank, according to Standard & Poor's.
As many as 135 companies were in danger of breaching targets set by their banks as recently as October, S&P reported. With newspaper and TV advertising revenue declining, Sam Zell's Tribune Corp might not garner enough cash from asset sales to avoid violating loan covenants, S&P said last month.
Appetite for the large takeovers that fuelled the boom of the past two years has vanished. Australia's BHP Billiton, the world's biggest mining company, abandoned its US$66 billion offer for London-based Rio Tinto on November 25, and BCE, Canada's largest phone company, said on November 26 that the economic slump might stop its US$42 billion takeover from closing.
"You are less likely to see deal sizes beyond the US$20 billion mark in 2009," said Larry Slaughter, the London-based co-head of European M&A at JPMorgan Chase, the biggest US bank by market value. "The balance-sheet capacity of the banking system will make it tough to finance much bigger" transactions, he said.
That may help drive smaller deals, as robust companies buy competitors weakened by the tight credit markets.
"Every sector will have a handful of acquisitive companies that can take advantage of relatively strong equity and credit positions," said Michael Boublik, co-head of Americas M&A at Morgan Stanley in New York, the fifth-ranked mergers adviser in the US this year.
Chinese and Japanese companies might be the most active buyers in 2009, bankers said. Japanese companies will use their cash and take advantage of the strong yen to make purchases abroad. Tokyo-based Mitsubishi UFJ Financial Group, Japan's biggest bank, invested US$9 billion in Morgan Stanley, the largest outlay made by a Japanese company outside the country this year, according to Bloomberg data.
As the collapse of the sub-prime mortgage market roiled Wall St, it has also moved the rankings of advisers on takeovers.
JPMorgan, which purchased Bear Stearns & Co in a Government-brokered takeover, climbed from fourth place last year to second this year behind Goldman Sachs Group, the world's No 1 M&A adviser since 2000.
"We are bullish about our ability to pick up market share," said Hernan Cristerna, London-based co-head of European mergers and acquisitions at JPMorgan. "We are hoping to continue to outperform the market."
* Companies that may need to sell assets at a discount next year:
American International Group is under pressure to sell US$60 billion of assets.
Citigroup is looking for a buyer for its Japanese trust-banking unit.
Royal Bank of Scotland may shed its insurance operations and a stake in Bank of China.
Collapsed retailers Circuit City Stores and London's Woolworths Group are being picked over by buyers.
- BLOOMBERG
