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Markets cool M&A activity
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October 18, 2000: 4:03 p.m. ET
Market volatility slows merger talks; ongoing deals struggle with valuations
By Staff Writer Tom Johnson
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NEW YORK (CNNfn) - The stunning decline of Chase Manhattan Corp. and J.P. Morgan & Co. shares shortly after the opening bell Wednesday generated instantaneous buzz on Wall Street that their $33 billion merger agreement might be in serious trouble.
By midday, both stocks had recovered as company officials swiftly moved to restore calm. But the reaction amplified a worrisome trend for acquisitive-minded companies and investment bankers across the land: The volatility on Wall Street is having an increasingly chilling effect on merger and acquisition activity, both on future and current deals.
"People are talking, but whenever it's volatile like this, they start talking a lot slower," said David Golden, managing director of Chase H&Q's mergers and acquisitions division. "You can do M&A deals in a down market, but with the volatility like this, it's hard to get your arms around just how to value the companies."
Market volatility got you a little nervous? Click here for full coverage
Indeed, with Dow Jones industrial average now off some 13 percent for the year and nearly 7 percent during October alone and the Nasdaq market posting even worse returns, M&A activity is already showing signs of cooling off.
 The 766 U.S. mergers charted by research firm Thompson Financial Securities Data last month was the lowest number recorded since November 1991, said Richard Petersen, an analyst with Thompson. The pace has slowed even more during October, which could potentially see fewer than 700 deals.
That pattern closely mimics what happened last April -- the last time Wall Street experienced such upheaval -- when the total number of deals fell 26 percent from March.
"There's a lot of uncertainty right now," said Gary Finger, director of mergers and acquisitions at investment bank Houlihan Lokey Howard & Zukin. "Any time you have this kind of uncertainty, it affects M&A deals, particularly these stock-for-stock deals."
Analysts and bankers predict that one ramification of the recent market activity will be a gradual move away from the stock-swap merger agreements that have become so common in recent years as companies look to reduce that uncertainty.
Time Warner, Morgan watch valuations slip away
To understand why, one needs to look no further than two blockbuster deals that have experienced significant declines in valuations during the past month: Chase/J.P. Morgan and America Online Inc./Time Warner Inc.
At one point Wednesday, the Chase (CMB: Research, Estimates) agreement valued J.P. Morgan (JPM: Research, Estimates) at $119.81 cents per share, or $19.1 billion, a 42 percent decrease from the deal's initial valuation of $207 per share, or approximately $33 billion.
Click here to read about Chase and Morgan's third-quarter earnings reports
The freefall started shortly after the deal was announced as analysts and investors expressed some reservations about the deal's rich price. But then the entire financial service sector got swept up in the market's downdraft, leaving the companies with a more difficult task of justifying the deal as shareholder votes loom.
"The bigger deals [pending] right now are almost all stock deals and hopefully, the management of the buyers are able to do a good selling job," said Tom Burnett, director of Merger Insight, an M&A research and advisory firm. "I think that we're okay overall, but at some point the [shareholder] votes are going to become an issue."
Shareholder votes are one concern that AOL (AOL: Research, Estimates) and Time Warner (TWX: Research, Estimates), the parent company of CNNfn, don't have. Investors of both companies approved the union over the summer. Since that time, however, a combination of regulatory angst and market forces have lowered the deal's valuation to $100.8 billion, well off its initial $164.7 billion level.
Time Warner Chief Executive Gerald Levin told reporters and investors Wednesday that the AOL merger was "in the home stretch" with U.S. regulators while brushing aside speculation the union might be troubled.
""While I know there are a lot of leaks and speculation, most of what I've read has been totally off base," he said.
Keeping all-stock deals in check
Still, the troubles experienced by AOL and Chase Manhattan will likely slow the exclusive use of stock as the currency used for acquiring companies. That should leave those firms with large cash coffers as the most viable acquirers in coming months as sellers insist on a more stable form of currency, analysts said.
Analysts also anticipate that more companies will consider leverage buyouts, a popular tool during the 1980s that essentially involves a group of private investors buying a public company, often with management's help.
LBOs have slowly made a comeback in recent months. Earlier this month, a mutual fund group controlled by U.S. investment bank Donaldson, Lufkin & Jenrette (DLJ: Research, Estimates) backed a $3.8 billion LBO of meat producer IBP Inc. (IBP: Research, Estimates). Other recent examples included buyout group Hicks, Muse Tate & Furst's $2.4 billion acquisition of Johns Manville Corp. (JM: Research, Estimates).
"There's always a lot of appetite in terms of the private equity funds," Finger said.
Golden said at the very least, investors should expect to see the re-emergence of certain deal parameters that have all but disappeared in modern-day deals, including walk-away provisions and large amounts of cash.
There also likely will be a fundamental shift back to the historical rationale behind doing mergers, said John Ormerod, managing partner for technology and media communications mergers at Arthur Andersen.
"Historically, people did mergers and acquisitions because they wanted to grow their revenues and earnings per share," Ormerod said. "In the 'new economy,' they do it to get access to talent, not necessarily for financial reasons. What this has done is made companies focus on more traditional measures."
A report that will be released by Arthur Anderson next week points out that two-thirds of those media and telecommunications companies surveyed by the company indicated that mergers generate a negative impact on their business. Ormerod said that trend would not continue if the market continues to deteriorate. 
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