This is not a coincidence. There have been five great waves of mergers in the past century, each one building in some way toward the unprecedented mania of the late 1990s. Driven by Wall Street enthusiasm for the New Economy, the sum spent on mergers and acquisitions hit a staggering peak of $3.4 trillion in 2000, when a deal was cut somewhere on the globe every 17 minutes. The CEOs at the center of this swirl insisted they could avoid the pitfalls that have given giant mergers an infamous record of failure, but few did. Now the greatest merger mania in history is unraveling before our eyes. If the historical trends hold true, roughly two thirds of these newly merged giants will disappoint on their own terms, which is to say they will lose value on the stock market. The inescapable conclusion: the world economy is now littered with some $2 trillion in failed or failing corporate giants, and that’s from the year 2000 alone.
In part, these deals represent a massive shift of paper wealth that doesn’t disrupt the underlying economy. Most of the companies created in big mergers won’t collapse like Enron, but they won’t generate greater wealth, either. They limp along, shedding employees and divisions to no productive end. Workers are too fearful for their jobs to service customers well. Productivity and sales grind to a crawl and rarely recover. At Tilburg University in the Netherlands, economist Hans Schenk says that since the 1960s, merged companies have typically performed 17 percent worse than independent rivals in terms of productivity, profitability, new patents and growth in market share. He figures that of the total of $9 trillion in U.S. and European merger deals between 1996 and 2000, about $5.8 trillion either failed to create or actually destroyed economic wealth. “Most mergers are an economic waste,” Schenk says.
Yet CEOs continue to chase the big deal, bullheaded despite the risks. Stock markets reward growth, and the fastest, most spectacular way to expand is with a big-bang buy. Typically, the buyer approaches a target company and offers to pay a premium over the target’s current share price. The buyer’s bet is that the merged company can cut costs or boost revenues by more than enough to justify the premium. It can sound so simple: just combine computer systems, merge a few departments, use sheer size to force down the price of supplies, and the merged giant should be more profitable than its parts.
Alas, it fails to work out that way more often than not. A study of the 20 biggest mergers of 2000, done for NEWSWEEK by Thompson Financial Datastream, shows that a majority of buying companies saw their stock drop in the 12 months after the deal was announced. When the buyers are compared only with rivals in their own industry, a dozen lost ground (chart).
It’s not that easy to cut costs or raise revenue through “synergies,” the misleading mantra of the dealmakers. Everyone in the merger game knows this fact but brushes it off. When AOL bought Time Warner for $106 billion in 2000, many saw history in the making–the New Economy upstart would lead the Old Economy stalwart into the Internet age. It was the ultimate synergy triumph, or so it appeared. Since then, new CEO Richard Parsons has admitted that the synergies were oversold; Time has not even been able to get its AOL e-mail to work properly. “The theoretical argument [for mergers] is flawless,” says Aloke Ghosh of Baruch College in New York. “But in implementation, things go wrong.”
From the beginning, merger waves have tracked the rise and fall of the stock market, which helps explain why dealmakers often show a stockbroker’s shortsighted eye for the quick kill. The robber barons at the turn of the 20th century created new manufacturing monopolies by going public on the fledgling New York Stock Exchange and using their shares to buy up smaller family companies. The next merger wave rose with the stock market of the 1920s and spread from manufacturing to banking, retailing, food and chemicals. Out of this tumult emerged both the first modern corporations like DuPont and General Electric, with a professional class of managers, and a new industry of consultants. In 1926 James McKinsey opened one of the first consulting firms, which would play a central role in future merger waves.
The next peak would not arrive until the stock-market boom of the 1960s. It was a time of unbridled faith in the science of management, which advised corporate chieftains to buy a variety of unrelated businesses to spread risk. Goldman Sachs set up the first M&A department at one of the big investment banks. It would help create conglomerates of bewildering diversity. The Wilson Co. came to be known as Meatball, Golf Ball & Goof Ball for dealing in meatpacking, sports equipment and drugs. But there was no signof real financial trouble until 1969, when the market turned on conglomerates and big ones like ITT saw their stocks drop by as much as 50 percent. Investors who had seen diversification as a clever way to spread risk now saw it as a recipe for bloat.
That set the stage for corporate raiders of the 1980s, who bought weak companies at rock-bottom prices and sold off the best parts at killer profits. Once notorious raiders like T. Boone Pickens and Carl Icahn had made a fortune picking apart the weakest companies, the wave crashed but left behind an important legacy. The financial-services industry had evolved into an inventor and aggressive marketer of financial tools, including the leveraged buy-out and other weapons of hostile M&As. Now a temporarily underemployed army of specialized M&A accountants, consultants, bankers and lawyers stood ready to fan the next merger flame into a bonfire.
Their chance came in the mid-1990s. Booming worldwide markets convinced CEOs that they needed to bulk up not only to compete, but to meet Wall Street expectations of double-digit growth. Deregulation in telecoms and banking got the merger game going, and it spread to pharmaceuticals and autos, media and entertainment. Every acquisitive CEO made all the right noises (on advice of consultants) about doing “strategic mergers focusing on core business,” which was code for avoiding the mistakes of the ’60s. Few succeeded. McKinsey recently found that only 12 percent of 160 mergers in 1995 and ‘96 managed to grow faster than their industry rivals in their first three years of operation. On average, revenues fell by 4 percent. “This wave looks like a carbon copy of before, just many times bigger,” says Mark Sirower, an economist and author of “The Synergy Trap.” “People make the same mistakes again and again.”
