At its peak, the credit crisis radically altered deal dynamics, rendering previously dominant players impotent while empowering others. Fighting for their survival, banks elected to preserve as much capital as possible, dramatically reducing loan origination and, consequently, slowing down deal making. Strategic buyers, concerned about an uncertain economy, decided to put their M&A plans on hold. The unavailability of cheap debt financing to fund transactions brought private-equity-backed deal making to a virtual halt.

Given its countercyclical nature, distressed M&A deal volume was robust during the recession. Private-equity firms experienced in buying companies out of bankruptcy acquired troubled companies at a rapid clip, especially through 363 asset sales and Article 9 foreclosure sales. Post-crisis, after banks and other lending institutions resolved their balance sheet issues via the Troubled Assets Relief Program (TARP), public stock offerings, and a return to profitability, they have resumed lending.
Given the anemic economic recovery and the still low probability of meaningful organic growth, strategic buyers are poised to become active M&A players. Likewise, record fundraising and the availability of debt financing has primed private-equity firms to re-enter deal making. The renewed appetite of strategic buyers for acquisitions and the desire of private-equity buyers to use their significant capital base bodes well for distressed M&A activity for the near future.

Height of the Crisis

Senior lenders’ pullback from lending and the resulting impact on the economy and deal financing had a seismic effect on the willingness and ability of strategic and private-equity buyers to engage in M&A activity. As securitization came to a halt, banks were forced to carry large portfolios of mortgages and leveraged loans on their balance sheets that they could no longer sell to outside investors and, as a result, they had to build big reserves (Figure 1).

Facing sizable write-downs on these loan portfolios and precipitous drops in their stock prices, banks scaled back their lending efforts to help build up their cash reserves. Banks’ unwillingness to lend during the credit crisis was one of the primary factors that slowed growth and sparked the recession.

Furthermore, banks tightened their lending standards, making it much more difficult to obtain deal financing. Concerned about potential leveraged buyout (LBO) targets’ ability to service debt in a recessionary environment, banks stopped offering loose financing terms, such as PIK toggles and covenant-lite loans. Similarly, banks discontinued the practice of providing staple financing to potential acquirers in M&A transactions. Combined, these factors contributed to a dramatic slowdown in deal making.

At the height of the credit crisis, strategic buyers in both “healthy” and distressed M&A transactions were relatively inactive due to the uncertainty in the economy. The effects of the collapse of the mortgage market rippled through financial markets and eventually sparked a global recession. The U.S gross domestic product (GDP) was negative for four consecutive quarters (Figure 2). As the economy deteriorated, customers pulled back on spending, causing corporate revenues to decline.

Feeling pressure from their shareholders to improve profitability, companies across the U.S. implemented cost cutting measures, such as headcount reductions, and improved their operational efficiencies. However, in a business environment characterized by little or no growth, there was a limit to how much companies could boost net income solely through cost reductions.

As organic growth seemed unlikely, the most viable option for growing revenue and increasing profitability was acquiring other companies. Instead, worried that the economy might get worse, companies held on to their cash reserves rather than use that capital to engage in M&A activity and buy struggling competitors at attractive valuations. As a result, during the credit crisis, companies in the U.S. had high amounts of cash on their balance sheets.

Similarly, private-equity firms that focus on healthy targets were generally absent from deal making during the credit crisis. Prior to 2008, private-equity firms drove the M&A boom by taking some of the largest public companies private through LBOs. The availability of cheap financing enabled private-equity firms to compete effectively with strategic buyers by bidding up valuations to record highs while still meeting their internal rate of return (IRR) hurdles.

During the credit crisis, private-equity firms were sidelined because of their inability to obtain financing at attractive terms. To close deals, they would have had to contribute significantly more equity compared to pre-crisis transactions, which would have impacted their IRRs adversely. As a result, the number of LBO transactions declined steeply during this period (Figure 3). Facing pressure from their limited partners (LPs) to deploy capital, private-equity firms acquired minority stakes, mostly in financial services companies. Within the course of a year, they lost their clout as the dominant force in deal making in the U.S.

Challenging economic conditions and the lack of cost-effective financing caused a surge in distressed M&A transactions during the recession. Before the credit crisis, companies took on high levels of debt due to the availability of cheap financing. Private-equity firms closed an unprecedented number of LBO transactions during the mid-2000s by levering up the balance sheets of target companies. In addition, companies borrowed heavily to fund their growth plans.
At the height of the credit crisis, large amounts of debt came to maturity. Moreover, the recession made it increasingly difficult for companies to service their debt. Banks’ conservative stance on lending meant that the likelihood of successfully refinancing debt was low.

