ues itor t ed l g ia Mergers and Acquisitions of the 1990s: A Record-Breaking Period Patrick A. Gaughan A s we enter the twenty-first century, weÕre riding the wave of the most intense period of mergers and acquisitions in U.S. history. The 1990s were the fifth "merger wave" in this countryÕs historyÑa period of unusually intense merger and acquisition (M&A) activity. There have been five such periods since the start of the twentieth century, the prior one occurring in the 1980s. That 1980s wave featured many record-breaking mergers. And when it ended, many thought there would be a long pause before another merger wave began. However, after a short hiatus, an even stronger merger wave took hold, far eclipsing the 1980s boom. WHAT’S HAPPENING NOW? The current merger wave is path breaking because of the unusually high number of deals and unprecedented acquisitions prices. While the fourth wave of the 1980s was known both for its megamergers and colorful hostile deals, the fifth wave has featured far larger deals, in addi- © 2000 John Wiley & Sons, Inc. tion to a good supply of hostile transactions. The latest wave also has an international flavor. While the fourth merger wave of the 1980s was mainly confined to the United States, large scale mergers and acquisitions finally made their way to Europe and Asia by the mid-1990s. In recent years, cross-border deals in England, Italy, France, and Germany have grabbed the headlines. Even hostile takeovers, long thought to be an exclusively American phenomena, started to become increasingly more common in Europe. In addition, transatlantic dealsÑwith European buyers of U.S. companies, and vice versaÑstarted to become commonplace. Most non-U.S. mergers and acquisitions are taking place in Europe, with Asia well behind but picking up momentum. However, the fact that corporate restructuring is taking place in nations such as Japan and Korea reflects their pressing need to revamp their conservative and poorly performing corporate structures in light of their prolonged recessions. One interesting characteristic of the fifth merger wave is the trend towards consolidating or roll-up mergers. In certain industries, such as the printing and funeral home industries, leading firms ("consolidatorsÓ) are acquiring competitors across the nation, in an effort to build dominant companies. Other industries, such as banking and long-distance telecommunications, spurred on by significant regulatory changes, also experienced many consolidations. A lot of these acquisitions are based on the pursuit of economies of scale and other efficiencies. However, the jury is still out on whether or not such deals will create benefits that more than offset their costs. In addition, increased size alone can present managerial problems. In banking, larger size has caused some deterioration in service quality, which will offset some of the anticipated benefits. WHY DO FIRMS MERGE? One of the most common motives for mergers is growth. But there are two ways a firm 3 4 The Journal of Corporate Accounting & Finance can grow. The first is through internal growth. This can be slow and ineffective, if a firm wants to take advantage of a brief window of opportunity when it has a short-term advantage over competitors. The faster alternative is to merge and acquire the necessary resources to achieve competitive goals. While bidding firms will pay a premium to acquire resources through mergers, this total cost is not necessarily more expensive than internal growth, in which the firm has to incur all of the costs that the normal trialand-error process may impose. While there are exceptions, in the vast majority of cases growth through mergers and acquisitions is significantly faster than through internal means. Another commonly cited motive for mergers is the pursuit of synergistic benefits. This is the new financial math that shows that 2 + 2 = 5. That is, combining two firms will create a more valuable entity than the sum of the two independent firms. However, while many merger partners cite synergy as the motive for their transaction, synergistic gains are often hard to realize. There are two types of synergy. One is derived from cost economies, the other from revenue enhancement. Cost economies are the easier of the two to achieve, as they often involve eliminating duplicate cost factorsÑsuch as redundant personnel and overhead. Many of the consolidating mergers of the 1990s are partially based upon the pursuit of such synergistic economies. Revenue-enhancing synergy is more difficult to foresee and achieve. An example would be a relationship in which each firm believes that it can sell its products and services to the other firmÕs customer base. Other motives for mergers and acquisitions include diversification, whereby companies seek to lower their risk and exposure to certain volatile industry segments by adding other sectors to their corporate umbrella. The track record of diversifying mergers is generally poor with notable exceptions. A few firms, such as General Electric, seem to be able to grow and enhance shareholder wealth while diversifying. However, this is the exception rather than This is why