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Corporate Supply&Flows (FEBRUARY 5)

The recent headlines have left no doubt that merger and acquisition activity will be changing the corporate landscape in 2004 to an even greater degree than many had expected.

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CreditSights: M&A Makes A Comeback

The recent headlines have left no doubt that merger and acquisition activity will be changing the corporate landscape in 2004 to an even greater degree than many had expected. North America is leading the charge, but in Europe we also see evidence that the pre-conditions for an increase in M&A volume are in place and there is activity in the wings.

There are numerous indications that the upward trend globally is sustainable and that, across many sectors, management is leaving behind a three-year "bunker" mentality of layoffs, restructuring and cost cutting and is once again focused on growth opportunities. This more-aggressive approach goes hand in glove with the fact that 2003's stock market rally, which lifted the Standard & Poor's 500 Index by more than 25%, has restored equity as a viable acquisition currency. The stronger level of economic growth has both inflated corporate profits and shifted the driving force behind those profits from expense control and tax benefits to volume expansion and the (very) early stages of margin growth.

While healthier balance sheets are a welcome development following the strained circumstances of recent years, equity investors have been quick to adopt a "use it or give it back" mantra with regard to cash, so the pressure is on for companies to detail either their investment and acquisition strategies or outline plans for increased dividends and stock buybacks. The M&A alternative is growing in appeal. As revenues expand, higher EBITDA improves the valuation math of asset sales and the prospect of higher cash flows and stock prices increases the price that potential suitors are willing to pay. More attractive deals equates to more deals.

Also, financial buyers in the form of leveraged buyout funds and private equity investors were able to clear the decks with a number of transactions in recent quarters and are reloaded with cash and are on the hunt for investment opportunities. The capital markets are lending their support with ready financing available across the spectrum, from bank lines of credit to commercial paper to the take-out bond deal. And, it cannot be denied that deals beget deals. M&A, particularly when it involves sizeable transactions, force a response from your competitors like few other changes in strategy can. This is most notably the case when you are operating in a mature but regionally fragmented business that is experiencing limited organic growth (such as the U.S. banking sector).

Consolidation is also a classic strategic response to a declining new product pipeline in an industry with high fixed costs (such as pharmaceuticals and telecommunications). In industries where over-capacity issues continue to serve as a drag on profitability (autos, paper and forest products), where the entrance of new competitors is creating a need for more numerous distribution channels to lower unit costs (life insurance), or where regulatory changes could recast the competitive landscape (U.S. utilities), the M&A question becomes more of when, not if.

This round of deals is likely to be driven by management teams more interested in protecting their turf than beating their chests. In the wake of the economic downturn, M&A is being recast as a defensive strategy to combat reduced growth opportunities, rather than a misguided expression of megalomaniacal tendencies. This augurs well for the deals that are executed to be well-considered, reasonably priced and prudently financed.

"...it cannot be denied that deals beget deals."

Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.

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