Activity Resumes

Consequently, the number of corporate bankruptcies in the U.S. was historically high during this period (Figure 4), leading to an increase in distressed M&A activity. Strategic buyers were not acquisitive because they were not comfortable with taking acquisition-related risks in an uncertain economic climate. Private-equity firms that traditionally focused on healthy businesses lacked the expertise and/or stomach to buy troubled companies. In contrast, private-equity firms with track records of buying financially distressed targets had the requisite deal experience to actively acquire bankrupt companies through 363 asset sales and other workout sales structures.

To be able to create the renewed loan environment, banks went through a cleansing process, although much of that was done with a helping hand by the U.S. government. TARP, instituted by President Bush and continued by President Obama, allowed banks to repair broken balance sheets devastated by major increases in loan write-offs. The Fed’s injection of capital provided liquidity and helped restore confidence in the marketplace to stave off bank runs and calm the panicked public.

Now, three years into TARP, the program has been labeled a success by the U.S. Treasury, with more than $10 billion in profit recovered by the government and more than $20 billion in total expected to be returned to taxpayers. The Fed’s continued promise to keep the fed funds rate low has kept banks’ cost of funds low, which should encourage increased lending, boost profits, and allow banks to build up their balance sheets.

As economic recovery slowly takes hold, strategic acquirers have emerged from the depths of the abyss to make key acquisitions for myriad reasons, including expanding product offerings (Johnson & Johnson acquiring Synthes), bolstering existing intellectual property (Google acquiring Motorola Mobility), and growing customer bases (AT&T acquiring T-Mobile). Healthy balance sheets coupled with a brightened economic outlook have provided strategic acquirers with an appetite to enhance organic growth through acquisitions.

Furthermore, companies in the S&P 500 index have been sitting on escalating cash balances. With the threat of inflation looming, as well as a low current yield, it is becoming more attractive for corporations to convert cash into acquisitions that help to positively change their businesses. Additionally, much of the fatty cost structure that corporations once carried has been pared back to improve profitability and create lean, mean acquiring machines.

Public equity markets have rebounded, with the S&P 500 Index showing gains of nearly 15 percent from July 31, 2010, to July 31, 2011, and of more than 30 percent from July 31, 2009, to July 31, 2011. The equity markets’ return to health provides fresh acquisition ammunition in the form of stock, while the Fed’s promise of low interest rates into 2013 creates a spirited lending environment that companies are using to add to a growing acquisition arsenal. With an ability to squeeze synergistic costs out of acquired businesses, corporate acquirers can typically justify higher prices for targets’ stakeholders and are using that muscle to increase acquisition activity.

Low interest rates are also benefiting the private-equity world. Previously, private-equity firms were required to put in greater percentages of equity into each new deal. But the lending spigot has been reopened, which has increased leverage back into acquisitions, albeit at reduced levels from the feast of the mid-2000s.

Fundraising has remained strong, with experts projecting about $300 billion in global funds raised for 2011. Combined with the record amounts raised from 2006 through 2010 (Figure 5), funds have ample dry powder to make new acquisitions. This dry powder burns a hole in the funds’ pockets, as they face pressure from LPs to put capital to work for appropriate returns. Additionally, LBOs are back, having recovered from historic lows. With the improved leveraged loan environment and the significant fundraising done by mezzanine funds, the likelihood of private-equity acquisitions has been increased.

No More ‘Kicking the Can’

The increased appetite of strategic and financial acquirers, bolstered by the return to health of the banking system, bodes well for increases in acquisitions of distressed businesses. The threat of a falling knife has lessened significantly as the economy has bottomed out and banks are better capitalized, more fully reserved, and more willing to take write-offs, all of which drive increased distressed M&A opportunity. Asset-based lending and other creative financing structures have returned to the market to allow for improved financing dynamics.

With the ability to find cost savings inherent in a distressed business and therefore ignore the profitability or lack thereof, strategic acquirers remain interested in tough deals as a way to expand while finding attractive valuations not seen in healthier deals. Distress-focused private-equity firms have followed the herd of their healthy ilk and have raised significant funds in the past few years. With a willingness to roll up their sleeves, these funds continue to seek new investments in tough deals. Due to the significant amount of fundraising completed over the past few years, even funds that typically require certain levels of profitability and general corporate health are starting to look at deals with hair, especially in industries in which the funds have specific knowledge.

