Why do firms engage in M&As? There are many reasons, and the more often cited ones are reviewed in Chapter 2. The two most common ones are growth and synergy. That is, M&As are a way in which a company can grow at an accelerated rate. This type of growth is usually much faster than growth through internal development. So when a company sees an opportunity in the market that it could fulfill if it had the resources to do so, one way to reach this goal in some cases is to buy a company that can help meet this objective. Synergy is also an often-cited motive for companies wanting to do deals. These synergies can come from reductions in costs as a result of a combination of two firms that have partially overlapping or redundant cost structures. Other sources of synergy can come from improved revenues that derive from the combination of the two companies. We will show that this source of synergy is often difficult to come by. It is much easier to talk about in advance of a deal than it is to actually make it come to pass.
Other motives or reasons for M&As include economic motives, such as the pursuit of economies of scale such as cost reductions from being a larger company. We will see that economies of scale are one of the more achievable forms of synergy, although even here many companies never achieve the synergistic gains talked about before the deal. Other economic motives include economies of scope, where a company may be able to offer a broader product line to its current customer base.
The reasons for M&As can be varied. We will review these motives and others that companies put forward to justify M&As. We will see that some types of deals are better than others for shareholders. For example, in many instances, mergers involving companies in different industries are often not well received in the market. However, deals that enhance a company’s focus tend to be better received. We will also see that the market’s initial reaction—something that is studied extensively by academic researchers—is often telling about the long-term effects of the change that is being implemented. Although some managers may not learn from prior similar events, the market seems to have a longer memory. It is sometimes fooled, but it seems that it is more on target than managers who seem to quickly forget where other managers, or even themselves, have gone wrong in the past.
TRENDS IN MERGERS
Some volume of M&As always exist, but there have been several periods when a very high volume of deals was followed by a period of lower deal volume. These periods of intense M&A volume are referred to as merger waves. There have been five merger waves in the United States. The first merger wave occurred during the years 1897 to 1904. It featured many horizontal M&As. Many industries started the period in an unconcentrated state with many small firms operating. At the end of the period, many industries became much more concentrated, including some being near monopolies. This was ironic because the Sherman Act, as previously discussed, was specifically passed to prevent such an industry structure. The first wave ended when the economy and the market turned down. During the slow economy there was less pressure to do deals. This changed in the 1920s, when the economy started to boom. The vibrant economic conditions led to a second merger wave, which was concentrated during 1916 to 1929. This period featured many horizontal deals but also featured many vertical transactions. Deals were especially concentrated in specific industries. When the stock market collapsed in 1929 and the economy went into a prolonged and deep recession in the 1930s, the merger wave ended. We did not have another major merger period until the end of the 1960s.
The third merger wave was an interesting period in that it featured many conglomerate M&As, because of the intense antitrust enforcement of that time period. The Justice Department was aggressive in its opposition to M&As and saw many deals that would be immediately approved today as antitrust problems. For this reason, companies that were acquisition-minded were forced to do deals outside of their industry to avoid the wrath of the Justice Department and the FTC. Many large conglomerates, such as ITT, Gulf & Western, Teledyne, and Textron, were built during that period. While the 1960s featured a booming economy for much of the decade, the economy and the market turned down at the end of that period. Like the prior merger wave, it ended when the economic and financial pressures to expand subsided.
The 1970s featured a more modest number of M&As but did have many others forms of restructurings as companies, which may have been acquired during the third merger wave, were sold off as companies adjusted to the slower economic conditions and questioned some of the deals they had made when the economy was booming and their judgment may have been clouded by dreams of wealth that never materialized. As companies felt the economic pressures of a deep recession in the middle of the decade, they implemented management changes, and some of those changes helped bring about the various restructurings and sell-offs we saw during that period.
