The next big threat to your job

1/9/2007 12:00 AM ET

Private investors and public companies did a lot of acquiring in 2006 and will be looking for quick profits. The easiest way to do that is to downsize the work force.

By Jim Jubak

The next threat to your job is already looming on the horizon. It could go to work as early as the second half of 2007 -- even if the economy as a whole stays relatively strong.

That would be a huge reversal of recent good news on job losses in the United States.

Layoffs announced in 2006 fell by 22%, according to a survey by outplacement specialist Challenger, Gray & Christmas. The number of layoffs in the Challenger survey was down 57% from the peak in the current layoff cycle that began in 2001.

The Challenger survey isn't especially comprehensive, since the company surveys only a fraction of the companies that might be announcing layoffs, but it is a good indicator of the trend in the labor market. And that trend is definitely positive. As I've argued in the first two parts of this series, "Why fewer U.S. jobs are going overseas" and "A 15% raise? Try India or China," the flow of U.S. jobs overseas, a big part of the peak in layoffs in the past few years, is definitely slowing.

But don't get too comfortable. If your job is less likely now to be outsourced overseas than was the case a couple of years back, that doesn't mean your job is safe. I can already see the first signs of the next big thing in layoffs. It was built on Wall Street and financed with cheap money from around the globe. I'm talking about the boom in acquisitions, both public and private deals, in 2006.

What's the first thing an acquirer does after the deal is signed? We all know the answer to that. It fires workers to achieve the "cost savings" that were touted as a key reason for doing the deal in the first place. Wall Street demands them, and CEOs, with their compensation frequently tied to achieving these cost-cutting targets, are only too "incentivized" to comply.

So the huge boom in mergers and acquisitions in 2006 is likely to be very, very bad news for workers in 2007.

How big was this boom? Record-breaking.

The total value of deals in which one company acquired another soared to almost $4 trillion globally in 2006, according to Dealogic, up about $500 billion from the record set in 2000, the peak year of the technology stock frenzy. The private equity market -- where investors use a pool of money raised from private investors to buy a public company, delist its shares from a public stock market and take it private -- saw an even faster rise, to a global total of $750 billion, up 103% from 2005. Private equity deals accounted for 19% of all global acquisitions, up from 12% in 2005.

Downsizing has already begun

The first layoffs from the mergers-and-acquisitions boom has started. For example, VNU, the parent of Nielsen Media Research and ACNielsen, among other media properties, in December began the first of a planned 4,100 job cuts, about 10% of the company's worldwide work force. VNU had been acquired in a $10 billion deal last summer by private equity company Valcon Acquisition, which represents private equity investors AlpInvest Partners, The Blackstone Group, The Carlyle Group, Hellman & Friedman, Kohlberg Kravis Roberts & Co. and Thomas H. Lee Partners.

But most are yet to come. Public and private acquirers are by and large saying they're not planning any layoffs. No guarantees, they're quick to add, however.

I believe them, too -- at least until the acquirers need to produce a profit to justify their investment.

Which is why the high prices being paid in many of these deals make me worry that we will see layoffs no matter what the acquirers' intentions.

So for example, Freeport-McMoRan Copper & Gold (FCX, news, msgs) has said that it's not contemplating any layoffs as a result of its $26 billion acquisition of Phelps Dodge (PD, news, msgs). Fair enough. On paper the deal works just fine as long as copper prices stay near the historic highs they hit in 2006. But if copper prices fall (and they've been moving lower recently), Freeport-McMoRan will be under pressure to justify the 33% premium to the last-traded share price it paid for Phelps Dodge. (Some pretty lofty expectations were baked into the price of Phelps Dodge shares even before the deal: Wall Street was already expecting 137% earnings growth from Phelps Dodge for the March 2007 quarter. The Freeport-McMoRan premium is on top of that.) Think job cuts and other "synergies" won't be on the table if copper prices retreat?

Or look at the $17.6 billion acquisition of Freescale Semiconductor by a private equity group headed by The Blackstone Group. The $40 share price in that deal represented a 36% premium to the share price before the deal.

I think this is a pretty savvy move by Blackstone and its partners, even with that premium. If Freescale moves to a fabless model -- the company would sell off its factories and hire a foundry such as Taiwan Semiconductor Manufacturing (TSM, news, msgs) to manufacture its chips -- it could reduce its need for capital, increase cash flow and improve the predictability of earnings. If the company combined with another semiconductor company, say the semiconductor business that these private equity investors just bought from Koninklijke Philips Electronics (PHG, news, msgs), it could actually produce the synergies -- in research, in product development, in manufacturing and in marketing -- that Wall Street so eloquently talks about. (The combined semiconductor company would be one of the 10 largest in the world.)

And I'm very sure that Blackstone and friends have figured out that they could easily load some debt on the balance sheet of this company, which right now, like a lot of technology companies, is just about free of debt. That would increase the return on equity at Freescale and might give the private investors a way to finance the sale of at least part of their stake back to the company at a favorable price.

But if the chip market slows or profit margins on new products disappoint, you can bet that, here too, job cuts will be on the table. No way are the investors in any of these private equity partnerships going to quietly accept a low rate of return.

Spiff up for the sale

The ultimate need for a profitable exit strategy also argues for layoffs as a result of the private equity boom of 2006. Private equity investors get their money back -- and produce their profits -- when they sell the company they've purchased to another buyer. Most often that buyer is the public market.

