Fun Again

'Fun Again'

Merger and acquisition activity picked up in 2003 after a bad year in 2002. Some predict 2004 will be even better.

NEW YORK (Bloomberg) - Goldman Sachs Group Inc. and Morgan Stanley extended their lead over the world's largest financial institutions in the global mergers and acquisition business by arranging the year's biggest takeover - the $48 billion purchase of FleetBoston Financial Corp. by Bank of America Corp.

Investment banks arranged $1.2 trillion of acquisitions in 2003, up from $1.12 trillion in 2002, the worst year for mergers since 1997. Rising stock markets and improved confidence among chief executive officers may encourage more buying in 2004, said Robert Kindler, 49, global head of mergers and acquisitions at J.P. Morgan Chase & Co., which ranked No. 4.

Goldman and Morgan Stanley have been the No. 1 and 2 merger advisers, respectively, since 2001. Goldman Chief Executive Officer Henry Paulson steered the 134-year-old firm through the departure of a lieutenant, former investment banker and co-President John Thornton, and a shift of power to the traders that generated 65% of 2003 revenue. Morgan Stanley was the top adviser to banks, the most active sellers of the year.

"It will be very difficult to break that duopoly," said Michael Holland, founder of Holland & Co., which manages $500 million, and former CEO of First Boston Asset Management Corp. Goldman and Morgan Stanley "never put themselves in the position where one group of people is in the ascendancy and they could take off and go to a rival."

Rising Stock Markets

Goldman's merger bankers, led by Gene T. Sykes and Jack Levy, advised on the highest value of acquisitions - $316.5 billion - earning fees of $1.13 billion, Bloomberg data show.

Morgan Stanley advised on $225 billion of transactions, taking in $925 million of fees. Goldman's market share rose to 26.3% from 25.1% and Morgan Stanley's rose to 18.7% from 17.1%.

Merrill Lynch & Co. advised on $185 billion of transactions, moving up from sixth in 2002. J.P. Morgan advised on $183 billion of deals, up from fifth in 2002 and 2001. Credit Suisse First Boston tumbled to 10th from third, measured by the value of transactions, while earning the fifth-highest amount of fees.

Investment banks were helped by global stock markets that gained about 28%, according to the Morgan Stanley Capital International World Index. Improved confidence among chief executive officers, buttressed by low valuations and interest rates, heralds further gains in 2004, merger bankers said.

'Fun Again'

"It's going to be fun again in 2004 for the first time in a long time," said J.P. Morgan's Kindler, a former partner at the law firm Cravath Swaine & Moore LLP. "I'm confident we will see increased value of deals next year. I've never predicted an up year for M&A before."

Merger advisers competed for about $10.1 billion in fees in 2003, according to Bloomberg data. J.P. Morgan gleaned $855 million, while No. 5 Citigroup Inc. made $861 million and CSFB took in $777 million.

Goldman advised Bank of America and Morgan Stanley advised FleetBoston in the year's biggest deal, which at $48 billion was almost twice as big as the second biggest, Olivetti SpA's $28 billion purchase of Telecom Italia SpA in March. Goldman advised Telecom Italia with Lazard, while J.P. Morgan and Merrill Lynch represented Olivetti, which later renamed itself Telecom Italia.

Merrill's biggest transaction was its work on General Motors Corp.'s spinoff of Hughes Electronics Corp., valued at $16.8 billion.

During the year, Paulson's deputies Thornton and John Thain left, leaving former bond and currency trader Lloyd Blankfein, 49, as next in line to become CEO. Thornton resigned in March to become the first non-Chinese professor at Beijing's Tsinghua University, and Thain quit in December to head the New York Stock Exchange.

At the same time, revenue from investment banking fell 4.2% to $2.71 billion while trading income jumped 21% to $10.4 billion.

Banking Mergers

Morgan Stanley advised on $73.8 billion of bank acquisitions, giving it 44% of the market. Besides the Bank of America purchase of FleetBoston, Morgan Stanley advised on First Virginia Banks Inc.'s $3.4 billion sale to BB&T Corp. and the sale of Lloyds TSB Group Plc's New Zealand unit to Australia & New Zealand Banking Group Ltd. for $3.8 billion.

The value of mergers in 2003 is less than half what it was in the record year of 2000, when mergers totaled $2.9 trillion. The value of deals announced in the fourth quarter was $401 billion, the biggest quarter of M&A since the third quarter of 2001.

"If you annualize the number and total value of the transactions announced in the fourth quarter you have a pretty good proxy for what the M&A market should be like in 2004," said Frank Aquila, a senior mergers partner at Sullivan & Cromwell. "The bankers I speak to are optimistic."

