The list of $1bn-plus US mergers and acquisitions has been growing steadily since the last quarter of 2004. And while there is no doubt that big bids are back on the corporate agenda, regulation in general, and Sarbanes-Oxley legislation in particular, have now become a major influence on corporate combinations.
Since the Sarbanes-Oxley Act was made law in 2002, boards, CEOs and their compliance advisors, auditors and consultants have all been wrestling with what it means to them.
On the face of it, the requirements are straightforward. Annual reports are to carry three levels of auditors’ opinion: on the financial statements themselves; on the effectiveness of the company’s internal controls on its financial reporting; and on management’s assessment of, and reporting on, those internal controls. But what no one has had experience of is how regulators, markets and shareholders will react to adverse auditors’ opinions.
Regulatory risk has kept M&A activity on the back burner for much of 2004 – especially so as Sarbox’s requirements came into play for companies reporting in tax years ending on or after 15 November 2004; and we are only now beginning to see the first fruits of company reporting under Sarbox.
“Simply complying with the rules is not enough,” said SEC chairman William Donaldson, at the National Press Club on 30 July 2003. “(Companies) should make this approach part of their … DNA. For companies that take this approach, most of the major concerns about compliance disappear. Moreover, if companies view the new laws as opportunities to improve internal controls, the performance of the board, and their public reporting, they will be better run, more transparent and more attractive to investors.”
Stephen Barrett, international chairman of KPMG corporate finance, says: “Our feedback from clients has been that getting to grips with the requirements of the regulator, and with Sarbanes-Oxley, has been hugely distracting over the past 18 months. Only now have they been able to turn their attention to the imperative of growth.”
But by the fourth quarter of last year, deal-making was back on track. The value of the 1,856 transactions announced, according to Dealogic, exceeded $272bn for the quarter. This was the highest quarterly figure for two years and the trend has continued into 2005. If Q1 continues as it started, the total value of deals could be over $300bn, which may not be up there with the glory days of the late 1990s but will keep the investment bankers and due diligence accountants busy into many nights.
Greater comfort with Sarbox is not the only reason for renewed corporate enthusiasm for combination and growth. Research by Goldman Sachs finds that US corporates have become not only “comfortable” with considering acquisitions but, in fact, “aggressive … bolstered by unprecedented cashflows”. It sees a good year ahead for M&A activity.
Funding is plentiful and cheap, and business leaders seem confident that global economic and political risks are not increased by events in the Middle East and, in particular, Iraq. Nor by the sky-high price of oil and the fact that due to China’s increasing consumption, it is running out faster than ever. So what seems to be happening in the US is a series of consolidation plays, led by likes of Procter & Gamble, which announced a $57bn acquisition of Gillette in January.
In retail there has been M&A activity on a seismic scale. Last November Kmart announced it was buying Sears Roebuck & Co in an $11bn deal that would produce the third-largest retailer in the US, with 3,500 stores. In late February this year, a similar size deal was announced as Federated Department Stores, which owns Macy’s and Bloomingdales, was reported to be buying May Department Stores, which operates Hecht’s among its 500 outlets. Again, a consolidation play to squeeze operating efficiencies out of administrative functions in the cause of sharpening its challenge for the US retail dollar.
In fact, mega M&As are spreading across entire swathes of US commercial life. The battle for MCI continues between Verizon and Qwest in the telecoms sector, but AT&T and SBC seem to have done their deal, as have Sprint and Nextel. In logistics, (Yellow Roadway/UDF), medtech (Johnson & Johnson’s purchase of Guidant and also of Closure Medical), financial services (Metlife/Travelers Life, Capital One/Hibernia) and home entertainment (Blockbuster/Hollywood Entertainment) there seem to be a-deal-a-day the further we progress into the year.
“We are seeing an uptick in activity,” say Dana Drury of PwC, New York. “But it has been building over the past year, since the end of 2003 through 2004.” Both Drury and colleague Jennifer Kreischer, who have been working closely with clients on implementing Sarbanes-Oxley, say that one of the reasons why deal volumes are growing now is that the timing of deals has been delayed and uncertain, while regulation was being weighed and due diligence was being especially carefully managed.
“We’ve found,” says Drury, “that a number of companies decided not to take advantage of the one-year delay. If they wanted to do a transaction they wanted to be able to announce that their target company controls were in place so they could include this in their current 404 report. They want to give a clear message to shareholders that they’ve taken a good look at their target company and know what they’re getting into.”
It will be interesting to watch over the coming months just how corporate America’s newly confident dash for growth is being chastened and tempered by tighter corporate governance. “With the problems (that companies) have suffered with corporate governance, it has become more important to be seen as an institution that really cares,” according to Citigroup’s chairman of the Committee to Encourage Corporate Philanthropy, Sandy Weill.
Jeffrey Garten, dean of the Yale School of Management and contributor to the Financial Times, wrote on 28 February: “It is not clear whether chief executives – no matter how skilful – can effectively manage companies with such a global reach. Consider how Citigroup – by any standard one of the world’s most impressive and important financial institutions – has become mired in deep political problems in Japan and Europe due to lack of effective oversight from New York, and look how Chuck Prince, its chief executive, is being forced to refurbish the financial behemoth’s culture from top to bottom.
“These days, chief executives are being held responsible for hands-on management of their enterprises; their duties include personally signing off on the accounts. But, as these businesses encompass more assets, engage in more complicated financial dealings and employ more people in more parts of the world, can their attestations remain credible?”
Garten says that one example of the sort of long-term considerations and consequences to spring from the new regulatory environment in the US is the need for big businesses to play a constructive role in the societies in which they operate. The reasons why this is vital, according to Garten, is because we may be on the brink of a massive and long-awaited leap forward in stock market valuation brought on by new combination activity in the US. And because whatever happens in the US will eventually happen in the UK.
It is significant to note that in the week before going to press, two FTSE-100 companies – BAE Systems and BHP Billiton – announced multibillion-dollar purchases of US businesses. Could it be that M&A activity is about to take off in a big way in the UK? And is it possible that the repercussions of Sarbox could be felt here as well?
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