Mergers Reached This Year Are Using
The Lowest Share of Cash in 10 Years

By GREG IP
Staff Reporter of THE WALL STREETJOURNAL

It's a good thing individuals are willing to pay such high prices for stocks, because Corporate America sure isn't.

Corporations are committing the lowest share of cash to mergers this year in at least 10 years, while reducing the amount of their own stock they say they'll repurchase. At the same time, Wall Street continues to sell a staggering amount of new stock via initial public offerings to investors.

That seems to suggest that Corporate America has a lower opinion of the value of stocks than individuals these days, although that doesn't necessarily foretell an imminent fall in the market. On the other hand, there might be features of the latest mergers that suggest otherwise.

In the three financial megamergers announced this month valued at more than a total of $160 billion, not a penny is being offered for the stock involved. All three have been "mergers of equals" in which the shareholders of the acquired company receive stock in either the acquiring company or a new, merged entity, rather than cash. (However, in two transactions slight premiums were offered to the acquired companies' shareholders.)

Thus, the value of the deal fluctuates with the stock of companies involved. Thanks in part to those three big stock deals, the cash-financed portion of mergers and acquisitions announced this year has dropped to just 13.4%, according to Securities Data Co., of Newark, N.J. That follows a steady slide from 42.3% in 1994.

That drop "would certainly seem to support the idea that corporations are starting to see their stocks as fully valued, maybe overvalued," says Elizabeth Mackay, chief investment strategist at Bear Stearns.

Ms. Mackay says Federal Reserve data show that the market value of corporate equity is now at a record of over 115% of the cost of replacing net assets. So in theory it should be cheaper for companies to build rather than buy new assets. But "if one's own currency is similarly overvalued, then stock deals become a viable option."

Reinforcing that conclusion, she says share-repurchase announcements appear to have peaked in mid-1997, suggesting "the return on buying one's stock at these levels is becoming less compelling." She noted that the accounting treatment of many mergers also prevents some companies from buying back stock.

Ms. Mackay says quite apart from what these trends say about perceived valuations, they are weakening an important support for stocks in recent years: the shrinkage in the supply of equity. "If you do cash deals you take stock out of the market. That's been a big prop: corporations have been net buyers of stock." But with all the initial public offerings coming to market and stock-financed mergers taking place, she says the supply/demand equation is becoming less positive.

Corporations announced plans to repurchase just $38.6 billion worth of their own stock in this year's first quarter, down sharply from $52 billion in the first quarter of 1997, according to CommScan LLC, a New York based analysis firm. At the same time, 126 IPOs worth $8.5 billion have been brought to market so far this year, compared with $6.2 billion a year earlier, according to CommScan. But that's still below the $10 billion quarterly average of the last three years.

Given the combination of stock mergers, new offerings and mounting insider selling among corporate executives, "you'd have to say that corporate investors have turned bearish," says Charles Biderman, president of Liquidity Trim Tabs, a Santa Rosa, Calif., newsletter that tracks money flowing into and out of the stock market.

The actual cash being committed to deals has not fallen as much as the cash percentage in part because of the sheer magnitude of the deal activity. Announced deals this year total $444.3 billion, according to Securities Data, almost half the record full-year total of $957.3 billion in 1997. The cash-only amount so far this year is a respectable $59.7 billion, about one quarter of last year's $228.3 billion.

However, that figure has tailed off sharply in the last four weeks, says Mr. Biderman. It has averaged less than $1 billion a week for four weeks now, the first time such a string has occurred since he began tracking the figure in 1995, he says. Until the last four weeks, the amount had been running at $3 billion a week. A similar dip occurred last August, at about the time the market reached its 1997 peak.

Stock-financed deals become more feasible as stock valuations rise, giving acquiring companies a more valuable currency with which to acquire others. The higher the stock valuation, the fewer shares need to be issued to pay for an acquisition, reducing the dilutive impact on existing shareholders.

Indeed, Banc One Corp., which said Monday it would merge with First Chicago NBD Corp. in a $30 billion deal, between 1994 and 1997 found its ability to do deals hampered by the low valuation on its stock price relative to its peers. That meant Banc One had to offer more stock when bidding for banks than did its rivals, and hurt its chances at the table. Its relative valuations began improving this year, making a deal more feasible.

But the reasons behind the surge in stock-financed deals are complex and not necessarily indicative of executives' perceived value of their stock.

Rick Escherich, managing director of the analysis policy group at J.P. Morgan Securities Inc., cites three reasons, all unrelated to stock valuations. First, many large transactions are now occurring in industries with a limited ability to assume debt to finance takeovers. For example, "In high tech, the ability of those companies to borrow a lot of money is small." Second, cash transactions normally force acquiring companies to use a type of accounting that results in substantial charges to earnings to reduce intangible assets, such as goodwill. By contrast, stock transactions allow a type of accounting which reduces such charges, and also minimize capital gains taxes for the shareholders of the acquired company.

Third, and most important, "the transactions are so large that you really can't do them on a cash basis. The combined companies need the capital, so you almost have to do a stock deal."

David Berry, director of research at Keefe Bruyette & Woods, a securities firm specializing in banks, concurs. "Cash deals tend to hurt bank capital ratios. Sixty or 70 billion dollars would be a lot of cash to come up with, for starters. It's a lot of capital walking out the door. It's almost impossible from a regulatory capital perspective to pull off a large cash deal."

But that said, rising valuations have certainly made mergers more likely, he says. "The run that bank stock prices have had for the last several years has had an effect on deal pricing and everyone's sense of optimism about doing deals. And sellers [are] looking at prices they never thought they could get."

Even though bank stocks' price-earnings multiples are still 20% lower than those of the overall market, that is relatively rich compared with the 40% discount in the late 1980s and early 1990s.

Some analysts, like Ms. Mackay, see the financial-merger frenzy uncomfortably reminiscent of previous deals that "smacked of poor market timing -- like BankAmerica/Charles Schwab Corp. in 1983 or General Electric/Kidder Peabody in 1986."

But Mr. Berry says the firms emerging from the current deals will be financially stronger and deserving of higher valuations than their predecessors. "As you get these really large companies coming together, it will tend to mute out the risks in the banking business. Problems in Texas sank all of the major Texas banks back in the mid-1980s. If Texas were to go through the same thing today ... the new BankAmerica might not make earnings estimates, but it wouldn't even remotely be an issue of survival."

--Matt Murray contributed to this article.