Market Overview

Since the Federal Reserve’s September 18 rate cut, the economy has sent mixed signals and leaves Wall Street expecting further easing to come in the short term.  On October 5, the Labor department released data that showed an increase of 110,000 new jobs added to the US economy.  In addition, the prior month’s numbers were revised from showing a loss of 4,000 to a gain of 89,000.  Meanwhile, the unemployment rate held at 4.7 percent and hourly earnings rose 0.4 percent.  Capital markets responded well to the rate cut and subsequent economic readings, all finishing up for the month of September.  The NASDAQ led the charge up 4.1 percent in the month of September, while the Dow and S&P followed suit up 4.0 percent and 3.6 percent, respectively.  Market fundamentals remain strong despite the worries surrounding the credit market.  As of October 19 the S&P 500 overall P/E multiple was 16.8x, slightly lower than the 30-year median historical multiple of 17.4x.  While current valuations are without a doubt at risk, the evidence suggests that it is not overvalued as a whole.

While the equity markets had a strong September, housing continued to show weakness as housing starts in the US dropped from an annual rate of 1.3 million units in August to 1.2 million units in September.  Compared to September 2006, when the revised annual rate was 1.7 million units, this is a drop of 30.8 percent.  Given the weakness in housing, the expected ongoing tightness in lending and the danger this brings to the consumer, trading in federal funds futures indicate an 86 percent chance of a 25 basis point cut at the Federal Open Market Committee meeting on October 31.

The Fed’s September rate cut has continued to have a significant impact on the US dollar.  In September the Canadian dollar reached parity with the US dollar for the first time since 1976.  As of October 22, the Canadian dollar remains strong at $1.02/CAD.  The Euro continues to climb against the dollar, seeming to reach new record highs almost daily.  In September alone it climbed from $1.31/Euro on September 1, to $1.42/Euro on Sept 28, the final trading day of the month.

Deal Overview

Evidence of the credit crunch influencing the buyout market has continued to dampen the large leveraged buyouts.  In the final days of September the market heard that the consortium led J.C. Flowers would not close the proposed $25 billion buyout of student lender Sallie Mae.  While the top of the market may be seeing some trouble, the middle-market has seen no slowing.  Yahoo acquired online ad-network BlueLithium for $300 million and continues to set its sights on Google, which has heavily outperformed its peers.  This recent acquisition boosts Yahoo’s capabilities in data analytics for advertisers.

With the falling US dollar the amount of international buyers targeting US companies is expected to continue to grow.  A recent high profile deal is the acquisition of 3Com by Bain Capital and China based Huawei Technologies.  Under the terms of the deal, Huawei would initially take a 16.2 percent stake in 3Com, with a possibility of that stake increasing by 5 percent.  3Com sells equipment to the US Department of Defense, which presents a problem, considering Huawei technologies is a privately held company set up in 1988 by a former Chinese army officer.  Bain has agreed to submit the deal to a review by the Committee on Foreign Investment in the United States (CFIUS), a federal inter-agency panel that reviews international takeovers.  It appears there is a chance this deal may go the way of the Dubai Ports World takeover, when a U.A.E. investment firm was snubbed by US politicians in its attempted acquisition of US ports.

This month’s metric reviews historical trends of Merger and Acquisition (M&A) activity in the United States per industry category.  As the exhibit clearly illustrates, all three industry sectors Mirus covers have experienced healthy growth from 2002 throuhg 2006, with a compound annual growth rate (CAGR) of 22% over that period.  This growth rate falls to 17% when including 2007 on an annualized basis, but is still above the 10% CAGR for all deals in the U.S. in that same period (which includes deal in other segments such as financial services, pharma/biotech, natural resources, etc.)

The exhibit suggests that the M&A environment might be cooling down somewhat in 2007 (based on annualized data through September). However, Mirus has seen very robust M&A activity to date and believes that some seasonality might be underlying this observation: the summer is typically slower, while deal activity tends to pick up as the calendar year draws to a close.

Through 2006, M&A activity growth has been balanced across all three sectors, as their CAGRs fall within a tight range 21% to 25% from 2002 to 2006.  From 2006 to (annualized) 2007, there is some disparity between segments: business service was the only segment of the three to see M&A activity grow (up 3%), while Industrial Products and Software deal activity was down (-3% and -8%, respectively).