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The trouble with mergers

Our advice from 1994 to lustful companies

Nov 17th 2014

As we noted in this week's print edition, the valuation of firms in the latest

mergers and acquisitions boom appears to be reaching dangerous levels. This is

not the first time we have warned that such dealmaking can be troublesome. In a

cover leader dated September 1994, we suggested that mergers are more difficult

to get to work than many executives think, and went on to explore why so many

of them go wrong. But what caused the most controversy at the time was the

decision to illustrate the leader with an awkward-looking pair of camels trying

to mate (see above). As a result, the issue was allegedly banned in Saudi

Arabia. We reproduce the article in full below to let our own readers judge.

The trouble with mergers

Corporate marriages are hard to resist, but rarely turn out happily

Sep 10th 1994

ELEPHANTS do it, birds and bees do it, even companies do it: all over America,

firms are falling in love and settling down together. So far this year, more

than $210 billion-worth of corporate mergers have been announced. The ritziest

marriage of all, a share swap worth over $10 billion, was announced a fortnight

ago by Martin Marietta and Lockheed, two giants that will henceforth bestride

the defence industry as a single colossus. Even bigger deals are said to be on

the way, not only in defence but also in drugs, media, entertainment and many

other sectors. If only a few of these pairings are consummated, their total

value this year will reach levels that have not been seen since the merger

frenzy that swept America in the 1980s.

At first glance many such merger look eminently healthy, not only for the firms

involved but also for the economy as a whole. They are portrayed as intelligent

adaptations to a changing business environment, caused variously by shrinking

markets (defence), government reforms (drugs and healthcare) or technological

change (media and telecoms). And unlike the hostile takeovers of the 1980s,

most of this year s mergers have been friendly. Entailing true romance rather

than shotgun weddings, tempting synergies rather than financial opportunism, no

rash of mergers has ever seemed more benign, or better calculated to boost

corporate profits.

The snag is that mergers can almost always be made to look that way at the

time. Troubles come later. And many studies of mergers stretching back to the

last century have shown that, despite some successes, the overall record is

decidedly unimpressive. It is not so much that marriages result in

asset-stripping, as the enemies of takeovers often allege. In aggregate,

mergers seldom lead to egregious cuts in R&D, investment or even jobs (though

many head-office jobs vanished in some 1980s mergers). Nor is it common for

mergers to vindicate the fears of trustbusters, by creating price-rigging

monopolies. No, the real disappointment about mergers is that, on average, they

do not result in higher profits or greater efficiency; indeed, they often

damage these things. And although they prompt a rise in the combined

stockmarket value of the merging firms, this gain is often short-lived.

Naturally not all mergers and not all waves of mergers are equal. Blessed with

hindsight, most economists now agree that the merging of the 1960s, when firms

grouped themselves into diversified conglomerates (ITT, Beatrice) on the

strength of faddish management theories, was a disaster. They have also come to

agree that many of the takeovers of the 1980s brought businesses from the

unwieldy conglomerates created two decades earlier. Unfortunately, the

ruminations of tomorrow s economists do not greatly help today s managers and

shareholders as they tremble on the threshold of corporate marriage. Is there a

reliable way to predict whether particular mergers are likely to succeed or

fail?

Two can tango

Much depends on the quality of managements. Even complementary firms can have

different cultures, which makes melding them tricky. And organising an

acquisition can make top managers spread their time too thinly, neglecting

their core business and so bringing doom. Too often, however, potential

difficulties such as these seem trivial to managers caught up in the thrill of

the chase, flush with cash, and eager to grow more powerful. Merger waves tend

to arrive when economies are buoyant and firms have plenty of money to spend

either their own or that of willing lenders.

For all this, not all mergers fail. And they are more likely to succeed when

inspired by a clear goal, such as the need to reduced excess capacity in an

industry. It is, for example, hard to argue with Norman Augustine, who is to

become president of Lockheed Martin, that three full factories are better than

six half-full ones. Yet there are surprisingly few industries, such as defence,

in which the strategic choice is so clear-cut.

Consider vertical integration , in the name of which a multitude of mergers

between telephone, cable, television and film companies are being mulled or

implemented. It makes sense for, say, a maker of television programmes to guard

itself against betrayal by a distributor. And managers caught up in the

multimedia revolution may be right to argue that, if they do nothing, their

firms will soon be as redundant as blacksmiths after the invention of the motor

car. Yet in some cases it might be better for them to follow General Dynamics,

a defence firm that is winding itself down and returning money to shareholders,

than to gamble on ill-defined synergies that may or may not secure a place on

the next century s information superhighway. Time will tell too late as usual.

Like all waves of mergers, the present one is accompanied by claims that it is

more rational than its predecessors. And yet a worrying feature of the current

wave is the very friendliness that so many admire. Most hostile takeovers at

least have the merit that they seek to replace the incumbent managers with

others who, the buyer believes, can run the firm better. Since the 1980s new

laws have made hostile takeovers difficult unless the managers of the target

firm put themselves in play by starting merger talks with another firm. If a

takeover does not install a fresh management, the justification in terms of

synergies or economies of scale needs to be all the stronger.

Ultimately the success of an individual merger hinges on price. By Definition,

shareholders of acquired firms are happy with their dowry, or they would not

have parted with their shares. By contrast, shareholders of acquiring firms

seldom do well: on average their share price is roughly unchanged on the news

of the deal, and then falls relative to the market. Part of the reason for this

is that lovelorn company bosses, intent on conquest, neglect the needs of their

existing shareholders. At this time of corporate romancing, these shareholders

might usefully offer such bosses some sage parental advice, along the lines of:

take your time, play the field. Otherwise they may end up in bed with an

elephant.