Tough times are supposed to be the land of opportunity for the brave -- the time for opportunistic companies to take over market share from the weak or to snap up businesses with profit potential on the cheap.
So it would stand to reason that with stock investors expecting a rebound in the economy later this year, the merger and acquisition business would be starting to mimic the market's sharp rally.
But don't expect to see mergers driving up stock prices the way they did before the market peak in 2007, or during the go-go days of a decade ago. Despite some recently announced acquisitions -- such as Tuesday's agreement for IBM Corp. to buy software-maker SPSS Inc. for $1.2 billion in cash -- investment bankers say the merger market remains dormant.
For the first half of this year, the volume of deals worldwide was down 35 percent from a year earlier, and the lowest since the beginning of 2004, according to data from Dealogic. In the U.S., volume was down 45 percent this year, with $365.7 billion in deals announced.
In a sign of the times, the one area of great activity has been "distressed sales," which are essentially done at low prices by desperate companies while creditors or a bankruptcy judge breathe down the business' neck. During the first half of this year, the volume of distressed sales in the U.S. was the highest on record, Dealogic said.
Instead of going shopping for acquisitions, healthy companies are essentially in defense mode, cutting costs, hoarding cash and hunkering down to manage what they already have as cheaply as possible.
"Public companies are just trying to get their hands around their old businesses," said Pat Goy, managing director of Lincoln International, an investment banking firm. "They are trying to understand the next six months."
In this environment, businesses have come to think of "flat as the new up," he said.
He has discouraged entrepreneurs from selling their businesses now because companies are making low-ball offers -- often 15 or 20 percent below an appropriate price. It's similar to the housing market, where buyers expect to take advantage of desperate sellers.
The financial backdrop is a long way from the frenzied period in 2007, when private-equity funds had so much money to deploy they drove prices to extreme levels -- eventually leaving companies weakened by too much debt.
Now, many banks are hunkering down, too -- nursing old, at-risk loans, rather than taking a chance on new ones.
The deals that are getting done are happening slowly, said Jason Lobel, an investment banker at financial advisory firm Duff & Phelps.
"There is more due diligence," and buyers are expected to come up with more cash, Lobel said. "Usually, in M&A the buyer puts in 20 percent to possibly 40 percent. Now, it's 40 to 50 percent."
The situation has implications for stock and bond investors. Investors often buy small-cap stocks on the assumption that a larger company might eventually acquire them and leave investors with a windfall. But, Lobel said, "I would not buy a single stock as an acquisition target. Even those deals that are announced don't close."
Bond investors must also beware. In the past, if a company was growing weak, it could sell part or all of the business. Now, that option often is not available and "they bleed cash flow," Lobel said.
Consequently, distressed firms often become more distressed than they would have been in the past and cannot reorganize and instead liquidate, leaving bondholders with little or nothing, said Tom Atteberry, manager of FPA New Income bond fund.
Meanwhile, Goy said he thinks the M&A market will start to improve in 2010 as the economy also turns up. Typically, he said, companies depend on cost cutting in recessions. But as soon as revenues climb, they become aggressive about buying businesses that will position them for the upturn.