A triumph of hope over experience

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Merger Monday has proved that in the merger market, hope springs eternal. The wall of money chasing alternative investments in hope of the returns achieved in the heady 1990s, made it possible to take almost any company private.

They called it merger Monday. On October 31, there were four separate approaches for British public companies. The coincidence of merger booms and market peaks is a firmly established, if poorly explained, economic law. Each successive wave of mergers has a distinct rationale, which is discredited by the subsequent failure of a majority of transactions. There is a pause for reflection, before the forces of ambition and greed reassert themselves. And then it starts again.

The intervals between cycles steadily shortens. Merger mania was first seen in the US at the end of the 19th century. Standard Oil and US Steel were created in unabashed pursuit of monopoly. Political reaction led to the antitrust laws that broke up Standard Oil.

Even if monopoly were indeed the motive for takeover, future industrialists would have to pretend otherwise. Economies of scale through assembly line production justified the merger wave of the 1920s. The flapper era framed the modern corporate economy and shaped General Motors and Unilever. Consumer preferences, as well as capital market forces, led to increased industrial concentration.

From the late 1950s, the first wave of globalisation spurred national consolidation. This was especially true in Britain, where GEC and British Leyland absorbed almost the whole of their domestic industries. One combination proved a mixed blessing, the other an unmitigated disaster.

The age of conglomerates followed. Individuals of genius could insulate their shareholders from market vicissitudes and apply their skills across many businesses. When faith in their abilities declined, the value of the paper they had issued so copiously declined more rapidly still.

The first hostile bids were made in the 1960s. But for two decades, they were as rare as they were ungentlemanly. Then Michael Milken and colleagues ensured that any company, however large, could be put in play and almost anyone could aspire to be a player. But Drexel and many of the deals it had promoted fell apart and Mr Milken went to prison.

The next wave came in the 1990s. Convergence of technologies justified improbable conglomerations of companies and astounding sums were paid for unproven businesses to stake out territory in unexplored areas. The worst deal in history – the merger of Time Warner and AOL – was consummated as the bubble burst.

Reflection and reassessment were short-lived. Two themes promoted the four approaches on merger Monday – the new cult of private equity and the arrival of modern investment banking on the mainland of Europe. The wall of money-chasing alternative investments in hope of the returns achieved in the heady 1990s made it possible to take almost any company private. Mostly for the better: an advantage of concentrated ownership is that managerial attention is focused on running the business.

Earlier waves of mergers were an Anglo-American phenomenon. But the single market and the eurozone provided a new rationale for cross- border mergers, and corporate activity within continental European states is today at unprecedented levels. The biggest deal on merger Monday was the proposed acquisition by Spain’s Telefónica of O2, formerly the mobile phone subsidiary of BT Group.

Could this be the Telefónica that participated vigorously in the disastrous telecommunications mergers only five years ago? Could the target be the division that BT sold to reduce debts resulting from its own unwise acquisitions? Yes, indeed. A second marriage, Dr Johnson remarked, represents the triumph of hope over experience. In the merger market, hope springs eternal.

That optimism is as generally rewarding for those who instigate the transactions as it is unrewarding for shareholders and customers of the companies involved. If investors read some of the surveys of the value destruction from merger activity – Dennis Mueller’s 2003 study is a good starting point* – market forces would reassert the quickly forgotten but well-documented lessons of experience.

*D.C. Mueller: The finance literature on mergers in M. Waterson (ed.) Competition, Monopoly and Corporate Governance, Elgar

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