Mergers, Acquisitions and Securing the Supply Chain

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 |  Includes: JAVA, JCI, MT, MTLQQ, NUE, ORCL
by: Jim Delaney

After a really a really bad fall, regardless of whether that comes while skiing, skateboarding, or in my case riding anything with two wheels (both powered and unpowered), the first reaction is an internal systems check. 'Can I move everything big: legs, arms, neck?' followed by an investigation of less critical things e.g. how bad are the cuts, scrapes and bruises? If all of that checks out reasonably well it’s on to, 'how badly damaged is the thing I was on?' and can I use it to get the heck out of here?

The market and its move up this year seemed to go through a similar process with the initial shock being felt in people’s wallets vs. on their persons. The relief of continued existence, albeit in some cases barely, has powered us from the devil’s doorstep (S&P 500 666.79 low on 3/6) to what are, in comparison, rather lofty heights.

The euphoria of mere continued existence morphed into a logical assessment of what needed to go on for the economy to move forward and stocks to continue their advance. Most of this, so far, has come from the cost cutting side of things; reducing the number of workers while getting more out of those that are left and although not a viable long-term motivational strategy, there is nothing that revs an employee’s productivity engine more than being the person that didn’t just get axed.

The crisis has also pushed companies to secure not only financing, but more of what they need in order to get their product from the inbox to the outbox. This is happening across a variety of industries and sectors from raw materials, ArcelorMIttal’s (NYSE:MT) acquisition of mines in Brazil and Russia and Nucor’s (NYSE:NUE) purchase of a scrap steel processor, to durable goods manufacturers like General Motor’s (OTC:MTLQQ) new minority stake in Delphi Automotive LLP and Johnson Control’s (NYSE:JCI) majority stake in Plastech Engineered Products Inc. The primary motivation of each of these moves was an effort to secure the supply chain. MT’s head of Strategy, Bill Scotting, put it this way: “If you’re buying fully from a market, you are relying on that market’s supply chain.”

Lest you think this is only occurring in those industries where big things are produced, Oracle Corp’s (NYSE:ORCL) Larry Ellison’s plan to buy Sun Microsystems (JAVA) and transform the software provider into a complete one-stop shopping experience for its customer’s enterprise computing needs shows just how far this idea has spread.

The last time this strategy was employed on a large scale was the conglomerate building that went on in the 1960s and Mr. Ellison himself invoked the title of the 1985 movie “Back to the Future” when discussing his plan with analysts.

The S&P 500 started 1960 at 59.89 and ended 1969 at 92.06. Besides the fact that the total index value at that point is now equivalent to two or three days movement, adding another 50% to last night’s closing value of 1095.95 would put the market near the 1600 level and almost 1000 points away from the Devil’s doorstep.

MT’s CDS/equity combo has been exhibiting the empirically proven negative correlation recently closing at 254bps and $40.62 respectively last night. The most recent low and high have been 231bps on 10/26 for the CDS and $42.00 for the stock on 9/16.

JCI’s CDS is also trading close to its lows (108bps on 9/28 vs. 122bps last night) while the stock closed at $26.49 yesterday vs. $28.30 on 11/17.

ORCL’s CDS has not moved anywhere but sideways since late July closing last night at 35bps while the stock has seen a bit more volatility moving between $22.86 on 9/11 and $20.34 on 10/2 before closing last night at $21.95.

JAVA has seen its CDS rise from the mid-20’s in the 3rd quarter to 46bps last night while the stock touched $9.35 on 8/21 and then traded as low as $8.10 on 11/6.