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Market Overview

Do you remember what you were doing five years ago this week?  If you were an investor in tech stocks, you were probably starting to wonder if the party was finally over.  On Monday, March 20, 2000 the NASDAQ dropped by 3.9%, closing down 8.6% from that month’s record high of 5048.62.  Despite the big decline, most analysts saw the slide as nothing more than a “correction”.  Accounting practices and revenue recognition were the talk of the day, after Barron’s published an article critical of online retailers.  Quoted in that day’s wrap-up by TheStreet.Com, one trader offered “Tech is not going away but it's going to struggle here because it moved so far so fast.  Valuations are still out of whack."   No kidding.  Tech stocks continued to fall for the next 30 months, with the NASDAQ reaching bottom at 1114.11 on October 9, 2002.

March 2005 has been a better month for the markets.  Earlier this month, both the S&P 500 and DJIA closed at their highest points since the summer of 2001.  As of March 17^th, the S&P 500 was up .07% and the DJIA was up .09% for the month.  US GDP increased at a 3.8% annual clip in the fourth quarter, faster than analysts’ expectations of 3.1%, with overall growth of  4.4% for the year, the fastest pace since 1999.  U.S. worker productivity rose at a rate of 2.1% in Q4, also beating expectations.  Hiring is up, as job growth for February was reported at 262,000 new jobs, twice that of January, and basic wage income grew at an annualized rate of 5.8% in January, the strongest growth in nearly four years.  Questions remain as to whether this shift will result in higher inflation or reduced corporate profits.

With oil prices continuing to rise and threatening global economic growth, Saudi officials have discussed a unilateral increase in oil output, if OPEC does not meet its current proposal to increase output by 2% (500,000 barrels a day). 

Merger Activity

Buy-outs are back.  In addition to record LBO volumes in the second half of 2004, valuations are going up.   Increasingly, valuations are high enough for sellers to enter the market, without being so high as to give buyers sticker shock.  In many “old economy” industries, LBO valuations have been higher than valuations paid by strategic buyers, as private equity firms are continuing to reduce their IRR expectations.  Deals are also being facilitated by the ever-greater availability of credit - competition among mezzanine lenders, especially over covenant flexibility, has provided a friendlier negotiating environment for borrowers and bank lenders.

Savvy financial buyers are also seeing an opportunity for increased deal flow through corporate divestitures.  Changes in accounting rules are forcing large companies to write down investments to reflect their true values, which may entice some companies to spin off non-core assets for less than was paid for them. For example, there are reports that Sears, Roebuck & Co. is looking to unload Lands’ End for $1.2B, after paying $1.9B for it three years ago.

The above exhibit shows total M&A activity over the last twelve months (measured by the number of deals), broken down by region. Activity is logically concentrated on the coastal areas (over 60% in West Coast, Southern East Coast and North-East regions), roughly in line with population density. Somewhat surprisingly, however, the Western States actually have the highest M&A activity relative to the Gross State Product (1,035 deals per trillion of GSP), followed by the West Coast (896 deals per trillion GSP). Lowest on this scale is the Mid-West (666 deals per trillion of GSP), with the North-East and the Southern East Coast both around the overall average of 750 deals per trillion of GSP.