Although banks will be required to maintain higher cash reserves in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and Basel III bank regulations, the Fed’s assurance that it will keep interest rates low through 2013 should encourage banks to continue lending. In the absence of significant organic growth due to the weak economic recovery, strategic buyers are expected to increasingly use M&A as a growth strategy. Record fundraising by private-equity firms in the near term and their access to cheap financing sets the stage for the return of the LBO, albeit not at the record levels seen in the mid-2000s. Distressed M&A activity is also projected to be robust in the near future.

During the height of the credit crisis, banks were not willing to sell portfolio companies at fire sale prices and take steep write-offs, so they often opted to “kick the can down the road.” Because banks have been able to repair their balance sheets and financing is no longer restricted, banks are more willing to exit their positions in troubled companies through M&A transactions without facing significant haircuts.

Mark Chesen Managing DirectorSSG Capital Advisors, LLC
Chesen is a founding partner and managing director of SSG Capital Advisors, LLC, a middle market special situations investment banking firm. He has more than 20 years of transactional experience involving M&A, private placements, capital allocation assessments, fairness opinions, and financial restructurings of middle market companies, both public and private, in a variety of industries. From 2001 to 2006 he was president and a founding partner of SSG Capital Advisors, LP, and from 2006 to 2009 was a senior managing director and co-head of the Special Situations Group of National City Investment Banking after it acquired SSG. The firm was reacquired in 2009. Chesen holds a bachelor’s degree from the University of Texas in Austin.

Bobby Mannepalli AssociateSSG Capital Advisors, LLC
Mannepalli joined SSG as an analyst in 2008 and works closely with senior bankers in advising clients on M&A activity, financial restructurings, and private placements. His primary responsibilities include financial modeling, conducting due diligence, preparing transactional materials, and interacting with potential buyers, sellers, and investors, and his transactional experience covers a broad range of industries. He holds a bachelor’s degree from the University of Pennsylvania.

By Mark Chesen & Bobby Mannepalli. Original story here.

On Dec. 27, Sears announced it was closing as many as 120 locations after same-store sales slipped 5.2 percent in the eight weeks ended Dec. 25. The shares plunged 27 percent on the news, the biggest drop since April 29, 2003. Sears fell 3.4 percent in New York on Dec. 30 to $31.78.

A former Avaya Inc. and International Business Machines Corp. (IBM) executive who joined the Hoffman Estates, Illinois-based company in February, D’Ambrosio is drawing on his tech background and telling managers to gather more information about customers’ buying patterns and product preferences and to ramp up Web operations.

“Everything starts with knowing what our customers want to buy and how and then delivering that across platforms,” he said in a telephone interview.

Sears technicians each year make 17 million visits to customers’ homes and communicate even more frequently with shoppers online and on the phone, according to D’Ambrosio.

As part of that effort, Sears has given store salespeople more than 5,000 Apple Inc. (AAPL) iPads and 11,000 iPod touches to track inventory and customer orders, he said.

Capital Starved

Sears named Ron Boire chief merchandising officer and executive vice president today. Formerly president and CEO of Brookstone Inc. (BKST), he will lead store formats for Sears and Kmart, and will focus on integrating Web and mobile services, the company said in a statement.

Chairman Edward Lampert, who along with his hedge funds owns 60 percent of Sears, has attempted multiple turnaround strategies that have failed to reverse a slide in sales. D’Ambrosio is the fourth CEO since Lampert merged Sears with Kmart in 2005.

The company’s larger stores have been starved of capital investment and customers have defected, according to Gary Balter, an analyst with Credit Suisse Group AG in New York.

Sears is spending less than a quarter of the $8 a square foot that retailers typically invest to maintain stores, according to International Strategy & Investment Group. In an August report, the New York-based company put Sears and Kmart at the bottom of the list of a dozen retailers ranked by sales per square foot and operating profitability.

‘Iconic Brand’

“Sure we want to have stores that look nice so we’re investing in fixtures, paint and new designs but store appearance in itself isn’t enough,” D’Ambrosio said. “Borders had great bathrooms but that didn’t help them because they missed the e-book revolution in their industry.”

While Lampert sticks mostly to his base in Greenwich, Connecticut, D’Ambrosio is in close touch with managers down the ranks and visited several Sears stores last month, he said.

“Eddie and I have aligned views about what it takes to make this company great,” D’Ambrosio said. “We’re in touch regularly.”

The retailer’s (SHLD) “assets are undervalued, which creates an opportunity,” said D’Ambrosio, who recalls visiting Sears auto centers with his father as a child. “Sears is an iconic brand. It’s important to revitalize this company.”