The 1980s proved to be the longest postwar economic expansion until we got to the following decade, which featured an even longer growth period. The 1980s provided the colorful fourth merger wave, which had many interested facets including the megamerger. This was the M&A in billion-dollar deals (see Exhibit 1.2). As noted earlier, some of these deals were highly levered and the fuel for these highly leveraged deals was provided by the junk bond market, which also boomed in response to the deal-related demand for this form of capital. The fourth wave also featured many hostile deals as companies, including major corporations, found themselves the target of unwanted suitors. Hostile deals certainly occurred before this period, but they were mainly bids by relatively smaller companies for other smaller companies. Before that period, it was unusual to hear of a hostile offer for large companies. It was even less common to have major reputable companies taking part in hostile takeovers. All of that changed in the late 1970s, and this set the stage for many of the hostile takeovers that occurred in the fourth merger wave.
The fourth merger wave ended when the economy slowed at the end of the decade and the junk bond market collapsed, in part as a function of weak economic conditions but also as a result of specific problems with that market, including the indictment of Michael Milken and his investment bank—Drexel Burnham Lambert. In the period 1990 to 1991, there was a mild recession, and the economy recovered slowly initially and then the rebound picked up steam. As with many prior expansions, companies looked to grow, and the fastest way to expand is to buy whole companies as opposed to building such a business internally. To some extent, this makes sense as expanding economic conditions create market opportunities that companies may need to react to quickly to take full advantage of. The problem occurs when dreams of economic riches cloud the judgment of management and it does not make the most enlightened decisions. Another problem with booming economic conditions is that they can mask poor management. Increased demand can lead to higher sales and profits even for some companies that are not that well managed. When this occurs, shareholders and the board may credit management with gains that they did not bring about. This may lead them to go along with acquisition proposals that they may not scrutinize carefully enough. Management may get a pass, so to speak, until, for some of the less astute managers, their acquisition schemes blow up in their face. For those who made well-thought-out deals, they may be able to advance the company and take advantage of competitive opportunities in the marketplace.
The fifth merger wave was precedent setting in terms of the total volume of mergers as well as the size of the deals that took place (see Exhibits 1.3 and 1.4). While many megamergers took place in the fourth wave, some of the deals that took place in the fifth wave made the fourth wave deals seem ordinary. In this book we will look at some of these leading deals and see that many of them were simply flops. Deals such as the AOL-Time Warner “merger of equals” were failures that left certain shareholders incensed. Others, such as the Warner Lambert acquisition by Pfizer or the merger between Exxon and Mobil, clearly were successes. The difference between successful and failed deals is the topic we will discuss throughout the rest of this book.
CONCLUSION
The field of M&A is multifaceted with many different aspects. Companies engage in these deals for a variety of reasons, including to take advantage of synergies. These are situations where a combination of companies lead to a greater value than what would have occurred if the company remained independent. In addition to synergistic gains, however, companies engage in M&A for other economic motives. These may come from the realization of economies of scale, such as what would occur in historical deals. Companies may also be able to lock up sources of supply to greater access to the market through vertical deals. Mergers and acquisitions is just one form of restructuring. Other forms of restructuring include restructuring in bankruptcy. This is a more extreme situation where the company may not have performed well. Other forms of restructuring include sell-offs and spin-offs. There are various ways that a company can rid itself of a division in the business unit that no longer fits into its strategic plan. They may do a divestiture or an equity carve-out or spin-off. We have devoted Chapter 6 to these types of restucturings because they often have positive shareholder wealth effects.
In the United States, M&As have occurred in waves or periods of intense activity. These waves have tended to occur in periods of economic expansion and have ended when the economy and the market have turned down. Each wave has distinct differences from the others. We have just completed the fifth merger wave—one that was truly international in its scope. The rest of this book is devoted to determining why many companies doing M&As do deals that are mistakes. In each of the major waves, mistakes were made. In some cases, it seems that we have learned from prior mistakes, but in others we seem to have forgotten our merger history and made some of the same mistakes. Some of the same companies, such as AT&T, have made major merger blunders in different merger waves.
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