From Volume 5, Issue Number 52 of EIR Online, Published Dec. 26, 2006

World Economic News

Bonfire of the Buyouts: Worldwide M&A Frenzy

Thanks to a large number of hostile takeover bids, 2006 was a record year for mergers and acquisitions (M&As), as both the Swiss Neue Zuericher Zeitung and London's Financial Times pointed out in their annual financial reviews on Dec. 21. With deals valued globally at $3.9 trillion, this represents a 30% increase over 2005, and is 16% higher than at the height of the dotcom boom of 2000.

The number of companies launching hostile bids rose dramatically in 2006, totalling 355 compared to 94 in 2005, and way above the record of 272 set in 1999. With $500 billion worth of deals in 2006, the financial services business has now become the most active sector for mergers and acquisitions, far outstripping the telecom and property sectors, each of which had $400 billion in deals. Delusional bankers told the FT they are "optimistic" that this pace of activity will continue in 2007.

Some of the deals announced just this week:

* PUBLICIS paying $1.3 billion for Digitas. So the synarchist, Paris-based ad firm, is getting a digital marketing capability.

* MITTAL, the global steel cartel, reached an accord to buy the Mexican steel firm, Sicartsa, for $900 million.

* OHIO bank mergers. Huntingdon Bancshares of Ohio, is merging with Sky Financial, also Ohio-based, for a $3.29 billion cash and stock deal.

* Express Scripts' hostile takeover of Caremark Rx—a merger of two of the biggest "pharmacy benefit managers" of the HMO jungle—involves $14 billion in new debt, which is nine times the annual earnings of the combined target company. Caremark Rx debt was quickly downgraded to junk as a result.

* Qantas Airways takeover by the pirates of Macquarie and Texas Pacific Equity Fund involves $9 billion in new debt, 15 times Qantas' earnings; the Australian government warned Dec. 18 that Qantas' debt will be junk-rated and the government will not bail it out in future. There is a desperation attempt by the Qantas pilots' union to buy enough shares to stop the takeover.

* Apollo Management Group's (private equity fund) takeover of Realogy Corp.—which owns Century 21 and Coldwell Banker real estate companies—involves $7 billion in new borrowings from JP Morgan Chase and Credit Suisse. Realogy's debt was immediately downgraded to junk on Dec. 19, and the cost of insuring its debt against default leaped up, from 0.6% to 3% of the debt.

* USAir's attempted takeover of Delta will leave Delta with an immense $23 billion in debt, as opposed to the $10 billion debt it would have otherwise. This $13 billion in new debt is more than 25 times earnings when last Delta had any earnings, in 2003. According to Delta's reorganization bankruptcy filing Dec. 19, the takeover would lose 10,000 jobs, 180 aircraft, and a 10% shrinkage of the combined airline. And absurdly, $6 billion of the new debt is to be floated to pay off unsecured Delta debt which is now frozen in bankruptcy.

* The Harrah's casino takeover by private equity firms Apollo Management and Texas Pacific involves $10.7 billion in new debt, or 13 times the target's earnings.

* The Freeport McMoRan Mining takeover of Phelps Dodge loads $15 billion in debt on the combination of two corporations which had no net debt, and produces a combined junk-rated company from two companies whose bonds were AA-rated.

According to Thompson Financial, the leading banks behind the worldwide M&A frenzy are: Goldman Sachs, with a volume of $1 trillion (472 transaction); Citigroup with $900+ billion (395 transactions); Morgan Stanley with $900+ billion (382 transactions); JP Morgan with $860 billion (429 transactions); and Merrill Lynch with $700 billion (300 transactions). Aside from these top five, Union Bank of Switzerland ($620 billion) and Credit Suisse ($620 billion) are runners-up. UBS's biggest merger consulting deal was Gaz de France with Suez ($41 billion), although last month, France's Constitutional Council said the merger, as now constituted, violates current European Union deregulation rules.

Buyout Mania Is Building Up Another Debt Bubble

Apart from the looting of many targeted firms, the leveraged takeover boom looks to many financial regulators like a repeat of the U.S.-centered housing/consumer debt bubble which is now bursting, but on a huge corporate scale.

A New York financial community source reported on Dec. 22 that, of the 30-40,000 corporate mergers and acquisitions worldwide this year, only perhaps 1,000 have been "leveraged" takeovers [premised on placing large amounts of new debt upon the target firm in the takeover], but these account for more than half the market value and most of the debt. About half of these involve hostile leveraged takeovers and/or attempts, which bids often involve really huge amounts of debt and "valuing" the target company at 20-40% above its current market value. These really drive stocks for short-term investment strategies—not long-term, because these companies are usually being "taken private"; i.e., off the public listed stock markets.

M&As in general are now the main, nearly the whole, driver for the stock market, led by the large amounts of money to be made in playing the leveraged takeovers. Investment banks/lending banks are making huge fees on this, as much as 2.5% of the whole takeover loan (compared to normal corporate loan fees of 0.5% or less). Hedge funds are completely into it now, because it is more profitable than their previous derivatives-based strategies, which are getting harder and harder to work.

