Love is in the air

LEADERS

Company mergers

Feb 3rd 2005
From The Economist print edition

But will the latest flowering of corporate romance have a happy ending?

AFTER a miserable few years in the executive suite, with only the ugly sisters of cost control and corporate governance for company, many a boss's thoughts have lately turned to love. A recent spate of headline-grabbing mergers seems to herald another wave of corporate marriages. The mood had already begun to sweeten last year, the most active for mergers and acquisitions (M&A) worldwide by value since the last wave broke in 2000. But the recently announced nuptials of some of the world's most celebrated firms—Procter & Gamble (P&G) tying the knot with Gillette, “Ma Bell” (AT&T) being swept (a tad Oedipally) off her feet by one of her own “Baby Bells”, SBC—have once again given the urge to merge the aura of respectability in the corporate world, a respectability lost when so many of the previous wave of beautiful marriages (remember AOL-Time Warner?) crashed so soon and so spectacularly on to the rocks.

Falling in love is often a triumph of hope over experience—and the history of mergers contains enough tragedy to terrify the most resilient romantic. The diversification wave on both sides of the Atlantic in the 1960s and 1970s famously ended in tears and break-ups. Yet despite claims that lessons had been learnt, the 1990s merger wave was as damaging as any before it.

Shareholders in acquiring firms typically gain less from mergers than shareholders in acquired firms. But in 1991-2001, according to a study by René Stulz of Ohio State University and two fellow economists, in the three days following American merger announcements, acquiring shareholders lost $216 billion—over 50 times what they lost in real terms in the 1980s, though they spent only six times as much. (The results are no better over longer time periods.) Strikingly, these losses were concentrated in just 87 big deals in 1998-2001. In total, mergers during that period actually destroyed some $134 billion of shareholder wealth.

In the mood

Will the current wave of mergers produce a happier ending than its predecessors? Many of the most disastrous mergers have been the result of a chief executive's excessive ambition (for instance, ill-fated empire-building such as Daimler boss Jürgen Schrempp's purchase of Chrysler) or of his desperation (intense pressure on Time Warner's Gerry Levin to embrace the internet led to the merger with AOL). In the past few years there has been so much hostility to M&A from investors and outside directors that the typical boss would sooner have proposed giving up his corporate jet than doing a merger. Now, with profits booming, balance sheets (mostly) strengthened and corporate-governance reforms implemented, investors and outside directors are increasingly asking the boss not what he is doing to get the firm back on track but how he plans to expand it. In this environment, a merger proposal may, once again, be enthusiastically received.

Much will depend, then, on whether bosses have curbed their imperial ambitions enough to propose only deals that truly make business sense—and on whether boards and investors have mustered the courage to question a boss's merger plans thoroughly or, equally, not to put him under such pressure that he proposes a merger out of desperation. And even if the balance of power is healthier than in the past, it remains to be seen whether shareholders or chief executives, acting together, are any better able than their predecessors to spot the difference between a faddish merger and a useful one.

One hope that they might be more skilful lies in changes to executive compensation. Linking a boss's reward to his firm's share price was supposed to deter him from mergers that destroyed shareholder value. Alas, during the 1990s, the link was often to short-term changes in share prices; when M&A was briefly fashionable, this rewarded acquisitive bosses handsomely but prematurely. If it is true, as is widely claimed, that executive remuneration is now more closely linked to the creation of long-term shareholder value—the formulas are often so complex that this is difficult to determine—then bosses may indeed become more selective in the mergers they propose.

Questions of focus

So far, the recent merger activity has mostly been characterised by the sort of focused deals that experience suggests are likeliest to create shareholder value. (However, on past experience at least, the growing use of shares, rather than cash, as payment is a bad sign.) P&G's acquisition of Gillette and SBC's purchase of AT&T were driven by cost-saving rationalisation within an industry. Another deal this week, the sale of Citigroup's Travelers Insurance arm to MetLife, another insurer, is at once both a focused, rationalising deal for MetLife and evidence that Citi is abandoning some of the grander ambitions of Sandy Weill, the erstwhile corporate empire-builder responsible for the merger of Travelers and Citibank in 1998.

Arguably, opportunities now abound for focused mergers, above all in globalising industries with excess capacity such as consumer goods, telecoms and banking. European firms, in particular, are far more diverse than their American counterparts, and face pressure from shareholders to become focused, not least by selling non-core businesses. The degree of conglomeration in Europe today is similar to that in America in the 1980s before a wave of rationalising mergers which produced both better-managed firms and real economic gains.

The emergence of big private equity firms—which now account for a growing slice of M&A activity—is making it much easier for firms to sell their non-core businesses, and for corporate buyers such as P&G to offload quickly unwanted parts of an acquisition (Gillette's Duracell battery business perhaps). Increasingly, bidders work with private-equity firms to carve up a target before a deal is done, which increases the likelihood of success.

Yet merger waves usually begin for the right reasons, only for bidders to be caught up in the thrill of the chase—waking up to a nasty shock the morning after. Sooner or later, alas, the same is likely to be true of the current wave of mergers, too.

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