The upward spiral of the stock market gave even dot-com entrepreneurs the kind of clout once enjoyed by robber barons. They used their own rising stock to buy companies, which raised their earnings, which drove up their share price, which enabled them to buy more and larger companies. Cisco and Tyco and WorldCom became market darlings, using stock to buy 20 or more companies a year. (Now they’re known in the pejorative as “serial acquirers.”) Little deals became megadeals. The billion-dollar buyout was a rarity before 1996, when the top 100 mergers all topped $1 billion.
Europeans charged into the U.S. markets, reversing the traditional flow across the Atlantic. The launch of the euro in 1999 inspired banks and other local champions to bulk up to compete across borders. That year more deals were done outside than inside the United States for the first time in history, including Vodafone’s world-record $183 billion purchase of Mannesmann. This marriage of a British telecom and a German media giant was hailed as a major step toward the creation of a European high-tech economy, in the kind of media hype that surrounded many a megadeal. Today, there’s a big difference between the faltering giants of Europe and the United States. Vodafone has written off huge losses that followed its big deal. But American companies have been caught in acts of fraud to cover their failures. “It is not so much that our accounting rules are much superior, but America had companies that were flying closer to the sun than any of the U.K. ones,” says Justin Steward of 7 Investment Management in London.
Very few people in a position of business responsibility counseled caution as the pace of mergers quickened. Investment bankers were raking in some $25 billion to $50 billion a year, and the quarterly rankings of top M&A advisers became a closely watched horse race between Goldman Sachs and Morgan Stanley. The consulting firms continued to churn out reports on how mergers fail to raise productivity or stock prices, but they rarely if ever advised against big deals. Their pitch: hire us, and we’ll show you how to make it work. “Think positive, it’s a good thing!” urged McKinsey’s Matthew Bekier, exasperated with questions about how he could continue to push mergers after detailing all the reasons “Why Mergers Fail” in a December report.
The upbeat message is what most CEOs want to hear, of course. Many top executives get a big bonus for merger deals, no matter what happens later to the share price. Qwest Communications CEO Joseph P. Nacchio earned a $26 million “growth payment” for buying US West in 1999, and Solomon Trujillo pocketed $15 million for selling it, but in April Qwest disclosed that the value of the assets have fallen so far that it expects to take a $20 billion to $30 billion charge this year. Nacchio was forced out of his job by the company board two weeks ago. “Never, ever underestimate the ego of a CEO,” says management guru Jim O’Toole of the University of Southern California, who works closely with many blue-chip firms. “They are fooling themselves.”
Of course, it takes a big ego to run a big company. The problem arises when the acquisitive impulse runs unchecked, as numerous academic studies have found. One Columbia University study concluded that the greater the hubris of a CEO–measured in part by media praise and salary–the higher the premium he or she is willing to pay to consummate a big deal. CEOs are also more likely to do big deals if they’re surrounded by board members who do big deals, creating a kind of locker-room effect. They’re also more likely to overpay for an acquisition if their own compensation is not closely tied to the price of their company stock. But few residents of a corner office seem to pay much attention to these warnings from the ivory tower. “I find it deeply disheartening,” says Richard Schoenberg, M&A specialist at the Judge Institute of Management, University of Cambridge. “Either our research is incorrect, or we are not communicating in an effective way.”
No one argues that mergers shouldn’t happen. Waves of consolidation are considered almost a physical constant in the “creative destruction” of capitalism. In a recent study of 25,000 companies in 24 industries, A.T. Kearney argued that consolidation generally begins with a trigger event, like deregulation or new technology, which attracts new players to an industry. The shakeout begins almost immediately, and over 18 to 24 years moves through stages of accumulation and focus before balancing out, usually with three giants (like GE or DuPont) dominating the market. The pace of dealmaking depends on where the industry lies on this evolutionary curve and explains, for example, why there are still takeover headlines in banking and brewing and autos, but not in cigarettes or soft drinks.
The question is how many mergers make sense, and it seems pretty obvious now that the recent mania was a time of excess. Schenk, the Dutch economist, describes the impulse to join a merger wave in terms of game theory. When one company buys another, rivals typically ask themselves how they must respond to achieve not the best but the least bad outcome. Their greatest fear is to be left behind by a smart merger. So the first deal inspires others. After Daimler bought Chrylser in 1998, Ford and GM started buying carmakers all over the world, and so on.
Yet BMW, Porsche and Toyota, the carmakers that refrained from the frenzy, are the most profitable. DaimlerChrysler CEO Jurgen Schrempp is still struggling to explain how the merger he called “a marriage made in heaven” is ever going to work. At Deloitte & Touche in London, Angus Knowles-Cutler studied 40 problem clients and found that half were in trouble because of botched acquisitions. “This is costing the world billions and billions,” he says.
Every merger wave produces a counterwave, and this one is no exception. A survey by PriceWaterhouseCoopers found that more than one third of the largest international deals done at the peak of the bull market are now being unwound in “demergers.” To cite just one example, LVMH is dumping bits of the global luxury empire it amassed in the 1990s. Walter Hewlett built his argument against the recent merger of Hewlett-Packard and Compaq on the decades of evidence that most mergers fail. Computer mergers are particularly troubled because of the industry’s quirky corporate cultures.
Looking over the current roster of failing giants, it’s hard to see the creativity in the destruction of the recent merger wave. Many CEOs along with their consultants and bankers made a huge killing, only to see much of it evaporate in the falling stock market. Some of the giants they created will survive as dominant companies, but many are stumbling, making a wealthy era less prosperous than it might otherwise be. “It’s not clear anything good is happening here,” says Princeton economist Paul Krugman. In theory, at least, failed giants should prove to be a temporary mistake, as new buyers swoop in to clean up the mess, just as corporate raiders of the ’80s brutally streamlined the conglomerates of the ’60s. For now, however, the only thing that seems certain is that this period of relative quiet is just a lull before the next merger mania begins.