The strategy in the big leveraged buyouts now, is for the takeover firm or fund to try to get as close as possible to borrowing the entire takeover price, and use the cash flow of the target company for repayment. An example is the current attempt on India's (Hong Kong-owned) Hutchinson Essar communications firm, by Blackstone Group and Reliance Group (one of several competing bids targetting this company) for $15 billion. All $15 billion will be borrowed from Citigroup and UBS, if the takeover goes through.

Predators Taking Over 'Deutschland AG'

"For Sale" is the lead headline of the Dec. 18 issue of the German weekly Der Spiegel, with a front-page picture of a gigantic locust. Spiegel details the recent offensive by big hedge funds and private equity funds, which already have transformed "Deutschland AG," with its traditional industrial culture, into a place increasingly taken over by "greedy" predators, whose only interest is to squeeze what they can out of the companies, make profit and sell them out as quick as possible. This leads to more unemployment and social misery, while the takeovers get riskier and riskier, leaving a credit debt which is heading for 30 billion euros in Germany.

Spiegel uses the example of the takeover of one of the biggest German commercial TV stations: Pro Sieben Sat.1 Media AG, which controls TV channels Pro Sieben Sat 1, Kabel eines, N24 and Neun Live, to illustrate the frenzy. The network was taken over by a major hedge fund "Premia," chaired by fund manager Thomas Krenz, for 3.1 billion euros. The Premia manager and the chief manager of KKR's European chairman, Johannes Huth, want to build a European media giant, which includes the ProSieben Sat 1 TV and SBS Broadcast.

This is only one among many PEF takeovers that have plagued Germany in the last weeks. More than 5,700 corporations in Germany are directed by hedge funds, such as Permira, KKR, Apax, Blackstone or Texas Pacific, writes Spiegel. Germany now has become the main battlefield for takeovers. Last spring, PE Blackstone acquired 4.5% in Deutsche Telecom; in 2004 Fortress acquired 80,000 apartments.

Worldwide, the PE raiders have $3 trillion capital at their disposal for takeovers. Their credo is: "Buy it, strip it, flip it." Spiegel points out that there is naturally a certain duplicitousness among those who criticize the locusts, since some among the SPD leaders, like Franz Muentefering opened the door for private equity companies. Another is the trade union federation DGB which, while criticizing the PEFs, one year ago sold 20,000 apartments to Fortress. Huge chunks of apartments in cities and communes, that are overindebted, are now on the top of the PE raiding lists. At the same time, Dresdener Bank in a special study warns of a possible "bloodbath" for corporations that have been taken over.

South Korea Court Declares Leveraged Takeover Illegal

With the 2006 leveraged buyout bubble apparently reaching $4 trillion or more, and threatening many nations with corporate debt blowouts, an effective way for governments to intervene and stop this destruction has been demonstrated in an important decision of the South Korean Supreme Court. In November, that court made an extraordinary decision, which reversed one apparently "successful" leveraged takeover, declared it illegal, and reinstated criminal prosecution against the CEO of the takeover company involved. This takeover, using debt borrowed against the assets of the company targeted for takeover, and the subsequent "restructuring" of the target firm to lower operating costs, had allegedly led to an increase in profits, and no personal diversion of funds or assets was involved.

The Supreme Court ruled the takeover a breach of fiduciary duty by the takeover firm, because of its and its CEO's prior intent to indebt the target company without compensation or benefit, and to subject the target company to economic burden, risk of default and impaired credit, risk of contraction. No post-takeover actions or results could be considered as disproving this criminal intent, the Court ruled: The criminal elements were complete, under the law, before the takeover took place, and were not compensated by any payments or economic benefits to the target firm which could be shown prior to the takeover. Thus, the Court ruled, the takeover was illegal—and by implication, the "leveraged takeover" method is illegal as practiced by the private equity pirates.

The decision was made in the takeover of an engineering firm of the Shinhan Bank group. It impacts other takeover battles and prosecutions in South Korea, including takeover specialists Lonestar and New Bridge Capital. Internationally, it provides a principled method for legislature, including the U.S. Congress, to stop the mad takeover wave.

Thailand Imposes Currency Controls

Imposition of strict exchange controls produced a 15% collapse in the Thai stock market on Dec. 19, and declines in the 3% to 4% range on other Asian exchanges. Measures announced, included requirements that 30% of any foreign investment in Thailand had to be pledged to stay in the country for one year—putting a halt to fast-buck trading on exchanges. The Thai Baht had risen 16% against the dollar in 2006 (compared to rises in the 6% range for neighboring countries), affecting earnings from export and tourism. Japan, which accounts for 38% of Thai foreign investment, had been warning they might prefer investing in China or Vietnam.

Following the market collapse, Thai Central Bank head Pridiyathorn lifted the controls as they affect stock market investments, but held them on real estate and bonds.

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