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A Market for Merging

Local firms specializing in advising businesses on the sale or purchase of another company say merger activity is on the rise, and it’s a seller’s market.

“I’d say M & A; (mergers and acquisitions) activity has definitely picked up in the last year and a half,” said Mike McArthur, managing director of Ernst & Young’s corporate finance division in Los Angeles. “The economy has improved and the stock market is obviously up, which drives valuations up, and that correlates to higher values in the private sector.”

McArthur said another reason behind the rise in corporate couplings is the abundance of capital sitting in public and private equity funds that’s looking for a home.

“I’ve seen estimates of about $100 billion of un-invested private capital looking for companies to buy,” he said.

Local merger advisers say the increase in deal-making comes at the end of a general economic slump caused when many larger companies retreated from acquiring new businesses, and were more focused on improving their internal operations.

Now that those operations and balance sheets are generally improved, companies are on the hunt once again.

Yet compared with the irrational exuberance of the late 1990s and early part of the millennium, the pace is positively anemic, say some observers.

“At its peak in 2000, it was a feeding frenzy,” said Ken Bender, managing director for the Software Equity Group, a San Diego-based adviser and investment bank focused on the software industry.

In that year, some 2,700 software companies were sold for record prices, averaging about five times a firm’s revenues. The buying craze was such that in some instances, companies without sales or a viable business model received outrageous prices, Bender said.

This year, SEG, which tracks the software industry, reports about 1,600 deals with the average prices between 2.3 and 2.4 times annual revenues.

But there are always exceptions.

Internet portal Yahoo was so intent on gaining entry into the growing space of music file management, it shelled out $160 million in October for Musicmatch, a San Diego company that makes music management software.

The announced price, paid in cash, was more than six times Musicmatch’s annual revenues of about $25 million.

David Michaels, managing director for Montgomery & Co., a Santa Monica-based advisory firm with an office in Del Mar, said the sale of Musicmatch, a Montgomery client, came about much faster than the average transaction.

From the start of discussions to the signing of a definitive agreement, the sale process ran about 60 days, compared with an average time to complete an agreement between four to six months, he said.

Michaels said Yahoo was familiar with Musicmatch, having held discussions in the past without coming to an agreement. Once discussions resumed, a few other potential buyers for Musicmatch emerged, which spurred Yahoo to consummate the deal.

The company also garnered a premium price because it was a well-known independent player in a growing market with rising users and revenues, Michaels said.

This year, Montgomery & Co. has closed a dozen transactions. Three of those deals were completed by his office and included the Musicmatch sale, the largest for his office.

Reflecting the increased deal-making business, Montgomery hired 18 investment bankers this year at its four offices, including three at the Del Mar office, which now has eight staffers.


Specialized Business

Asked why companies don’t rely on their own internal staff or attorneys to arrange a sale or acquisition, Michaels said that wouldn’t be a smart move.

“M and A is a highly specialized business,” he said. “For an entrepreneur to negotiate a merger or acquisition without an adviser would be like playing poker with the pros. You’ll definitely lose your shirt.”

Conversely, bringing on a professional merger adviser usually results in stronger competition among acquirers, and higher bids.

Also, buyers are less likely to play tricks and try to take advantage of the sellers, Michaels said.

Michaels’ office concentrates on deals involving companies in the communications and electronics industries, with particular emphasis on firms in wireless and in semiconductor manufacturing.

The firm also has worked with client companies generating revenues ranging from less than $1 million (as in the case of a semiconductor firm) to a few with sales between $100 million and $150 million.

Another factor influencing the uptick in buying, especially in high-tech, has been a trend for many larger companies that cut back in research-and-development spending in recent years to go out and buy startups that have been working on new technology.

Along with a surge in acquisitions, local advisers said stricter regulatory oversight in the wake of corporate accounting scandals such as Enron and WorldCom has caused deals to take longer to consummate.

“In our experience, deals are taking a little longer to get closed and in some cases aren’t getting closed, and that’s due to a lot of additional regulatory scrutiny,” said Joel Reed, principal of Relational Advisors, a Carmel Valley-based M & A; consultant.

Relational Advisors, which has provided its expertise to Enron Corp. following its Chapter 11 bankruptcy, was involved in the largest corporate acquisition in San Diego that didn’t happen this year , the attempted purchase of Titan Corp., the locally based defense contractor, by Lockheed Martin Corp. of Bethesda, Md.

The sale announced in September 2003 fell apart in June after allegations of bribery on the part of contractors hired by Titan prompted investigations by the Department of Justice, Reed said.

Even after Titan accepted a reduction to the original sale price by $2 per share, resulting in an overall price of $2.2 billion (including outstanding debt of $550 million), Lockheed ended up walking away because of potential liabilities that emerged this year.

In addition to the bribery allegations, Titan was also hit with heavy criticism arising from charges that former employees were involved in the abuse of prisoners in Iraq.

Reed said his firm worked on the Titan deal starting in August 2003, at times putting in round-the-clock hours.

“We were disappointed the transaction didn’t close, and disappointed for everybody involved, but that’s the nature of M & A;,” Reed said.

Relational Advisors earned about $1.25 million for two research reports on the proposed sale of Titan, but because the deal wasn’t completed, lost out on collecting about $7 million in fees, Reed said.

Merger advisers generally collect flat retainer fees based on a deal’s size, and a percentage based on the sale price that can range between 2 percent to 6 percent.

The Titan sale was larger than most deals Relational Advisors gets involved in, with most companies’ sales coming between $100 million and $500 million, he said.

This year, Relational has been involved in some 10 transactions that include sales, corporate financings, private placement, turnarounds, and selling off parts of a company.

Reed said Relational Advisors has been busier than ever this year.

“We’ve been very busy and we’ve got probably more projects than at any other time in our history, but they’re taking longer,” he said.

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