Market

The markets are currently in something of a holding pattern after last week’s rally as investors await the Fed’s comments on the economy and inflation. Due to a slowing economy and temperate inflation reports, the widely held expectation is that the Fed will keep rates unchanged at 5.25% at Wednesday’s meeting.

The IMF has recently revised its projections of US economic growth downward for 2007, with most recent numbers forecasting 2.9% growth, down from 3.3% projections.  In contrast, the global economy is expected to see substantially higher growth, at 5.1% this year before moderating to 4.9% in 2007.  Recent economic reports have added evidence that a slowdown in US economic growth is underway, with output at US factories, mines and utilities unexpectedly falling by 0.1% in August. On the contrary, analysts’ expectations of a 0.2% increase is the first decline in industrial production since January.

Inflation numbers have also reinforced market expectations that the US central bank would keep interest rates unchanged at this week’s meeting, as both August’s CPI and core CPI were in line with Wall Street’s expectations. US consumer prices and costs, excluding food and energy, rose 0.2% in August and the core CPI increase was lower than July, as gas prices were only up 0.2% in August after a 5.3% increase in July.

Mergers

The buyout deal environment in 2006 continues to be extremely competitive, with transaction multiples climbing to an average deal multiple of 8.6x earnings, according to Standard & Poor’s Leveraged Commentary and Data.  If multiples continue at these levels they would eclipse 2005’s average 8.2x multiple for PE deals which is currently the highest year on record.

A consortium of private equity shops recently swooped in and made a last minute offer to buy Freescale Semiconductor for $17.6 billion. Beating out another financial buyer syndication, this could be an indication of increasing competition among large private equity shops with significant capital to put to work. Freescale was spun off of Motorola as a publicly traded company in July 2004 and generated $5.8 billion in sales in 2005.

One of the biggest buyout deals seen this year was the recently signed agreement to take Kinder Morgan private for $15 billion in cash and the assumption of $7 billion in debt, representing a total deal value of $22 billion, or more than 13x LTM EBITDA as of June 2006. The deal values the company at $107.50 per share and represents a 27% premium over the company’s closing stock price the day before the initial deal was announced in May. When the offer was first announced in May the deal was ranked as the second-largest leveraged buyout in history. Nevertheless, it was knocked down a peg when Bain Capital, KKR and Merrill Lynch submitted a $33 billion offer for HCA.

The above exhibit illustrates the impact that various forms of consideration have on enterprise value to sales multiples (TEV/sales) paid on merger and acquisition transactions across various business categories.  Clearly, transactions involving equity as a form of consideration tend to have greater multiples than those executed only with cash.

This conclusion is true for all industry groups we covered.  As illustrated in the exhibit, transactions for which the target received equity as a component of total consideration show higher multiples than those that only received cash.  One reason for this is that sellers are willing to concede on the value of their business in exchange for the certainty of receiving cash instead of stock.  This way, the seller avoids the risks associated with accepting stock as consideration, such as the potential loss of future value of the stock being offered. 

Another reason is that buyers are willing to pay more for a target that is willing to share the financial and operational risks the combined or surviving entity will likely face.  This signals to the buyer that the target’s management team is confident about the robustness of their business and the effective execution of the integration process.  By accepting stock as part of the overall consideration, targets show that they have “skin in the game” to ensure the success of the combined or surviving entity.

Sources: CapitalIQ and Mirus analysis. Copyright 2006, Mirus Capital Advisors, Inc.  All rights reserved. Mirus Capital Advisors does not assume any liability for errors or omissions.