Here's the process: Buy the company, rearrange the assets, rejigger the finances and put as much lipstick on the pig as is necessary so investors in the public market will pay a high price for the shares in an IPO (initial public offering).

It used to be that this round trip from public to private to public again would take two or more years. For example, disk drive maker Seagate Technology (STX, news, msgs) went private in 2000 and then went public again 2002. (After shedding 40,000 jobs, I might note.) That was fast, way back then.

But recently the turnaround has been much speedier. For example, FTD Group (FTD, news, msgs) took just a year from its February 2004 private equity buyout to its February 2005 public offering.

Quick profits are good profits

Why is that important? First, because time is money -- an investment that produces a profit of $1 in a year shows a higher rate of return than one that produces a profit of $1 in two years -- the quicker turnaround has increased the profits of private equity investors. Which, of course, has brought more money into the private equity funds, which in turn fueled the deal boom of 2006. And which should keep the private equity market in full feeding frenzy in 2007.

And, second, because the quick turnaround has led to expectations on the part of private equity investors for big, quick profits, this isn't exactly patient money. That in turn has increased the pressure for these big pools of private cash -- private equity funds raised $400 billion in 2006 and started 2007 with about $700 billion in cash to invest -- to do deals and put their investors' money to work, and then to cash out quickly by selling to buyers in the public markets.

Of course, the rules of supply and demand tell us that when there are a lot of impatient sellers looking for buyers, the sellers can expect to get lower prices for their deals. I doubt that will be acceptable to the investors in these private equity funds, who will look to impress buyers in the public market with the superior value of their deal.

How do you do that? By showing a higher profit margin, faster earnings growth or an improving cash flow. And, unfortunately, the easier way to produce those, in the short run, is by cutting jobs. In the long run that may well reduce revenue and create an earnings crash, as customers flee to competitors who provide better service and superior products. But, hey, by the time that happens, private equity investors will be long gone, if they're smart.

If I'm right -- if private equity investors don't get bailed out by surprisingly strong economic growth and higher than expected earnings increases, or by a Federal Reserve interest-rate cut that lifts all stock prices -- I'd expect to see the pressure on private equity deals and investors to increase noticeably in the second half of 2007.

• Video on MSN Money: Is M&A bubble about to burst?

How will you be able to tell? Because the number of announced layoffs will start to climb again.

I hope I'm wrong.

Updates on Jubak's Picks

Sell Nvidia (NVDA, news, msgs).

Looks like I stayed just a little too long at the fair with this one. Nvidia shares peaked in December and have been sliding gently downward since then, until, in early January, they broke below their 50-day moving average. That's not a huge red flag yelling sell, but the stock has been sinking on days when the rest of the technology sector rallies, and that makes me nervous. The Oct. 10 buy of Nvidia did what it was supposed to for Jubak's Picks by giving the portfolio more exposure to the kind of higher beta stocks that tend to do well in an end-of-the-year rally. With that job accomplished, I'm going to take some risk out of the portfolio by selling the shares as of Jan. 9, 2007. I have a 6.5% positive return on this position.

Sell American Eagle Outfitters (AEOS, news, msgs).

Stocks, particularly earnings-momentum stocks, eventually become the victims of their own success as investors come to expect not only a home run every quarter, but longer and longer blasts. I think that problem has started to emerge for American Eagle Outfitters, which announced amazing 13% growth in same store sales for December compared with December 2005. On the strength of those numbers, the company raised guidance for the quarter by a penny to a range of 64-65 cents a share. That would bring earnings growth for the fiscal year that ends in January 2007 to something just above 30%. See the looming problem? The shares are already priced for that expected growth, and Wall Street, ever ungrateful for past performance, is likely to start looking ahead at the next fiscal year. Growth is projected at just 12%. I think American Eagle Outfitters is likely to do better than that in fiscal 2008, but I prefer to be out of the shares while Wall Street adjusts its expectations. These shares, added in October, also did their job for Jubak's Picks in the end-of-the-year rally. As of Jan. 9, 2007, I'm selling them out of the portfolio with a return of 9%.

New developments on past columns

"The housing bubble is deflating -- but gently": I wrote the column that went with that headline about a year ago, and I still think that's the case. But I sure wish the data were more reliable. Turns out, according to the economists at Moody's, the figures for new-home sales and inventory are off by as much as 20%. The Census Bureau, which compiles the new-home sales numbers, doesn't subtract canceled contracts from its figures. If a contract doesn't go through, the house is not only reported as sold in the monthly numbers, but it is subtracted from inventory and never gets added back to inventory.

That's a huge problem when a market goes south like this one has. Cancellations in November constituted 38% of gross sales at 30 large home builders surveyed by the National Association of Home Builders. That's up from 26% in November 2005 and an average of 18% in the first half of 2005. All this could result, says Moody's, in the Census Bureau overstating the annual rate of new-home sales by 150,000 to 200,000. Adding those houses back to inventory sharply increases the supply of homes awaiting sale, officially measured at 545,000, or 6.3 months of supply, in November. Existing-home sales numbers, put together by the National Association of Realtors, only count actual sale closings and don't suffer from this problem.

Meet Jim Jubak at The Money Show

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Editor's Note: A new Jubak's Journal is posted every Tuesday and Friday. Please note that Jubak's Picks recommendations are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jim's new portfolio, Dividend stocks for income investors. For picks with a truly long-term perspective, see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.

E-mail Jim Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak did not own or control shares of any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.

Source: http://articles.moneycentral.msn.com/Investing/JubaksJournal/TheNextBigThreatToYourJob.aspx