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.