Fallout from MMC’s Kroll Acquisition

May 20, 2004

Major acquisition announcements inevitably trigger a lot of fallout – very like the effect of throwing a large rock into a still pond. The ripples spread out over the pond’s surface. MMC’s announcement that it will acquire Kroll, Inc., the New York based risk consulting and security firm (See IJ Website May 19) is no exception.

The most immediate affect was on Kroll’s shares, which predictably jumped over 30 percent as 30,526,288 shares were traded, closing at $36.56 (MMC’s offer prices them at $37) on the NASDAQ exchange. MMC shares even rose slightly, closing at $43.00.

The commentary from various analysts, as reported by Reuters and other sources, largely followed the “glass is half full or half empty,” depending on how you look at it, formula. The optimists, including MMC President Jeffery Greenberg, stressed the synergies, cost savings and increased revenue stream MMC could expect from the acquisition, while the pessimists questioned the costs, how much Kroll would actually add to MMC’s earnings, and when.

Two of the major rating agencies largely split along these lines as well. Standard & Poor’s Rating Services announced that it has placed MMC’s “AA-/A-1+” counterparty credit rating on CreditWatch with negative implications as direct result of the Kroll acquisition announcement.

S&P noted that Kroll is a “global risk consulting company providing professional service expertise in security services, bankruptcy, turnaround and business recovery, forensic accounting, litigation support, crisis management, and background screening. These business lines generated $485 million in revenue in 2003.”

The rating agency indicated that although it believes “the successful integration of Kroll’s operations would enhance MMC’s competitive position, the adverse impact of financing the transaction primarily through debt, coupled with the risks of integrating a ‘BB-‘ rated organization that has itself grown dramatically through recent acquisitions, poses an additional risk to the MMC rating. This risk, in combination with the continued uncertainty of various regulatory issues facing MMC’s operating companies, drives the rating action.”

S&P said it plans to “meet with MMC management to discuss these risk factors further, with the intention of resolving or updating the CreditWatch status of the ratings within the next several days.” S&P credit analyst Steven Ader noted that the rating agency “expects to either keep the rating on CreditWatch and lower it by one notch upon the close of the transaction or remove the rating from CreditWatch and affirm it.”

Moody’s Investors Service, however, immediately announced that it has affirmed MMC’s senior debt A2 ratings. The action “reflects the company’s strong franchise as the world’s largest global insurance brokerage organization as well as its consistent cash flows, strong interest coverage and attractive margins in diverse businesses,” Moody’s indicated. “The benefits associated with the group’s earnings diversification are readily apparent in today’s environment, with strong results posted by the insurance brokerage operation offset by earnings declines in asset management, following customer withdrawals and payments to settle certain matters stemming from allegations of market timing.”

Moody’s noted that “Kroll’s business expertise is largely complementary to that offered by Marsh, Inc., adding further diversification of revenues and earnings that are generally not correlated with the insurance cycle. As a result of the transaction, financial leverage will increase over the near term, but is expected to revert to the 40 percent range over the medium term. While MMC has a successful track record of integrating large acquisitions, Kroll was formed through a series of acquisitions and it has integration risk as a standalone company.

“Nevertheless, Moody’s expects that these risks will be managed prudently, consistent with the company’s past practices, and that they will be substantially reduced over the next few years. Moreover, the current ratings contemplate that large acquisitions might occur on an opportunistic basis and could be funded substantially through increased leverage, subject to maintenance of a financial leverage profile in the 35-50 percent.”

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