M & A Outlook - 2004

Jeffrey J. Presogna, CPA CVA

During the end of 2000, the world’s largest economy fell into a recession. This time marked the end of the longest expansion period in U.S. history and the beginning of the nations 10th recession since World War II. The most recent recession, which ended by most accounts in the fourth quarter of 2002, will be one of the most memorable recessions in U.S. history. Trillions of dollars were wiped out in a broad based stock market decline. Unemployment rose to more than six percent. Business spending including advertising and capital expenditures were essentially put on hold. Corporate earnings and top line revenue growth plummeted due to the excesses of the 1990’s. Merger and acquisition activity has been almost non-existent due to depressed stock prices and the conservation of cash by business entities. During a difficult recessionary period, the general mood tends to be quite gloomy. With respect to the U.S. economy, a recession is like bringing a large steaming locomotive to a halt. It is not a very easy task to bring an economy like this to a halt and certainly significantly harder to re-ignite it. However, if history has taught us anything, the turnaround can be the beginning of a long expansionary period in history.

During 2003, in particular just after the U.S. went to war with IRAQ, the economy began to expand. Quarterly GDP in the first quarter grew nearly 3.5 percent to more than eight percent in the third quarter. Real GDP is expected to grow 4.5 percent during 2004. The enthusiasm of the consumer has been resilient. The housing market is having the best year of growth in more than 20 years. Continuing purchases of consumer durables and discretionary products continued to fuel the retail sector. Technology companies began a new cycle as semiconductor companies helped lead a depressed stock market higher. A weak dollar has provided more U.S. exports which will translate into larger profits due to currency exchange rates. Commodity prices are running at all time highs but inflation remains in control. The third quarter of 2003 began to show signs that the manufacturing sector was starting to rebound primarily due to demand from an overheating economy in China. The Federal Reserve has repeatedly said that there would not be any future increases in interest rates in the near-term. The tax incentives provided by the Bush administration combined with stimulus provided by the Federal Reserve have provided the necessary formula for the consumer and business to kick start this economy and start the locomotive moving again. The prospects for corporate profits have continued to improve as evidenced by mostly better than expected results in the fourth quarter for most companies in the S&P 500 index. The Middle East continues to be a problem for business and consumer confidence. However, most Americans feel much safer due to the increasing security agenda mandated by the Department of Homeland Security. At no other time in U.S. history do I remember security initiatives as we have seen in the last two years. The geopolitical situation is somewhat disturbing to say the least, however the American community will most likely process events as they unfold.

Merger activity is beginning to ignite in the large capitalization companies. As with the early 1990’s, the financials will lead the way. The acquisition of Bank One by J.P. Morgan is just the beginning of what will most likely be a booming year for deals in the financial industry. The deal flow will not be dominated by the financials and will most likely include the wireless sector, the travel and entertainment sector and the fiber optic and telecommunications sector at a minimum. I would expect defense and defense technology companies to continue to share the leadership of the new economy. Additionally, healthcare facilities and services should be included in the top industry groups to do well in 2004. The global demand for quality healthcare, an aging population and rising R&D outlays, should lead to a steady flow of new diagnostic and therapeutic products. The health care facilities should also benefit from higher Medicare payments and increased admissions from the baby boomer generation.

Corporate profits are improving significantly as the economy continues to fuel growth and profits. As corporate profitability continues to rise, merger activity will also begin to rise. Stock values will be increasing as well as cash flow, which provides the necessary fuel for merger activity. Top line or sales growth will come from acquisitions and an improving economy. I expect that companies with strong balance sheets and strong operating fundamentals will attempt to consolidate their proprietary business to fuel their growth. It will be a very interesting year to say the least.

Mr. Presogna is a CPA and CVA and has provided tax strategies, valuation, merger, and acquisition related services to a wide range of clients. He is Managing Director of the Northeast office of Vercor.