Industrial companies--flush with cash and lean on debt--are loading up on acquisitions in anticipation of slower sales and profit growth next year.
The Federal Reserve Bank expects U.S. industrial production to grow 4.3% in 2011, 20% less than this year's growth rate, as companies rebuilt inventories depleted by 2009's economic recession. Next year's slower output will likely translate into more modest performance for many companies whose revenue and income this year increased by more than 10% from 2009.
"2010 was a big recovery year. It's going to be harder to get that growth over the next couple of years. You can get it by acquiring another company," said Walt Liptak, an industrial analyst for Barrington Research in Chicago. "The deals are starting to happen."
Some of the biggest spenders of 2010 included companies that have mostly abstained from major acquisitions in the past, such as Caterpillar (CAT), and Tyco International Ltd. (TYC), as well as regular shoppers like Emerson Electric Co. (EMR) that had reputations for being cost-conscious buyers.
After routinely being outbid by private equity firms a few years ago, chief executives are now paying premium prices for businesses with better growth outlooks than their companies' core operations. The median price paid this year for acquisitions by multi-industry conglomerates equates to two times the acquired companies' trailing annual sales. That's the highest deal multiple in more than a decade and is up from 1.2 times in 2009, according to Deutsche Bank Securities Inc.
Ironically, the severe downturn in 2009 provided companies with the motivation and resources to become more aggressive buyers. When their sales tanked in late 2008, companies slashed payrolls and overhead expenses, eliminated debt and piled up cash. Multi-industry companies' net debt to market capitalization is at an all-time average low of 11%. Coming out of the last recession in 2003, it was 27%. Moreover, their cash holdings amount to 8% of their combined market capitalization.
This unprecedented buying power is prompting some observers to warn that purchase prices could easily become overheated next year, especially if returns on acquisitions begin to weaken. At the moment, though, it's a risk that companies appear willing to take.
With an uncertain end to the slump in U.S. housing and commercial construction, Caterpillar plunged deeper into the mining sector by buying mining equipment maker Bucyrus International Inc. (BUCY) in November. Chairman and Chief Executive Doug Oberhelman concluded that developing countries' increasing consumption of coal, copper and other mined commodities will support prolonged demand for more mining equipment.
"We think it's a great time to invest in mining," Oberhelman said during a conference call with analysts Nov. 15. "All of us have been to China, India, Africa, and certainly Brazil--everywhere you go, modernization is occurring as the middle class strives to progress. We like that."
With a price tag of $7.6 billion, Bucyrus is the most expensive acquisition in Caterpillar's history. Illinois-based Caterpillar, which already builds big haul trucks for mines and quarries, is counting on Bucyrus providing as much as $400 million a year in cost savings and growth opportunities for Caterpillar, starting in 2015. It's a goal that some view as a stretch, given the traditional boom-and-bust cycles for mining equipment caused by volatile commodity prices.
"There's not a lot of margin for error in that deal because of what they paid for it," said Adam Fleck, an analyst for research firm Morningstar Inc.
Profitable public companies with desirable business lines are inevitably requiring full-price offers to convince investors to part with their shares. ABB Ltd.'s (ABB, ABBN.VX) $63.50-a-share offer for electric motor manufacturer Baldor Electric Co. (BEZ) is 15% above Baldor's all-time high stock price. Baldor's stock price had already climbed about 60% this year before ABB agreed in November to pay a 41% premium for the Arkansas company's shares.
"It could have been a bit cheaper, but from a strategic standpoint, it's a good deal" for ABB, said Samuel Eisner, an analyst in New York for Sterne Agee & Leach.
The Swiss company's willingness to pay up for Baldor was likely influenced by the company's failed attempt this summer to buy Chloride Group PLC, a U.K.-based maker of backup power systems for computer server centers.
ABB dropped out of a bidding war for Chloride with Emerson, whose $1.5 billion offer for Chloride amounted to roughly 22 times Chloride's projected 2011 pretax earnings and about a 90% premium to Chloride's average stock price in the three months before the bidding commenced.
Emerson has spent about $4 billion on acquisitions over the last 18 months, much of it on deals to expanded the St. Louis, Mo., company's presence in the equipment market for computer server centers. The $8-billion-a-year global market for backup power systems has been growing 6% to 8% a year, roughly twice the rate of other industrial sectors.
Other companies also have fortified positions in their most-appealing markets. Tyco expanded its leading share of the North American market for home alarm systems by buying rival Brink's Home Security Holdings in a stock-and-cash deal worth $2 billion. It was Tyco's largest acquisition since former CEO L. Dennis Kozlowski resigned in June 2002, following a decade of high-flying deal-making that left the company with a mountain of debt and dozens of inefficient and incompatible businesses.
"We've been through a horrendous downturn and all these companies have prudently deleveraged their balance sheets," said Deane Dray, a analyst for Citi Investment Research. "Now, they have the balance sheet room and the ability to do more deals."
-By Bob Tita, Dow Jones Newswires; 312-750-4129; firstname.lastname@example.org