Market Overview

This past week the Dow briefly climbed above 14,000 for the first time, led largely by the large manufacturing companies in the index. Although the recent surge has been driven by large multi-national companies, the broader S&P 500 has also seen increases, recently surpassing its early 2000 highs. However, after reaching these highs the markets declined following Fed Chairman Bernanke’s midyear comments to Congress and continued concern over the subprime market.

Federal Reserve Chairman Ben Bernanke delivered his midyear address to Congress on Wednesday, highlighting economic growth and the Fed’s continued concern over inflation.  Bernanke stated that economic growth for 2007 (at 0.7 percent for Q1, the lowest in four years) would probably end up slightly lower than forecast but he anticipated increasing momentum in 2008.  In addition, he reiterated the fact that the Fed was keeping a close eye on price pressures and that recent inflation numbers may be the result of temporary influences.

On the inflation watch, overall consumer prices moderated in June, rising by just 0.2 percent after May’s big jump of 0.7 percent. June’s CPI increase was the smallest in five months. Core inflation, which excludes often volatile energy and food costs, rose a modest 0.2 percent last month. The Producer Price Index fell by 0.2 percent in June, following a 0.9 percent jump  in May. The decrease was led by gasoline prices, which fell for the first time since January, and food, which declined for the second month in a row. 

These tame inflation readings have most investors expecting the Fed to remain on the sidelines for the rest of 2007, with interest rates remaining at 5.25 percent.  The Fed has kept rates steady for the past year, in contrast to the European markets, where the European Central Bank, which has raised rates steadily, is expected to increase its benchmark rate to  4.25 percent in September. The Bank of England, who recently increased rates to 5.75 percent, is also expected to continue to raise rates in an effort to fight rising inflation.

Deal Overview

Insurance brokers have seen recent attention in the market, with several leading brokers recently being targeted by private equity buyers.  In February, Hub International agreed to a deal worth $1.8 billion with a team led by Apax Partners and in May USI International closed its announced deal with Goldman Sach’s private equity group for approximately $1.4 billion, or $17.00 per share.  Following those deals, Blackstone Group announced a deal for Alliant Insurance Services, a Newport Beach based insurance brokerage.  Middle market insurance brokers have not been left out of the ongoing consolidation in the insurance brokerage space. Hub has announced three acquisitions since its buyout closed on June 13^th and USI Holdings has scooped up four regional insurance firms since its deal was announced in January.

This month’s metric looks at the type of consideration offered by an acquirer in Mergers and Acquisition transactions over last twelve months.  As the Exhibit illustrates, in 73% of all transactions for which data was disclosed, cash is the main consideration offered to a target.  Sellers in most situations prefer cash over other types of consideration, since it does not expose the seller to business or liquidity risk associated with the buyer’s equity.

One factor that that drives the use of the buyer’s equity as transaction consideration is the liquidity of the buyer’s stock. In situations where the acquiring company has significant market capitalization and stock trading activity, buyer equity becomes more attractive to sellers as an alternative to cash and is used more frequently as acquisition currency.

Another factor is the relative size of the buyer and the seller. If buyer and seller are closer in size (i.e. in transactions that are considered “mergers” more than outright acquisitions), equity can be used to effectively share risk and return from the transaction between the two parties. If the buyer is significantly larger than seller, this benefit is likely negligible.

Buyers also frequently use equity in situations where their stock is trading at high valuation multiples. Specifically in situations where management believes that their stock may be overvalued, an incentive exists to use equity rather than cash.