To contact the reporter on this story: Carol Hymowitz in New York at chymowitz1@bloomberg.net

By Carol Hymowitz – Jan 3, 2012 7:04 AM CT (original story here)

The Food and Drug Administration cleared 30 new treatments in 2011 compared with 21 the year before, a Bloomberg review of agency records shows. Johnson & Johnson and GlaxoSmithkline Plc each had three products approved after no company had more than one medicine cleared in 2010.

More frequent approvals may help drugmakers overcome a rash of patent expirations. At least 21 medicines will lose a combined $11.5 billion in revenue as a result of patent expirations in 2012, including Paris-based Sanofi and Bristol- Myers Squibb Co.’s anti-clotting treatment Plavix, projected to see $4.5 billion in lost sales, according to Bloomberg Industries. Drugmakers will generate more than $4 billion in 2012 from products that were introduced in 2010 and 2011.

“I think people have realized that FDA has gotten more difficult and they’re improving what they turn in,” said Yaron Werber, an analyst with Citigroup Inc. in New York, in a telephone interview.

Bloomberg tracked approvals from an FDA database of “new molecular entities” that excludes blood products and new vaccines. The 30 drugs cleared last year were the most since 36 were cleared in 2004.

Yervoy, Xarelto

Compounds approved in 2011 included New York-based Bristol’s Yervoy, the first drug cleared to prolong the lives of people with advanced skin cancer that uses patients’ immune systems to attack tumors, and New Brunswick, New Jersey-based J&J’s Xarelto, the second in a new class of anti-clotting therapies for people with irregular heartbeats.

The agency also cleared Benlysta, developed by London-based Glaxo and Rockville, Maryland-based Human Genome Sciences Inc. The compound is the first treatment for lupus, a debilitating autoimmune disorder, in 50 years.

The novel design of the drugs give the agency more flexibility evaluating them, said Janet Woodcock, the FDA’s director of drug evaluation.

“There’s a whole range of things that are novel,” Woodcock said. “That’s what we hope to keep seeing going forward.”

2007 Powers

Congress expanded the FDA’s oversight powers in 2007 after the agency was slow to react to heart risks associated with Whitehouse Station, New Jersey-based Merck & Co.’ s painkiller Vioxx and Glaxo’s diabetes pill Avandia. The FDA has since raised standards for safety and efficacy data required from companies, Werber said.

Companies meeting the criteria “are starting to see the fruits of their labor” after years of spending heavily on product research and development with little reward, said Michael Meyers, chief executive officer of Arcoda Capital Management in New York, in a telephone interview.

“I think the companies are being a lot more selective around where do they invest their own resources and where can they make the most impact,” Paul Huckle, Glaxo’s chief regulatory officer, said by telephone.

The FDA also is holding advance consultation with companies on what data should be included in drug applications to avoid having to make last-minute requests for more information on how a compound works, said Les Funtleyder, a portfolio manager with the Miller Tabak & Co. in New York, in a telephone interview.

Fewer Data Requests

Pharmaceutical companies filed 29 novel drug applications with FDA last year as of Nov. 30, compared with 22 in 2010, according to John Jenkins, the agency’s director of new medicines. Nineteen of the 30 therapies approved in 2011 were cleared without requests for more data, said Sandy Walsh, an agency spokeswoman, in an e-mail. In contrast, regulators approved about half of the 21 treatments in 2010 on the first try.

The pace of approvals this year may be influenced by the pace of Congressional efforts to renew the system that allows pharmaceutical companies to pay user fees for product evaluations. The drug industry and the FDA struck a deal last year to extend reviews two months in exchange for additional discussions while a medicine is being tested. Congress must pass the deal by Oct. 1, when the current user-fee system expires.

New York-based Pfizer Inc. leads drugmakers with 85 products in development, followed by Basel, Switzerland-based Roche AG with 83 and Sanofi with 79, Meyers said.

–With assistance from Catherine Larkin in Indianapolis and Drew Armstrong in New York. Editors: Adriel Bettelheim, Bruce Rule

To contact the reporter on this story: Anna Edney in Washington at aedney@bloomberg.net.

To contact the editor responsible for this story: Adriel Bettelheim at abettelheim@bloomberg.net. Original story here.

A decision to reveal forecasts for the federal funds rate starting this month represents the biggest step toward openness since Bernanke took office in 2006 promising greater transparency, according to Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. and a former Fed board economist. The central bank didn’t even start announcing changes in interest rates until 1994.

