Market Overview

As confirmation hearings begin for Ben Bernanke, inflation continues to be a concern with federal policy makers.  The Federal Reserve has shown no sign of discontinuing its measured increases of interest rates and the Federal Reserve chairman nominee, although an outspoken proponent of stated inflationary goals, is expected to continue the Federal Reserve’s existing policy.  Inflationary concerns have increased as some sectors of the economy have seen increasing pricing power.  Reduction of inventories and increasing demand have allowed some companies, such as high end retailers, to successfully pass along cost increases, while others, such as automobile manufacturers and companies with significant overseas competition, have had less leeway in passing costs to consumers.  However, the high energy costs that have precipitated much of the raw material cost increases are showing signs of cooling down.  In early November benchmark crude futures fell under $58 a barrel for the first time since July as the International Energy Agency revised its estimate of world oil demand downward after slowing US consumption in September and October.

Among Ben Bernanke’s other challenges as he prepares to replace Alan Greenspan is the growing US trade deficit, which rose to a record $66.1 billion in September as energy prices increased in the wake of hurricane season.  The trade gap widened 11.4 percent from August, the biggest percentage jump in more than a year.  Despite the news of a widening trade deficit and bearish sentiment in the market, the dollar has climbed to a two year high against the euro and 26 month high against the yen.  Analysts point to US interest rates, well above those in Europe and Japan and attracting foreign investment in US securities, as a primary driver behind the dollar’s recent run.  In addition, the limited discounted tax rate that was a part of President Bush’s tax bill is leading companies to repatriate overseas profits and these transactions are believed to be playing a role in the dollar gains.  As the Fed’s interest rate tightening slows in 2006, the flow of foreign capital is expected to decrease as well, leading to increased pressure on the dollar from the widening trade deficit.

Merger Overview

The dust has finally begun to settle following Refco Inc.’s stunning collapse in October.  Man Financial, the brokerage arm of Man Group PLC, acquired Refco LLC’s assets in an auction, following the disclosure its CEO hid $430 million in bad debts.  The deal to acquire Refco LLC’s assets and business in the US, Canada, London and Asia was for $323 million, including $282 million in cash and the assumption of $37 million of Refco liabilities.  Tangible assets in the deal amount to $115 million, consisting mostly of the market value of futures exchange seats Refco owns.  The deal excludes around $750 million in regulatory capital at Refco, as Man Group is well capitalized and currently has excess regulatory capital on its balance sheet.  Including the regulatory capital in the deal value would have put the deal in excess of the $1 billion estimated price tag for the Refco assets.  In addition to the deal with Man, Refco also sold some of its foreign exchange assets to  futures commission merchant Forex Capital Markets LLC, in a deal valued at more than $110 million.  Forex is acquiring more than 15,000 retail client accounts of Refco FX Associates LLC as well as 35 percent of Refco’s foreign exchange unit.

The hotel industry, battered in the aftermath of 9/11, has seen a resurgence of interest recently with high levels of deal activity.  La Quinta Corp. was recently acquired by the Blackstone Group for about $2.3 billion in cash, or $11.25 for each paired share of La Quinta, a 37% premium over the closing price when the deal was announced.  Blackstone is also assuming $810 million in debt, raising the total deal value to around $3.4 billion.  Blackstone has been especially active in the space with La Quinta adding to holdings consisting of Prime Hospitality, Extended Stay America and Boca Resorts.  In addition, Blackstone completed the purchase of Wyndham International Inc. in June and then turned around and sold the company to Cendant.

Consolidation in the industry is expected to continue, as Starwood Hotels & Resorts recently announced a plan to sell more than a quarter of its hotels to Host Marriott Corp., a REIT created when Marriott International split in two, in a deal valued at $4.1 billion.  Host Marriott will pay $1 billion in cash, issue $2.3 billion in stock, and assume $700 million in debt.  The properties being sold operate under the Sheraton, W and Westin brands, and include the 1,216 room Sheraton Boston.  Also, Carl Icahn recently disclosed a 9.3 percent stake in Fairmont Hotels & Resorts Inc. and said the company should consider options, including a sale of individual properties or the entire company.

The above exhibit illustrates the deal structures of acquisitions that occured over the last 12 months. In a stock transaction, the buyer acquires the equity of the target, and thereby gains control over the assets of the company while assuming all of the target's liabilities (both financial liabilities recorded on the balance sheet, as well as off-balance sheet liabilities). In an an asset transaction, the buyer acquires select assets (and typically also select operating liabilities) of the target company and leaves the remaining liabilities with the seller. All things being equal, buyers often prefer an asset transaction, since they do not need to rely on representations and warranties to protect them from liabilities that emerge after the transaction closes. However, in many situations asset transactions are not efficient for the seller due to tax reasons (double taxation may occur), liquidity reasons (cash raised from the asset sale may need to be retained within the remaining shell company to cover contingent liabilities) and other legal or practical factors.