Wall Street Sees 20% M&A Slump on Scarce LBO Credit (Update1)

Dec. 17 -- Even Goldman Sachs Group Inc., the world's leading takeover adviser since 2001, is prepared for a decline in mergers and acquisitions income next year when a slowing economy reduces the market for leveraged buyouts.

The value of transactions may fall 20 percent from a record $3.9 trillion this year, executives at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Bank of America Corp. estimate. That may reduce fees on Wall Street and contribute to Goldman's first profit drop since 2002, the last year M&A decreased, according to analysts surveyed by Bloomberg.

LBO firms, responsible for half of this year's 10 biggest purchases, now face financing costs that have more than doubled since June to the highest in four years. The pace of takeovers fell 33 percent since the end of the second quarter as chief executive officers at companies, including Virgin Media Inc. and Cadbury Schweppes Plc, delayed asset sales amid signs economic growth in countries ranging from the U.S. to Britain is ebbing.

``It's the end of an era for a while for the very large LBOs,'' said Piero Novelli, 42, the London-based head of global M&A at UBS AG, Switzerland's biggest bank.

Lehman's backlog of investment banking fees is lower than earlier in the year, Chief Financial Officer Erin Callan told investors on Dec. 13 after the No. 4 U.S. securities firm said fourth-quarter earnings dropped 12 percent. Callan estimates M&A may fall 20 percent next year. Her comments echoed Goldman CFO David Viniar, who said in September that the investment-banking pipeline at Wall Street's most profitable firm fell from a record in the second quarter.

Fed's Outlook

``We're in a very different environment than we were a year ago,'' said Stefan Selig, 44, the New York-based global head of mergers at Bank of America Corp. The value of deals may drop by 15 percent to 20 percent, he said.

The size of acquisitions may hinge on the U.S. economy, which the Federal Reserve has said will grow as little as 1.8 percent next year, which would be the slowest pace since 2002 when global mergers declined 29 percent.

The proportion of matchmaking from the U.S. declined to 42 percent since July 1, the lowest since the first half of 2002, data compiled by Bloomberg show. The largest transactions announced today were in the U.S., led by Ingersoll-Rand Co.'s $10.1 billion agreement to buy Trane Inc., the Piscataway, New Jersey-based maker of air conditioners for vehicles.

Botched Sale

Leveraged buyouts accounted for 24 percent of the $2.4 trillion of purchases announced in the first half, crowned by the $32 billion offer for Dallas-based power producer TXU Corp. by a group led by New York-based Kohlberg Kravis Roberts & Co. LBO firms comprised just 10 percent of the $1 trillion total since Aug. 1.

``There are more bankers chasing less transactions,'' said Jimmy Elliott, 55, global head of mergers at JPMorgan in New York, who predicts acquisitions may slump as much as 30 percent. ``There's no evidence that there will be any large public-to- private transactions in the near and intermediate future.''

UBS's Novelli expects global takeovers to drop at least 15 percent next year. The slowdown will be particularly severe in the U.S., where rising borrowing costs caused by the collapse of the subprime mortgage market hurt private-equity firms, he said.

Cerberus Capital Management LP, the New York-based private equity firm that buys troubled companies and corporate cast-offs, scrapped a $6.2 billion bid for Dallas-based Affiliated Computer Services Inc., the biggest processor of U.S. student loans, in October, saying funding had become harder to arrange. Georgica Plc, the U.K.'s largest operator of pool halls and bowling alleys, ended talks with bidders Dec. 12, blaming a ``difficult banking market and deteriorating trading conditions.''

Falling Fees

``There is a pure systemic lack of trust in the financial system,'' said Eric Bissonnier, Geneva-based chief investment officer for Asia and Europe at EIM, which has $14 billion invested in hedge funds. ``Costs are higher and the outlook for the economy is bleaker, so if you put that together, people will hesitate to do deals.''

Global fees from acquisitions will fall 5 percent in 2008 from this year's $36.9 billion, said Teck-Tjuan Yap, managing director at Freeman & Co., the New York-based research firm that tracks the securities industry. Revenue will decline 10 percent in the Americas and 3 percent in Europe, he said.

Morgan Stanley banker Michael Zaoui predicts 2008 will be a ``strong year.''

``The beauty of the mergers business is that it's a permanent feature of capitalism,'' said Zaoui, 50, chairman of European M&A, in a Dec. 10 interview in Paris.

Market Volatility

Goldman, Morgan Stanley, Citigroup Inc. and JPMorgan, all based in New York, were the top financial advisers this year, Bloomberg data show. Private-equity clients accounted for about 30 percent of their assignments.