successful bidders in takeover battles are sometimes afflicted with what is called the “winner’s curse.” the norm. Not all kinds of diversifications turn out poorly. While research studies show that unrelated diversifications tend to yield poor results, related diversificationsÑmergers and acquisitions into a field that is close to the acquiring firmÕs main line of businessÑtend to have a more impressive track record. This result has intuitive appeal. And whatÕs the take-home message? ItÕs that staying with what a company knows best may yield positive results but straying into businesses that you do not know is an uphill battle. Only a select few companies can manage that successfully. HOW DO MERGERS TURN OUT, AND WHAT CAN GO WRONG? As IÕve said, certain types of mergers, such as diversifications, tend to yield poor results. Unfortunately, many other acquisitions and mergers also yield mediocre results, while some are outright failures. Prominent examples include the Snapple acquisition in which the bidder, Quaker Oats, overpaid in a deal in which synergies were impossible to find. While hindsight is 20/20, it is hard to see how Quaker Oats could justify the high premium it paid in a market that was saturated and showed limited growth potential. The adverse result in the Snapple deal illustrates one of the pitfalls of mergersÑ overpaying. The higher the price that a bidder pays (as a multiple of earnings), the higher a growth in earnings needed to justify the price. Sometimes bidding contests can cause acquisition prices to rise well above what can be justified by any reasonable expectation of growth. This is why successful bidders in takeover battles are sometimes afflicted with what is called the ÒwinnerÕs curse.Ó More recent examples include the failed Rite Aid acquisition program. Rite AidÕs 1996 $1.4 billion acquisition of the incompatible Thrifty Pay Less chain was one of the factors cited for the firing of the companyÕs chief executive. When a potentially compatible acquisition of Revco was halted by the Federal Trade Commission, Rite Aid pursued the less favorable choice. But Thrifty proved to be incompatible with the previously successful Rite Aid drug store chain. Rite Aid did not anticipate the integration problems it would have following the acquisition. This underscores another pitfall of mergers and acquisitionsÑ © 2000 John Wiley & Sons, Inc. January / February 2000 postmerger integration. In spite of abundant premerger planning, sometimes it is difficult to predict all of the postmerger integration problems that will occur. ARE DEALS BECOMING TOO PRICEY? As deal volume rose to record-breaking levels, deals prices also reached new heights. Several factors explain this. For one, the growth of the economy created a situation where aggressive bidders, seeking fast growth, bid up the prices of target companies. In addition, the persistent decline in long-term interest rates helped lower discount rates that are used for valuation. Lower discount rates increased the present value of future cash flows and resulted 5 in higher values of target companies. Between high demand for companies and lower discount rates, values have reached unprecedented levels in the late 1990s. How long will the current merger wave last? It is impossible to predict that. Starting in the late 1800s, we have had four prior merger waves in U.S. economic history. Each one ended The current economic expansion is fast becoming the longest one in modern U.S. economic history. with an economic or stock market downturn. The current economic expansion is fast becoming the longest one in modern U.S. economic history. While it is impossible to accurately pre- dict the end of an economic expansion, we know that unpredictable events such as the onset of Mideast tension, can convert an expansion in a recession. If the economy turns down, it is going to become difficult for the fifth merger wave to continue. So what should potential buyers and sellers do? The high prices currently prevailing are a boon to sellers. No one knows how long such acquisition multiples will last. Given that the current economic expansion is nearing record lengths, the odds that it will continue are questionable. For sellers who are thinking of selling at some time in the foreseeable future, this may be the time to lock in a good price. On the other hand, it may be in the interest of buyers to wait it out a little longer, in the hopes that the merger frenzy may cool off and prices might weaken. Patrick A. Gaughan, Ph.D., is a president of Economatrix Research Associates, Inc., which is an economic and financial consulting firm specializing in analysis of economic damages in litigation and valuation of businesses, with offices in Newark and New York City. He is also a tenured full professor at the graduate level in the College of Business at Fairleigh Dickinson University. Dr. Gaughan has authored two of the three textbooks in the field of mergers and acquisitions, including the award-winning Mergers, Acquisitions, & Corporate Restructuring (John Wiley & Sons, 2nd ed., 1999). He has also authored numerous other books and journal articles. © 2000 John Wiley & Sons, Inc.