M&A slow in 2002

Activity could pick up slightly in 2003

Merger and acquisition activity is unlikely to increase substantially this year, experts say, although large companies will continue to seek out niche targets that can help them round out their wares and present users with single-package products and services.

“Customers want all-in-one products,” says Kurt Jaggers, a managing director with investment firm TA Associates. “They don’t want to deal with a variety of vendors. So there are some large buyers out there.”

At the end of 2002, some large software outfits went on a bit of a buying spurt:

• IBM picked up Rational Software, a producer of development tools, for $2.1 billion.

• Yahoo spent $235 million on search-engine firm Inktomi.

• Veritas Software acquired Precise Software Solutions, an application-performance management company for $537 million.

However, December’s M&A flurry wasn’t characteristic of the rest of the year. According to Mergerstat, a company that gathers information on the M&A market, telecom mergers slipped to $36.4 billion in 2002 from $38 billion in 2001. Internet deals rose slightly from $17 billion in 2001 to $20.7 billion in 2002. Both years are a far cry from 2000, when companies spent $148 billion on Internet deals and $250 billion on telecom purchases.

Part of the reason for the low M&A dollar totals is that stock market valuations are way down from their highs of 1999 and 2000. So even though some companies are buying, the value of the deals is considerably lower than it would have been in 2000.

Another reason for the slow 2002 market is that investors were encouraging companies to show free-cash flow, says Judy Reed Smith, CEO of Atlantic-ACM, a telecom consulting firm. Most of the deals tended to be small.

“We had a very strong property we were offering for sale – a healthy, profitable long-distance company,” Reed Smith says. “The problem was, people were only looking for bargains in 2002.”

Some companies sold pieces of their networks that didn’t fit into their long-range plans, she says. Verizon sold many of the small, rural portions of its GTE network to local, rural incumbent carriers.

The tech sector might see an increase in M&A this year, Reed Smith says.

“Wall Street is wondering why these companies are sitting on that free-cash flow,” she says. “Investors are saying it’s time to do something with the money.”

However, it’s also possible that companies might continue to sit on their free cash until they see if a Bush administration proposal to eliminate taxes on dividends creates pressure from investors to declare large dividends, Reed Smith says.

If there is a big telecom deal this year, Reed Smith expects it to be in the wireless market.

“If you look at someone like Sprint PCS with its low stock price, it could be a nice buy for someone,” Reed Smith says.

Changes in telecom regulation also could help drive the market. If the government changes the rules about unbundled network element-platforms, as expected, many providers that rely on UNE-P could be pressured to sell, Reed Smith says.

Paul Hammer, senior vice president at investment firm Houlihan Lokey Howard & Zukin, says large companies in the government services sector could shop for bargains this year. “It’s not considered the hottest area, but government services spending has remained very stable,” he says.

TA Associates’ Jagger says he thinks most M&A activity this year will be driven by companies such as Microsoft, Oracle and IBM, which continue to look for smaller companies providing a service or product that the large companies consider to be bargains.