Merger Pace, Values Drop In Slowdown.

Los Angeles mergers-and-acquisitions activity slowed significantly in August, with 20 percent fewer deals announced than were struck in August 2000, according to Mergerstat, an L.A.-based research firm.

There were 32 mergers involving at least one L.A.-based company announced last month, down from 40 such deals in the year-ago period. The aggregate value of L.A. deals for which values were publicly disclosed totaled $244 million, down more than 80 percent from $1.3 billion in August 2000.

"Where there was irrational exuberance before, now we're faced with irrational pessimism," said Bruce Ballenger, managing director at L.A. turnaround consultancy Ballenger, Strike and Associates LLC.

August traditionally is a slow month for dealmaking, but this year it was compounded by three factors:

* Company owners are reluctant to sell out at today's lower valuations.

* Lenders have become unwilling to finance mergers unless buyers put up significantly more equity.

* Values of public company stocks, which are often used as currency in buyout deals, have been steadily sinking -- reducing their purchasing power.

"Mergers that are being made now are being made out of necessity, not out of advantage," said Glenn Golenberg, a principal at the Westside investment firm Golenberg Schmitz Capital Partners LLC. "The strong guys are taking advantage of the weak."

One of the most active investors has been Alex Gores, principal of Los Angeles-based Gores Technology Group.

Late last week, Gores sold the education assets of The Learning Co. to an Irish-based company called Riverdeep Group PLC. As compensation, Gores received $40 million in Riverdeep stock and Riverdeep agreed to assume $20 million of The Learning Co.'s liabilities.

"We don't really view this as a total sale; it's like we just went public with these (Riverdeep) guys," Gores said. "We're getting the (Riverdeep) stock at a good value right now, and our stock will be appreciating."

Gores conceded that the valuation his firm received -- about one times annual revenues -- could be two- to three-times annual revenues in an up market. But he concluded that the upside potential of the Riverdeep stock would be greater than the upside of The Learning Co. education assets.

"By waiting (until the economy improves), we could have gotten a better valuation, but we wouldn't have picked up the synergies. We'll catch the upside on the Riverdeep stock," Gores said.

Riverdeep stock closed at $21.06 a share, down $1.22, on Sept. 6, the day the deal was announced. That's still above its $20 initial public offering price in March 2000.

Strategic mergers between competing or similar companies -- such as The Learning Co. and Riverdeep -- are becoming increasingly common.

"We're seeing a lot of competitors with duplicative overhead that, since there isn't enough business to go around, decide to join forces," Golenberg said. "We're seeing that a lot in the computer consulting business."

While some deals are strategic and mutually beneficial to the buyer and seller, an increasing number are essentially forced sales of distressed assets.

David Barnes, director of the Mergers & Acquisitions Group at Houlihan Lokey Howard & Zukin, an L.A. investment bank, is among those who have noticed a vulture aspect to many buyouts.

"The mix has definitely changed," he said. "Whereas 18 months ago you saw far more healthy deals, now there are a lot more distressed deals."

Most business owners looking to sell are not in such dire straits, and for the most part are staying on the sidelines, waiting for valuations to rise along with the overall economic tide.

Lenders are likewise on the sidelines, unless the buyer is willing to put a big chunk of equity into the deal.

"The average equity contribution to leveraged buyouts in July was 40.1 percent -- that's huge. In 1996, it was 22.9 percent," said Barnes. "That (larger equity requirement) severely limits buyers' ability to do leveraged deals."

The result: a severe slump in deal action.

Some believe the level of M&A activity in Los Angeles and nationwide is likely to pick up in the months ahead -- regardless of which way the economy turns. If the economy improves in the fourth quarter, or first half of 2002, then deal flow would likely accelerate as company valuations rise and lenders loosen their purse strings. If the economy worsens, there may be a "capitulation" by business owners who thus far have deferred selling out.

"There is this built-in expectation that these markets are going to improve in the fourth quarter, and if you don't get that, then you may see a corporate capitulation, where business owners say, 'I'm not waiting any longer. I need liquidity now,'" said Rod Essen, managing director at the L.A. office of investment bank A.G. Edwards Inc.