2014-11-18 05:42:49
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.