Fifth in Fees

CSFB came fifth in fees even as its merger ranking fell by concentrating on deals in which it can be the lead or sole adviser. That lets the bank, whose M&A unit is co-headed by Donald Meltzer and George Boutros, keep most or all of the fees. It also works on smaller deals than Goldman, Morgan Stanley or J.P. Morgan, which generate higher commissions than those paid on larger deals.

Lazard, which moved up a spot to sixth in the rankings, had a "record year" for advisory fees, said Kenneth Jacobs, head of investment banking in the U.S. Lazard earns fees on more than just announced M&A advisory work, while league table rankings give credit to firms that may only be providing financing on a deal, he said.

'Healthier Market'

Banc of America Securities, which along with Goldman advised its parent on the FleetBoston deal, leaped to 11th in the league tables this year with 61 deals worth $89 billion, from 16th last year with 71 deals worth $31 billion.

The rebound in M&A - which along with equity sales is one of Wall Street's most profitable activities, in part because firms put no capital at risk - still leaves bankers much less busy than during the boom years of 1999-2001.

"It's premature to call it a turnaround," said Yoel Zaoui, co-head of European M&A at Goldman Sachs. "Relatively speaking, this year has been good. The market is healthier than it's been for the past two years, but activity is still relatively volatile."

Declining Risks

Other concerns include whether corporate mergers make sense at all. Of the 277 deals done between 1985 and 2000, 64% destroyed shareholder value, according to a study by Boston Consulting. Some bankers say this sentiment may be waning.

"The risk of criticism for doing deals has gone down," said Stefan Selig, vice chairman of Banc of America Securities. "Once the market digests a transaction and perceives it to be sound, then acquirers' stock prices can quickly rebound."

Shares of Bank of America tumbled 10% after the deal was announced. They're now trading at $79.59 a share, compared with $81.86 the day before the transaction was announced.

As much as 25% of next year's transactions will come from the financial services industry, Kindler at J.P. Morgan said. The global value of mergers in 2004 may increase between about 15%, the estimate of Lazard's Jacobs, and 25%, the prediction of Tierney at Fox-Pitt Kelton.

Investment bankers have been reporting an increase in their merger backlog for three quarters.

Growing Backlog

"The backlog is well up from this time last year, which should presage a pickup in activity for 2004," said Selig at Banc of America Securities.

Among the mergers that bankers speculate may occur in 2004 are Citigroup's acquisition of Deutsche Bank AG; Barclays Plc or Royal Bank of Scotland Group Plc's acquisition of Sovereign Bancorp Inc.; and BellSouth Corp.'s acquisition of AT&T Corp.

"I see several catalysts for M&A activity in 2004," said Steven Baronoff, head of M&A at Merrill Lynch. "CEO confidence is improving. The cost of capital is low and makes deals attractive. Corporations are willing to sell assets because valuations from financial sponsors and corporates are attractive. There will be more cross border deals because the falling dollar makes U.S. assets more affordable."

A Goldman Sachs survey found U.S. chief executives' confidence in the future rose to 81 from 15 between October of this year and September 2002, Thain said at a conference last month before leaving the firm. A score of 50 represents neutral sentiment.

GE Buys, Sells

General Electric Co. Chief Executive Officer Jeffrey Immelt has announced more than $27 billion of purchases this year including Vivendi Universal SA and Amersham, and at least $8 billion in divestitures. He has said he expects GE to spend about $8 billion a year in the future on acquisitions.

While gains in global stock indexes may help make chief executives receptive to mergers, leveraged buyout firms will remain active next year, bankers said.

Private equity firms spent a record $117 billion on 644 deals in 2003, versus $98 billion on 422 deals in 2002.

The dollar's 16% slide against the euro this year may boost U.S. acquisitions by European companies. Henkel KgaA of Germany, the maker of duct tape and Persil detergent, agreed earlier this month to buy U.S. soap maker Dial Corp. for $2.9 billion in cash.

Longest Downturn

"The weakness of the dollar could spur more European companies to look into buying U.S. companies," said Lazard's Jacobs.

On the other hand, he said European economies lag the U.S. by six to 12 months, and won't have as strong growth. Corporate governance changes are also an issue for European companies.

Bankers' optimism aside, history may be the best indicator that the M&A market is about to rebound.

"Three years of downturn is the longest we've ever seen," Michael Zaoui, a senior banker in the strategic engagements group at Morgan Stanley and Yoel Zaoui's brother, said. "I don't see that going on."