MarketView for September 28

 

 

Summary  

  

The financial markets shrugged off their concerns of the past three trading days as several major corporate acquisitions in the technology and health-care sectors fueled optimism among investors. M&A activity, as it is generally referred to, is viewed as bullish because it suggests companies are more optimistic about the business outlook.

 

Included in the M&A announcements were Xerox’s agreement to acquire Affiliated Computer Services and Abbott Laboratories announcement that it agreed to pay $6.6 billion for Solvay's drug unit. Abbott climbed 2.6 percent to $48.58, while Affiliated Computer advanced 14 percent to $53.86. Xerox, which valued the cash-and-stock deal for Affiliated at an initial $6.4 billion, sank 14.5 percent to $7.68.

 

Other deals on Monday included Johnson & Johnson's purchase of an 18 percent stake in biotech firm Crucell for 302 million euros ($444 million) as part of a flu vaccine development deal, the Dutch company said on Monday.

 

With Monday's gains, the Dow Jones industrial average held an advance of about 16 percent in the quarter so far, which would make it the index's best such period since the fourth quarter of 1998. However, the end of the third quarter on Wednesday may spur volatility as fund managers engage in what is known as "window dressing" -- when they sell laggards in favor of outperformers to spruce up portfolios at quarter's end.

 

Apple rose 2.1 percent to $186.15 after China Unicom said it would sell Apple's iPhone in China, beginning in October. France Telecom's Orange also said it would sell the product later this year. As a result, Apple was the Nasdaq's top performer, followed by chip maker Qualcomm, up 2.8 percent at $45.97.

 

Cisco Systems gained 4.4 percent to $23.61 after Barclays Capital raised its rating on the network equipment maker, citing improving demand. Dow Chemical was up nearly 5 percent to $26.39 after antitrust regulators cleared Dow's $1.68 billion sale of Morton Salt to Germany's K+S AG.

 

Boeing saw its shares close up 3 percent at $53.07, while 3M chalked up a gain of 1.6 percent at $75.01.

 

Volume was light as a result of the Jewish holiday on Monday of Yom Kippur.

 

Xerox Buying ACS

 

Xerox announced plans to acquire Affiliated Computer Services for $5.4 billion following others into the realm of outsourcing and data center management. The cash-and-stock deal, the largest one ever for Xerox's was not too surprising given the reliable revenue streams that have attracted others in the hardware industry to make similar decisions. A week ago, Dell announced it was acquiring Perot Systems after Hewlett-Packard picked up Electronic Data Systems a year prior.

 

According to Xerox, it plans to pay 4.935 Xerox shares and $18.60 in cash for each share of ACS, totaling $6.4 billion or $63.11 per share based on Friday's closing prices. That represented a premium of 33.6 percent, and compares to ACS's record high share price of $63.66 in 2006. However, shares of Xerox fell about 16 percent to $7.50 on Monday morning, shrinking the deal value to $55.61 per share. ACS shares rose nearly 14 percent to $53.73.

 

Xerox, which has about $1 billion in cash, said around $3 billion of the deal will be financed through capital markets. Its credit default swaps rose by 0.10 percentage point to 1.78 percentage points, indicating the cost of protecting its debt has risen.

 

ACS competes with Accenture Ltd and Computer Sciences Corp in data center management, as well as technology services giant IBM. Roughly two-thirds of ACS' revenue comes from handling back office operations for companies, and the rest comes from providing technology services.

 

Xerox Chief Executive Ursula Burns said the company's revenue from services will triple to an estimated $10 billion next year from $3.5 billion in 2008 after the deal.

 

"The reason why we pursued this is that our customers have been telling us that they need a ... deeper connection between back-office document infrastructures and front office business process services," Burns said on a conference call. "Putting our two companies together allows us to do this."

 

Xerox will assume ACS's debt of $2 billion and issue $300 million of convertible preferred stock to ACS's founder Darwin Deason. On an adjusted earnings basis, the deal is expected to add to Xerox's earnings in the first year. Xerox has been focusing on its so-called annuity business, in which customers consistently order supplies and services for their printers.

 

It derives some 70 percent of its cash flow from the sale of supplies, financing and services to repeat customers. But the economic downturn has forced some of its customers to slow their plans to buy new equipment or order service.

 

The companies expect annualized cost savings of $300 million to $400 million in the first three years after closing, expected in the first quarter of 2010. ACS CEO Lynn Blodgett said some jobs will be affected. After the deal closes, ACS will operate as a standalone unit, run by Blodgett.

