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JPM's Imran Khan expects cash-rich Internet companies to take advantage of the weak M&A market
In 2008, about 45 companies were acquired, about half the value of companies snapped up in 2007. But depressed valuations for potential targets have created an opportunity for cash-rich Internet companies to start making some bets through acquisitions.
That means Google, which made some 18 acquisitions in '07 (see table) and only four last year, according to JP Morgan, might just be prepared to get more active again.
In 2009, large-cap Internet companies have seen their valuations rise an average of 3% so far this year. Amazon shares, in particular, have run up nearly 18% to over $60 a share this year. This compares to a year-to-date decline of 23% for small- to mid-cap stocks.
"We think discrepancy in valuation could make small- to mid-cap stocks more attractive acquisition targets," wrote Imran Khan, analyst at JP Morgan. While Khan is referring to publicly-traded small caps, like Ommiture ($727 mln market cap) and MercadoLibre ($625 mln market cap), his analysis could also apply to the many private companies across the Internet and technology landscape.
"With expectations set for lackluster GDP growth, we think companies will look outward to find growth drivers," he said. JP Morgan currently forecasts GDP growth to be down 2.2% in 2009. Given the difficult economic environment curbing growth, "companies may need to look to M&A for growth," he said.
Slashing R&D budgets
Additionally, companies have cut R&D budgets sharply. Khan estimates that R&D budgets will grow by only 9% this year vs. 25% in 2008. Amazon, which grew its R&D budget by 24% in '08, is expected to grow that budget by 15.5% this year. Google, which grew its R&D budget by 33% in '08, is expected to grow that budget by 9.4% this year.
Importantly, "significant cash builds and little debt exposure provide large-cap Internet companies to make acquisitions," he said. On a trailing, 12 months basis, large caps that Khan follows (Google, eBay, Priceline, Yahoo, Amazon), have seen free cash flow grow by 39%, with Priceline up 112% and Google up 63%.
So, what's attractive? Companies that potential acquirers will seek out include 1) brand strength 2) product leadership 3) ease of integration 4) barriers to entry.
- Brand strength: Acquirers will likely seek a company that has recognition and respect from both partners and customers.
- Product leadership: Acquirers will seek a company with the best product as viewed by customers, partners, and competitors.
- Ease of integration: Acquirers will attach more importance to the integration process and the time required to recognize synergies.
- Barriers to entry: High barriers to entry will be a key determining factor in the build vs. buy-decision-making process.
Here's a table for acquisitions in 2008: Courtesy JP Morgan
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