Market Overview

Expectations of a future rate cut drove the overall market higher in recent trading, ending a prolonged slump and cheering a battered Wall Street.  Although pessimism remains about the state of the US economy, Wall Street recently saw its biggest two-day rally in five years despite November tracking to be the worst month on record since September 2002.

Notwithstanding the brief respite from the gloom and doom that has permeated the market and headlines in general, the US housing market is showing no signs of recovery. US foreclosure filings in October increased nearly 100 percent over the same month last year, reaching 224,451 filings according to RealtyTrac Inc. Compounding the foreclosure issue is the continued fall in existing home sales, which reached its fifth straight month in October.  The National Association of Realtors reported that sales dropped 1.2 percent in October, representing a drop of 20.7 percent from activity a year ago.

Not helping the increasing foreclosure rates is the fact that the London interbank rate (LIBOR), to which many US consumer loans are tied, is also feeling the impact of the credit crunch. Due to the increase in banks’ liquidity concerns, the LIBOR recently reached its highest rate in a month, impacting everything from futures contracts to home mortgages.  Despite central banks’ assurances they will maintain strong liquidity through year end, the upwards of $1 trillion in commercial paper that is expected to come due before year end has banks concerned about preserving capital and avoiding a liquidity crisis.

Deal Overview

With seemingly daily increases in energy prices (and Al Gore’s headline-grabbing new job in the “green VC business”) green energy and technology has been a recent focus of discussion. Recent deals and market data have proven that as the focus on cleantech has increased, so too have the amount of investment dollars flowing into the space. VeraSun Energy Corp., one of the nation's largest ethanol producers, recently announced it will acquire competitor US BioEnergy Corp. in an all-stock deal in which 0.81 shares of VeraSun stock will be issued for each outstanding share of US BioEnergy. The combined company is expected to have a market capitalization of about $1.5 billion and total production capacity of more than 1.6 billion gallons by the end of 2008.  In addition, SunPower Corp., a leading provider of solar energy products, recently announced a $190 million financing agreement with Morgan Stanley to fund solar-power installations for commercial and public agencies. Venture capitalists have also been active in the cleantech space, investing $2.6 billion into US cleantech companies in the first three quarters of 2007, according to Thomson Financial and the National Venture Capital Association.  This dollar volume represents a 46% increase over full year 2006 dollar volume of $1.8 billion.

This month’s metric looks at the relationship between the profitability of acquisition targets and the valuation multiples paid by acquirers since January 1, 2002.  The exhibit clearly illustrates the obvious principle that profitability is a major driver of value. However, other factors such as industry dynamics, cyclicality, company-specific growth prospects, synergy potential and access to capital also play important roles.

Software firms commanded higher valuation multiples than those in other categories due to their typically strong growth trajectories, high profitability and often compelling synergies with strategic buyers.  Industrial and Business Services companies typically operate with less scalable models and at lower profitability, which reduced the value of future revenue growth. For Business Services firms, operating leverage is often limited by recruiting, training and development costs as the company grows. Industrial Products firms are typically capital intensive, which translates into additional cash outlays to support revenue growth.