Marriages in metal fabrication

With the economy a mess, many can"t wait for things to bottom out. But what will it take to get there, and what will happen after all is said and done? Among other things, consolidation has entered the conversation. Analysts view it as inevitable if business conditions persist, and today an analyst from J.P.Morgan, Ann Duignan, released an investor note that predicted some hefty M&A activity on the horizon in the metal fabrication arena.

Imagine if Deere & Co. and Terex merged? How about Caterpillar and mining equipment-maker Joy Global? Or Cat and AGCO Corp., the agricultural equipment OEM? The analyst also made a prediction for the welding industry that"s sure to raise eyebrows: What if Illinois Tool Works, parent of Miller Electric and Hobart Bros., acquired Lincoln Electric?

As Duignan stated in her report, ITW"s welding business is about 7 percent of its overall revenues, and [Lincoln Electric] could provide a complement to ITW"s existing welding line (albeit there would be significant overlap).

Duignan presented recently at a conference hosted by the Manufacturers Alliance/MAPI, and as she put it in today"s investor note, As a group, we pondered the next likely move in the capital goods sectorconsolidation, which in our view may be inevitable at some point, if the current macro environment persists. But like all Wall Street analysts, Duignan included a disclaimer, saying We are not suggesting that these combinations will or should occur, only that they might make strategic sense given recent market events.

Still, putting such predictions in print counts for something. My bet is that recent market events have changed the view of many a corporate strategist. What was crazy 12 months ago seems plausible today.

According to the report, the consolidation predictions are based on two factors. First, companies are cheaper than they"ve been in a long time, and buying low is just good business. As the investor note stated, We believe that well-capitalized, larger companies could pick up assets on the cheap as many small-cap and former mid-cap companies now face a potentially longer downturn in demand as well as potential balance sheet and cash flow issues.

Second, diversity protects companies from the ebb and flow of the business cycle. Diversified industrials have generally held up better than other industrials because they are less cyclical, the report said. On average, companies on Duignan"s watch list are trading at 56 percent below their 52-week high, but diversified firms such as 3M (down 29 percent) and United Technologies (down 38 percent) haven"t declined as dramatically.

The analyst pointed out one big caveat. Despite the falling equity values of potential targets, cash balances are insufficient for most of these suggested potential acquisitions. In other words, the deals won"t start until credit loosens up a bit. But once it does, a dramatically different metal fabrication marketplace may emerge.