 

Abbott and Johnson & Johnson Also Strike Deals

 

Abbott Laboratories and Johnson & Johnson announced deals worth $7.3 billion with European rivals on Monday, aimed at securing vaccines and other products key to future growth. Abbott said it would buy the drugs unit of Belgium's Solvay in a 4.5 billion euro ($6.6 billion) deal, giving it full control of its development partner's cholesterol treatments and exposure to emerging markets.

 

"This is a great use for the assets and a heck of a good return," Abbott Chief Executive Miles White said. Abbott has a comfortable amount of debt and was not "financially constrained at all" in pursuing other deals to bring more medicines into its research pipeline, he said.

 

Johnson & Johnson bought an 18 percent stake in Dutch biotech company Crucell for $444 million as part of a flu vaccine development deal, Crucell said. Takeover talks between Crucell and Wyeth broke off in January after Pfizer moved in to buy Wyeth.

 

Vaccine-makers have been hot M&A targets recently, particularly for large drug manufacturers eager to secure new products as exclusivity on existing best-selling products nears an end.

 

Abbott's deal includes Solvay's vaccines business, whose Dutch cell-based flu vaccine production facility, which can produce both seasonal and pandemic influenza vaccines, was validated earlier this month.

 

Abbott said it would finance its deal with cash and expected it to add 10 cents to ongoing earnings per share in 2010, doubling to more than 20 cents by 2012 and increasing thereafter, all before one-off transaction items expected in 2010-2012.

 

Abbott had been reviewing a potential Solvay deal for months and had little initial interest, but reversed course over the summer after getting a better understanding of Solvay's drugs and their sales potential, White said.

 

"We did more homework and made the increased effort," said White, Abbott's longtime chief who has spearheaded four other significant deals this year. The Solvay transaction should help Abbott continue to deliver double-digit percentage earnings growth in coming years, he said.

 

Johnson & Johnson's transaction will have an estimated dilutive impact of 2 cents to 4 cents on its 2009 adjusted earnings per share. Crucell issued 14.6 million new Crucell shares to Johnson & Johnson, which paid about a 30 percent premium based on the average price of Crucell shares in the past 35 days.

 

Crucell said the collaboration will focus on developing "flu-mAb," a universal product targeting all influenza A strains. That includes H1N1 strains that cause seasonal flu and the current pandemic flu, along with the H5N1, or avian, strain.

 

"A universal antibody or vaccine that protects against a broad range of strains would be an important advance in helping ... control acute epidemic and pandemic outbreaks," said Paul Stoffels, global head of pharmaceuticals R&D at Johnson & Johnson.

 

Crude Up On World Concerns

 

Oil rose more than 1 percent with sweet domestic crude futures for November delivery settling up 82 cents per barrel at $66.84. London Brent settled up 43 cents per barrel at $65.54.

 

Support for oil came from Iran test-firing a type of missile on Monday that defense analysts said could hit Israel and U.S. bases in the Gulf region. Tensions over Tehran's nuclear program have supported oil prices in recent years. The country is the second-largest oil producer in the Middle East.

 

In late 2008, Iran threatened to block the Strait of Hormuz, through which about 40 percent of the world's globally traded oil passes, when tensions rose in another row with the United States around the nuclear work. Even so, sluggish oil demand, reinforced by some lackluster economic data continued to command investors' attention.

 

Oil prices posted their largest weekly decline in two to three months last week, pressured by government data showing crude oil inventories had risen, suggesting demand remains weak.

 

The markets are awaiting weekly crude inventory data on Tuesday from the American Petroleum Institute and Wednesday from the EIA.

 

ECB Says Support Cannot Continue Forever

 

The European Central Bank cannot maintain its current strong support of money markets forever, the bank's President Jean-Claude Trichet said on Monday. The ECB has been pumping billions of euros into money markets over the duration of the crisis in an attempt to restore order and to reduce the cost of borrowing for banks, firms and consumers. For many commercial banks it has become the dominant source of funding, but Trichet stressed the situation could not continue indefinitely.

 

"The strong intervention of the Eurosystem in the euro area money market cannot be maintained forever," Trichet told a hearing of a European Parliament committee. "We have introduced exceptional measures under exceptional circumstances. We will have to phase them out once the rationale for these measures fades away and the situation normalizes."

 

However he remained clear that, while the economic situation was improving, it was not yet time for the ECB to retract its support. "Now is not the time to exit. However, at some point in time exit strategies will have to be implemented," he said, echoing comments made by policymakers over the last few weeks.

 

"The ECB has an exit strategy and stands ready to put it into action when the appropriate time comes. Our exit strategy is an integral part of our overall monetary policy strategy."

 

The introduction of one-year lending to banks is one of the measures the ECB brought in during the financial crisis. It holds the second of its three planned one-year refi tenders this week.