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Outlook rosy for 2006 M&A activity
M&A activity soared this year and experts say 2006 could easily be a record year for deals.
December 20, 2005: 2:22 PM EST
By Shaheen Pasha, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) - Happy days are here again for mergers and acquisitions as 2005 is expected to close out as the best year for M&A since 2000.

And if early signs are any indication, the wheeling and dealing is set to continue in 2006 as ongoing positive economic factors as well as increasing hedge fund and private equity interest set the stage for another strong year of M&A activity.

Year-to-date, global M&A volume is pegged at about $2.86 trillion with almost $1.14 trillion of that amount stemming from announced deals in the U.S., according to M&A tracking firm Dealogic. That's up 37 percent globally and 28 percent domestically from 2004 levels.

M&A experts say 2006 is likely to be a record year for M&A activity, easily swamping the $3.327 trillion in global volume and $1.525 trillion in U.S. volume posted in 2000.

"2006 will be higher for a lot of the reasons that drove activity in 2005," said David Stone, partner in corporate and securities practice at Neal, Gerber & Eisenberg LLC. "Interest rates are still at relatively low levels and hedge funds have taken an active role so you have more buyers willing to allocate cash."

He added that takeover activity did slow down somewhat in the fourth quarter of 2005, as corporations took a breather following the economic devastation of Hurricane Katrina, which put a damper on consumer sentiment and caused a spike in energy prices. But as the year comes to close, the M&A engine is revving up once more and Stone expects the first quarter to be ripe with deals.

Low interest rates fuel deals

For one thing, experts said interest rates aren't expected to show any dramatic spike next year. At the most recent Federal Reserve meeting, the Fed raised rates by a quarter-point to 4.25 percent but modified its language regarding policy -- a move many on Wall Street interpreted as a sign that the Fed may soon stop boosting interest rates.

And while economists expect a few more rate hikes in upcoming meetings after former Fed governor Ben Bernanke replaces Alan Greenspan as chair, the market is betting that rate hikes will level off before rising too dramatically, Stone said.

That should keep M&A buzzing in the new year, experts said.

Hedge fund happy

And hedge funds and other private equity firms should have a particularly voracious appetite for deals, said M&A expert Steven Kaplan, a professor of finance at the University of Chicago Graduate School of Business.

Currently, hedge funds are holding historically high levels of cash on their balance sheets and some are opting to get into the private equity market.

Kaplan said in the last couple of years, hedge funds have also taken on a more activist role in shaping the direction of corporate America. In 2005, shareholder activism became an increasingly popular strategy for hedge funds that have increasingly agitated for change at corporations in which they have a stake.

Carl Icahn and his latest battle with Time Warner (Research) over the media giant selling its stake in AOL became one of the best known examples of this strategy in 2005. Kaplan said a sale of AOL is a likely possibility next year and, in the absence of any significant economic downturn, will likely be one of several hedge-fund related mergers and acquisitions in 2006. (Time Warner is the parent company of CNNMoney.com)

Real money vs. monopoly money

But is the expected surge in M&A cause for worry on Wall Street?

Not this time around, said Stone.

Unlike the heydays of 1999 and 2000 when technology companies were king and irrational exuberance of the stock market resulted in poorly thought out deals, he said the market is viewing M&A in a more pragmatic fashion.

"Back then, they were playing with monopoly money and now they are playing with real dollars," he said. "Hedge funds do it for financial reasons and corporations are realizing that they need to acquire other businesses for growth."

And the fact that there were significantly higher numbers of cash transactions in 2005 -- rather than stock deals -- also bodes well for the M&A market, experts said.

According to Dealogics, of the $1.14 trillion in U.S. M&A volume, pure cash deals made up $563.2 billion of that volume while combined cash and stock deals made up $340.6 billion.

"This year has been pretty heavy in cash deals," Kaplan said. "While I don't know if that will continue, it's considered a good thing if there (is a tendency towards making) cash deals because these deals appear to be more successful and create more value."

One reason is that banks that lend money to fund cash acquisitions are more like to closely examine the proposed benefits of the deal before doling out any cash -- making the chance of a successful merger even higher.

If 2006 proves to follow the course laid out in 2005, experts say there's a strong chance for continued success in the M&A market.

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