Lehman, which ranks as the No. 6 adviser this year, won't cut jobs as M&A fees clients because it plans to win clients from rivals, said Mark Shafir, 51, the firm's global head of mergers, in an interview with Bloomberg TV today.

``The mega-LBO is dead,'' said Tom Willett, 39, joint head of European takeovers at ABN Amro Holding NV in London. ``Equity markets are extremely volatile.''

The recent increase in stock-market swings is making it difficult for buyers and sellers to agree on prices, said Joel Cohen, 69, chairman of Sagent Advisors Inc., a New York-based investment bank. Market movements measured by the Chicago Board Options Exchange SPX Volatility Index, or VIX, rose in November to the highest since 2003.

Blankfein's View

``If stock-market volatility stays high, it may be an impediment to equity-based deals as the value of both the bidder's and the target's stock moves around,'' said Frances Hudson, a market strategist at Standard Life Investments in Edinburgh, which has 142 billion pounds ($289 billion) of funds under management. ``On the funding side, there may be less investor appetite for rights issues to fund cash bids.''

Buyout firms are paying 370 basis points over benchmark rates for senior bank debt instead of 200 basis points earlier in the year, according to Guy Hands, CEO of London-based LBO company Terra Firma Capital Partners Ltd. Banks also are lending an average of 5.7 times of a target company's earnings, down from 10 times earlier this year.

Lloyd Blankfein, Goldman's chief executive officer, told investors last month the company strives to dominate the most- active parts of the market. The firm's advisory fees jumped 53 percent in the first three quarters to $2.98 billion, comprising about 8 percent of revenue.

Earnings Outlook

``Throughout recent cycles, we have consistently been sought out as a strategic or financial adviser across industries and regions,'' Blankfein said in a Nov. 13 speech at an industry conference in New York. The firm was the top adviser to financial institutions during a merger wave in the early 1990s, and to technology companies during the Internet boom later in the decade, he said.

Goldman's profit probably will fall 8 percent to $10.5 billion next year from a record $11.4 billion in 2007, according to the average estimate of analysts surveyed by Bloomberg. Lucas van Praag, a New York-based spokesman for Goldman, declined to provide M&A estimates for next year.

Goldman, Morgan Stanley and Bear Stearns Cos. are scheduled to report fourth-quarter results later this week. Analysts estimate Goldman's earnings declined 1.5 percent to $3.1 billion, or $6.64 a share, while Morgan Stanley may report a loss of $397 million, or 39 cents a share, and Bear Stearns may post a loss of $248 million, or $1.82 a share.

Sovereign Funds

Areas of strength for M&A bankers include advising gas, electricity and water companies, and sovereign wealth funds. Funds from the oil-rich Persian Gulf states and China were together responsible for about 4 percent of takeovers this year, up from less than 3 percent in 2006, according to Bloomberg data.

Gulf investors more than doubled their spending on acquisitions this year to about $76 billion, as oil prices soared 58 percent, Bloomberg data show. With crude above $90 a barrel, oil produced by Gulf nations, including Saudi Arabia and the U.A.E., is worth at least $1.3 billion a day.

Citigroup, the biggest U.S. bank by assets, said Nov. 26 it will receive a $7.5 billion cash infusion from Abu Dhabi to replenish capital after record mortgage losses caused the stock to fall almost 50 percent. Saudi Basic Industries Corp., the biggest chemicals company by market capitalization, agreed in May to buy General Electric Co.'s plastics unit for $11.6 billion in a record acquisition for the Gulf.

`Funding Appetite'

Russian steelmaker OAO Severstal bid for London-based Celtic Resources Holdings Plc, its first purchase in precious metals. Industrial & Commercial Bank of China Ltd., that nation's largest bank, invested $5.6 billion in Johannesburg-based Standard Bank Group Ltd., Africa's largest lender.

``You will see emerging markets plugging in the gap,'' said Thomas King, 47, the London-based head of European investment banking for Citigroup. ``The further you move from the U.S, the less affected the markets tend to be. Transactions in the emerging markets are getting larger.''

Tata Steel Ltd., India's oldest producer of the metal, completed the 6.2 billion-pound purchase of the U.K.'s Corus Group Plc in April. China's sovereign wealth fund this year bought a $3 billion stake in New York-based buyout firm Blackstone Group LP.

Macquarie Group Ltd., the world's largest private infrastructure investor, is betting on Europe.

``The focus is on strong cash-flow producing businesses such as utilities, toll roads, ports, airports,'' said Andrew Hunter, the London-based head of Macquarie Capital Advisers Europe. ``Credit markets will slow down M&A activity more generally, but in defensive assets that produce stable and predictable cash flows, we expect deal flow and funding appetite to be no less than 2007.''