“This is a complete 180-degree shift from the old mysterious-institution approach,” said Ethan Harris, co-head of global economic research at Bank of America Merrill Lynch in New York. “There’s been a steady move toward opening up the central bank to outside scrutiny and trying to explain to the public the logic of what they’re doing.”

The first forecasts will be announced after the Jan. 24-25 meeting of the Federal Open Market Committee, according to minutes of the Dec. 13 gathering released yesterday. That may boost economic growth by delaying expectations for an increase in the benchmark rate, which has been kept close to zero since December 2008, according to Feroli. At the same time, publishing a range of forecasts risks sowing confusion by showing disagreement among policy makers, Harris said.

“It’s a bit awkward — you’re going to reveal to the public how much uncertainty the Fed itself has about where it’s going,” Harris said.

Additional Accommodation

The minutes said “a number of members indicated that current and prospective economic conditions could well warrant additional policy accommodation.” Those members also decided that “any additional actions would be more effective if accompanied by enhanced communication” about the FOMC’s longer- run economic goals and policy framework.

The decision to publish forecasts “is a part of trying to manage expectations,” said Diane Swonk, chief economist in Chicago at Mesirow Financial Inc., which managed $59 billion as of Sept. 30. “The theory is that if households and companies are convinced that the Fed is not going to tighten too quickly, there is reason to invest now.”

Central bankers in August decided to replace their statement that interest rates would stay near zero for an “extended period” with a date of mid-2013. Bernanke said at his Nov. 2 press conference that the statement “says at least mid-2013” and that “clearly it could well be some point beyond that.”

Stocks maintained gains yesterday after the release of the minutes, buoyed by a report showing that manufacturing in the U.S. expanded at the fastest pace in six months in December. The Standard & Poor’s 500 Index rose 1.6 percent to 1,277.06 at the close of trading in New York. The yield on the 10-year Treasury note increased to 1.95 percent from 1.88 percent on Dec. 30.

Danger of Confusion Seen

Some Fed officials voiced concerns at last month’s meeting that publishing the forecasts would “confuse the public,” as there is an “appreciable risk that the public could mistakenly interpret participants’ projections of the target federal funds rate as signaling the Committee’s intention to follow a specific policy path rather than as indicating members’ conditional projections,” according to the minutes.

While “most participants viewed these concerns as manageable,” some Fed officials “did not see providing policy projections as a useful step at this time,” the minutes said.

Releasing the forecasts will also demystify officials’ abilities to predict the economy’s path, according to Ward McCarthy, chief financial economist at Jefferies & Co. in New York.

Risks of Forecasting

“You run the risk of every other forecaster, and that is of making an idiot out of yourself,” McCarthy said.

The increased disclosure may make monetary policy “less flexible” if markets perceive the Fed as committed to a particular path of action, said Christopher Low, chief economist at FTN Financial in New York.

“The Fed is no better at forecasting than the best market economists, none of whom are right all the time,” Low said in an e-mailed response to questions. He said he worries that “it will be harder for the FOMC to change direction quickly if it means there is a risk of embarrassment or diminished credibility when they do so.”

Bernanke has made an unprecedented push for Fed openness as chairman. He has aired his views on monetary policy and the financial crisis in television interviews and taken his message on the road in town hall meetings with ordinary citizens in places such as El Paso, Texas.

Press Conferences

In 2011, the 58-year-old former Princeton University professor began holding press conferences four times a year. The FOMC now publishes forecasts for economic growth, inflation and unemployment four times a year, up from twice during the tenure of Bernanke’s predecessor, Alan Greenspan.

Fed officials have also been considering ways to make more explicit the conditions under which the benchmark federal funds rate would remain near zero. Fed Bank of Chicago President Charles Evans has advocated a promise to keep rates low until either unemployment falls below 7 percent or the medium-term inflation outlook rises above 3 percent, while Charles Plosser of Philadelphia has pushed for an inflation target of 2 percent.

Bernanke said Nov. 2 that the central bank may take new steps to boost growth, including changing the way it communicates its policy goals to the public.

“They have developed a potentially powerful easing tool,” and publishing rate forecasts “is a great move,” said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington.

“You can’t be against greater transparency,” said Bomfim, a former senior economist at the Fed. “It’s like motherhood and apple pie.”

–With assistance from Scott Lanman in Washington at Steve Matthews in Atlanta. Editors: Christopher Wellisz, James Tyson

To contact the reporters on this story: Caroline Salas Gage in New York at csalas1@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

By Caroline Salas Gage and Craig Torres. Original story here.