Mergers and acquisitions making a slow 2005 start.

Despite early predictions of robust deal making for 2005 and a few high-profile deals, merger and acquisition activity fell in the first quarter, both nationally and locally.

Mergers involving Los Angeles-area companies as either buyers or sellers fell to the lowest level in two years, according to data from Factset Mergerstat LLC.

Announced deal value involving local companies fell 39 percent in the first quarter to $1.7 billion from $2.8 billion in the year-ago period, Mergerstat said.

The first-quarter drop is even steeper when compared with the fourth quarter, when a handful of multi-billion-dollar deals in Los Angeles pushed dollar volume to $10.6 billion.

Nationwide, the value of announced deals in the first quarter fell 12.7 percent to $243 billion from $278.4 billion in the first quarter of 2004.

Dissecting the meaning of announced deal value can be tricky, because two-thirds of the companies that announce deals do not disclose dollar values--so the actual value is always higher than the amount reported.

However, nationwide deal volume fell in the first quarter as well to 1,986 merger agreements from 2,066 in the year-ago period.

The number of local deals fell to 105 in the first quarter, down from 110 a year earlier. The first-quarter drop was even more dramatic when compared to the 124 deals in the fourth quarter of 2004.

The first quarter's largest announced local deal was Freeman Spogli & Co.'s $307.2-million purchase of an 80 percent stake in Indianapolis-based H.H. Gregg, a home entertainment and appliance retailer. By comparison, the largest deal in the fourth quarter, DaVita Inc.'s acquisition of Sweden's Gambro AB's dialysis unit, was 10 times the size of the largest deal in the first quarter.

Investment bankers say that private equity companies and hedge funds have driven up prices because they have access to cheap capital. As a result, smaller companies wishing to make acquisitions have been priced out of the market.

"People are happy to pay for large transactions but for deals where there are detailed issues about merger integration and a lot of synergies required to create shareholder value, we're not seeing as much of an appetite," said Scott Wendelin, president and chief executive of Prospect Financial Advisors LLC.

Choosy buyers

A recent Bank of America survey found that 32 percent of chief financial officers believe that purchase prices for companies in their industry, as a multiple of earnings, will increase in 2005. The result is that buyers may only bite when a combination has obvious cost savings.

Scott Adelson, senior managing director at Houlihan Lokey Howard & Zukin, insists that the deal environment is "healthy, solid, sustainable," as evidenced ChevronTexaeo Corp.'s $16.4-billion acquisition of El Segundo-based Unocal Corp., announced last week. (It will be tallied in the second quarter.)

"The Unocal deal makes a ton of sense, but it's the perfect example of a deal that would not have occurred in 2002," he said.

Adelson said Houlihan Lokey is seeing a strong backlog and more willingness on the part of executives to complete meaningful transactions.

Other investment bankers are trying to determine whether the first-quarter drop-off is an anomaly or the beginning of a cooling-off period as credit markets return to more typical levels.

James Hunt, managing partner at Bison Capital Asset Management LLC, a private equity firm in Santa Monica, said he sees a direct parallel between the strong merger and acquisition cycle of the last year and Los Angeles' robust housing market. The commonality is easy access to capital.

"We are seeing credit-market excess fueling transactional activity," Hunt said. "One of the problems is that when there's aggressive lending, it starts the cycle all over again. The real question is whether the slight cooling of the M&A market presages a cooling off of the overheated housing market."

Though mergers and acquisitions did not catch fire in the first quarter, some sectors saw a boom in deals, including oil and gas, electronics, communications and technology.

David Hernand, a partner at law firm Latham & Watkins, said technology deals are poised for a rebound, prompted by the sale in December of Santa Monica-based Rent.com to eBay Inc. for $415 million.

"That was a great transaction because it was the first technology company to get sold for a significant amount of money in Southern California in several years," Hernand said. "What that means is the dark days of the Internet are behind us."

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