The deals keep coming. eBay buys Skype for cash and stock worth as much as $4.1 billion. News Corp. shells out $580 million in cash for Intermix, which owns the hot social networking site MySpace.com. Oracle nabs Siebel Systems for cash and stock worth $5.85 billion -- and on and on.
Yes, mergers and acquisitions (M&A) are back. According to Thomson Financial, there have been $707 billion in announced M&A deals so far this year, an impressive 30% increase from the same period in 2004.
Expect the good times to continue. Companies have spent the past few years dealing with new regulatory requirements from Sarbanes-Oxley. Now, with most of that compliance machinery in place, they can focus more on dealmaking.
In fact, by improving internal controls, companies are in a better position to understand their own organizations and detect problems (and opportunities) within prospective acquisition targets. Many of these target companies have cleaned up their balance sheets, making their acquisition less risky. Indeed, any company that survived the tech crash of 2000-2002 has proved itself to be a real business, unlike the DrKoop.com-type companies that came public during the Internet bubble of the 1990s.
In addition, the strong economy over the past three years has generated a huge amount of cash that's now available for deals. Interest rates in the 3.5%-4% range encourage spending this cash rather than saving it. Companies like Microsoft, Intel, and even Google -- especially with its latest secondary offering -- have the firepower to make all-cash transactions. Besides, many target companies have a lot of cash on their balance sheets as well, thereby reducing the true cost shouldered by potential buyers. For example, Siebel has $2.24 billion of cash in its coffers, thus reducing the net cost of the deal for Oracle by that amount.
Besides, a variety of industries are poised for consolidation. Look at the software industry. Do we really need over 10,000 of these firms? Oracle doesn't think so. It's been gobbling up PeopleSoft/JD Edwards, Retek, and iFlex in the recent past.
Finally, private equity firms are flush with cash (according to estimates, buyout funds have raised more than $100 billion in 2005 alone) and need to do deals. Interestingly enough, even hedge funds are entering the deal game. The managements of CircuitCity (NYSE:CC) and Beverly Enterprises (NYSE:BEV) know this all too well, having received bids from hedge funds in the past year.
Is this yet another example of a bubble in the making? Perhaps. Every other M&A boom has ended in indigestion for buyers. Yet history shows that M&A booms can continue for a while, and this one appears to be in its early stages.
How can an investor capitalize on this? Unfortunately, it's tough to find buyout candidates. Small public companies with beaten-down stock prices and large amounts of cash on their balance sheets may be a good place to start looking. That's no guarantee, however, that anyone actually wants to buy those firms; takeover talk is often nothing more than speculation. After all, if you really had insider information on specific takeovers, you could land in jail for acting on it.
But there is another angle: Look at companies that advise on M&A as potentially good investments in the current strong M&A environment -- Goldman Sachs (NYSE:GS), for instance. Yesterday, the company reported stellar results, partly thanks to its M&A advisory division, which saw a 24% increase in revenues to $559 million. There are other major investment banks, such as Morgan Stanley (NYSE:MWD), Merrill Lynch (NYSE:MER), Lehman Brothers (NYSE:LEH), and Bear Stearns (NYSE:BSC), which should also benefit from the M&A wave.
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Fool contributor Tom Taulli does not own shares mentioned in this article.
