Mergers & Acquisitions: An abundance of caution in 3Q

Posted: 6:42 pm Thu, October 15, 2009
By Danielle Ulman
Daily Record Business Writer

There may be bargains aplenty in the merger and acquisition market, but an abundance of caution on transaction terms and financing has slowed deal activity considerably this year.

And analysts say they will wait until they see how the fourth quarter goes to decide if mergers and acquisitions have turned the corner.

Significantly more deals that involved Maryland companies occurred in the third quarter than in the second quarter, but activity is still slow compared to 2008.

Maryland companies announced 50 deals over the course of the third quarter worth $1.36 billion, compared to 31 planned transactions in the second quarter valued at $1.83 billion. Not all companies announce the amount of money or stock that changed hands in the deal, so deal count is generally a better comparison. The third quarter of 2008 saw 62 deals, and the second quarter had 73.

Many of the deals in 2009 may have been in the works for more than a year because buyers and sellers have exhibited more caution than in the past.

Where deals took nine months to a year to complete in 2005 through 2007, they can now take a year to 18 months to get out the door, said Greg Boucher, managing director of the Baltimore office of the McLean Group, a middle-market investment bank.

“Deals take longer to get done, financing is more cumbersome,” he said. “As clients and as an industry, we’re a little more willing to allow for longer due diligence.”

The Daily Record studies mergers and acquisitions data provided exclusively to the newspaper by Bloomberg Financial each quarter to determine trends in pending and completed deals in which Maryland companies were the buyers, sellers or targets.

Data over the last year has shown how reluctant banks have been to lend money. And while the economic slowdown has made many firms pessimistic enough about the future that they want to sell, without strong buyers in the market, many sellers remain stuck.

“The recession is easing, but financing for these deals is still tight, and many businesses, even if they’re in the mood for acquisition activity, still do not have enough cash flow to support that kind of activity,” said Anirban Basu, chairman and chief executive of Sage Policy Group Inc., a Baltimore-based economic and policy consulting firm.

Private equity returns

The good news that might not be apparent in the data is that in the past month or so, private equity financing has returned to the table, and Boucher said that could be the sign of a trend. Private equity backed six deals in the third quarter worth $70.5 million in Maryland, compared to five deals worth $55.7 million in the second quarter of 2009.

By the end of the third quarter last year, private equity was behind 26 deals involving Maryland firms, while in the first three quarters of 2009, private investors backed 16 deals.

“We’re seeing at the top end of the M&A universe there are a lot more deals that are being financed, and they’re being financed on terms they would not have been financed with at the beginning of the year,” Boucher said.

That does not necessarily mean that investors are engaging in riskier behavior, but that they have dialed down their fears, he said.

“People were very, very risk averse at the beginning of the year and are less so now,” Boucher said. “They’re more comfortable than they were six to nine months ago.”

Bank regulators are still highly averse to risk, evidenced by the increasing number of financial institutions that have been ordered to increase their capital levels — the money they have on hand to cushion against losses.

In the third quarter, Bradford Bank became the second Maryland bank to get shut down by the Federal Deposit Insurance Corp. this year when it could not meet the regulator’s capital requirements and later could not find a buyer. The FDIC selected M&T Bank to acquire some of Bradford’s branches because M&T’s proposal was the most cost-effective of the 266 bids it received.

Under scrutiny

Other banks that have fallen under federal scrutiny have opted to sell off branches or business units to increase capital levels. Owings Mills-based K Bank sold off two of its branches during the third quarter after the FDIC ordered it to raise its capital levels in April.

“Troubled banks are being bought in big number across the country,” said Richard Clinch, director of economic research for the Jacob France Institute at the University of Baltimore.

On Tuesday, First Mariner Bancorp agreed to sell 95 percent of its consumer finance business, Mariner Finance, in order to satisfy regulatory requirements that it increase capital at its subsidiary 1st Mariner Bank. The $10.5 million sale will appear in the fourth quarter, and signifies a continuing trend in bank mergers and acquisitions.

“You’ll continue to see many banks in their efforts to raise capital sell assets. First Mariner in some sense was very lucky to have a sellable asset like Mariner Finance,” said Basu, who is a member of First Mariner’s board of directors.

Other areas of the mergers and acquisitions market have stalled, possibly in part because the recession has conditioned Americans to seek out the lowest price.

Looking for a bargain

“This is more than just about mergers and acquisitions, but mergers and acquisitions are a reflection of the mood in the American marketplace,” Basu said. “Everyone is looking for a bargain, like ‘Cash for Clunkers,’ and absent those bargains, people aren’t buying.”

The problem there is that for a lot of small- to medium-size businesses, the sale of the firm represents the way the owners will fund their retirements. That has lead to some firms holding tight and waiting for the market to return so they will not have to sell at a bargain.

“Unfortunately that’s what buyers are looking for; they’re looking for desperate sellers,” Basu said. “In an environment where sellers are looking for a reasonable price and buyers are looking for prices at rock bottom, fewer deals are being made.”

Also, lots of firms have gone belly up while waiting for a buyer because the only value left in the business has been goodwill, known as brand-name recognition.

“In a service-based business that is set up specifically on what their next project is going to be … if they don’t have a lot in their pipeline, that’s really true, unless they have a unique brand name or a service that a buyer can’t find anywhere else,” Boucher said.

At the end of September, Baltimore architecture firm Cochran, Stephenson & Donkervoet Inc. folded after 62 years in business. The company said private financing for continuing-care retirement communities and demand for those facilities, its bread-and-butter business, had dried up.

“Under normal cases, that firm would have been acquired, but instead that firm failed,” Basu said.

A slow comeback

Despite proclamations from economists that the recession has ended or will end soon, those assertions mean the economy has stopped contracting, not that it will grow by leaps and bounds. Even with improvements in the stock market, mergers and acquisitions are not expected to come roaring back.

“The economy hasn’t returned, so I don’t think we’re expecting mergers and acquisitions to return. Recovery is still hoped for in 2010, but I think people are getting more pessimistic,” Clinch said.

According to mergermarket, a mergers and acquisitions intelligence service with offices in New York, Hong Kong and London, recent rallies in the equity markets and improving credit markets have elevated deal activity. But mergermarket is not certain if that means that the world is “on the cusp of a wave” of mergers and acquisitions.

“Only time will tell,” the company said in its quarterly round up of the market. “The next three months will be crucial in sustaining the wave.”