07-15-2000

TRADE: The M&A Game's Global Field

"Catch a wave, and you're sittin' on top of the world." And
these days, the Beach Boys' surfer ballad is dead on at such
establishments as Unilever and Bestfoods, at Vivendi and the Seagram Co.,
and at dozens of other corporations riding the merger wave that has swept
the corporate world during the past few years. But managers at
telecommunications giants WorldCom and Sprint Corp., whose merger was
recently short-circuited by U.S. and European antitrust authorities, are
humming a different tune: the Surfaris' classic
"Wipeout!"


The business community-in the United States and abroad-is now caught up in
the fifth and greatest surge of mergers and acquisitions to occur in the
past 100 years. This burst of corporate restructuring, which began in
1993, is notable for its growing number of international transactions and
the central role played in many of the deals by media properties and other
holders of intellectual property.


Many factors have contributed to this latest surge of corporate takeovers
and combinations. One is the companies' search for broader and deeper
revenue streams in a period of relatively slow economic growth worldwide
and low inflation rates. It has been further fueled by easy access to the
cash, and stocks that are as good as cash, needed to underwrite
billion-dollar transactions. The merger and acquisition action constitutes
a new drive to build businesses around complementary emerging information
technologies. It's a response to business opportunities created by
unprecedented government deregulation and privatization around the world.
And, most important, it's a byproduct of the establishment of a single
European market that has created a new playground for corporate
deal-makers.


Like all waves, this surge will eventually fade-or end in a dramatic
crash. Indeed, M&A activity slowed dramatically in the first quarter
of this year, and it remains highly vulnerable to the inevitable bursting
of the Wall Street financial bubble. Overreaching could create inefficient
corporate behemoths that quickly break apart. The quest for new
technologies could lead down blind alleys, cooling the takeover fever. In
many countries the breakwaters of economic nationalism will limit the
wave's reach. And the deepening scrutiny of M&A transactions by
antitrust authorities suggests that businesses may already be bumping up
against legal constraints.


But, for all the risks, the takeover wave shows no signs of ebbing. The
economic resurgence of Europe and Asia, as well as efforts by Third World
governments to divest themselves of treasury-draining utilities, phone
companies, and banks, will afford additional opportunities for M&A
activity in the near future. If history is any guide, the current surge
could go on for several more years. And the corporate giants now being
assembled could dominate the business landscape for decades to
come.


Trillions and Trillions


By any measure, corporate enthusiasm for stitching together and tearing
apart companies has never been greater. In 1999, there were nearly 34,000
announced mergers and acquisitions worldwide, valued at $3.2 trillion,
according to Thomson Financial Securities data. To put these staggering
numbers in some perspective, the number of M&A transactions last year
was more than 10 times those announced in 1985, and their value last year
was nearly the size of the French and German economies combined. At the
same time, the number of U.S.-only takeovers nearly quintupled.


Moreover, the M&A game has clearly evolved from a largely American
affair to a global one. In 1985, 86 percent of all takeovers involved at
least one American party. Last year, only 40 percent of the total had a
U.S. player at the table. During the same span, the portion of corporate
takeovers involving at least one European party grew from 15 percent to 43
percent. And the share involving an Asian party rose from just over 2
percent to nearly 14 percent.


The recent M&A boom is only the latest in a recurring cycle of
corporate restructuring. (See box, p. 2292.) The first wave, marked by
creation of Standard Oil Co. and other big trusts, resulted in classic
production and distribution monopolies that were eventually broken up by
Washington. The conglomerate boom of the 1960s, by contrast, involved
voluntary (and shotgun) marriages of companies in radically different
kinds of business. The dysfunctional complexity of these new entities all
but ensured the eventual demise of many.


The current wave has its own defining characteristics. Just as John D.
Rockefeller assembled regional oil companies into a national colossus,
Juergen Shrempp of DaimlerChrysler has transcended state borders to build
a new global car company. Old-fashioned empire builders, such as Henry
Ford, attempted to control all phases of production: mining iron ore,
rolling his own steel, assembling and selling Model A's and T's. Many of
the current cutting edge transactions-such as America Online-Time
Warner-involve creating competitive advantage through more narrowly
defined control and multiple uses of intellectual property, be it
software, music, or databases.


The Driving Forces


As has been the case in all previous takeover waves, the era's prevailing
economic climate has made the current M&A activity possible. The past
decade has been marked by low inflation, Japan has been in the doldrums,
Asia has weathered an economic crisis, and Europe is only now on the
upswing. In this environment, companies have been unable to increase
revenues and keep their stockholders happy by expanding consumer demand or
raising prices. To bolster their bottom lines, firms have turned to
acquiring the revenue flows and valuable assets of other companies through
takeovers.


Deep and accessible pools of capital around the world have made many of
these transactions possible. With interest rates low, companies have been
able to borrow as much as they need to underwrite takeovers and take their
time paying down the loans. Until recently, the run-up in the American
stock market enabled corporate deal-makers to fund "all-stock"
transactions. Most important, thanks to the 1999 creation of the Euro, the
currency used by most members of the European Union, the emergence of a
single European corporate bond market-which tripled in size in its first
year-has broken European firms' dependence on bank capital. Moreover,
European stock markets now account for a third of world market
capitalization, up from a fifth a quarter-century ago. As a result, French
or German deal-makers can now finance takeovers by raising capital from
investors, not stodgy bankers. Olivetti's recent takeover of Telecom
Italia, for example, would have been impossible even two years
ago.


In fact, the emergence of European players in the M&A game is probably
the single most distinctive feature of the current takeover wave. The
creation of a unified European marketplace has exposed continental banks,
retailers, and high-tech firms to unprecedented competition. In a sign
that fundamental change is afoot, the number of hostile takeovers in
Europe is up dramatically. And European takeovers of American firms have
substantially exceeded in value the U.S. takeovers of European firms in
each of the last two years.


M&A activity is truly a global phenomenon. Renault's decision to
purchase a controlling interest in Nissan and Ford Motor Co.'s effort to
buy Daewoo are attempts to crack previously closed markets with takeovers,
instead of trade. More broadly, with many firms' clients and customers now
hailing from all parts of the world, managers of banking, advertising, and
other service-providing industries are increasingly feeling the need to
have global operations. Hence, the mergers that created the Big Five
accounting firms.


Government deregulation and privatization in Europe and much of the Third
World have also created immense new opportunities. Banking, insurance,
telecommunications, and utilities operations that were previously state
owned have all become fair game for takeovers. No longer subsidized by the
taxpayer or the beneficiary of government-set profit levels, newly
privatized companies have had to look to other firms for capital. At the
same time, many of these newly independent firms have turned to
cross-border acquisitions to bolster their profitability (the rationale
for Ameritech Corp. investing in Tele Danmark and Telecom Italia buying a
piece of Telecom Austria).


Recent technological innovations that permit seamless, reliable voice and
data transmission through computer networks, wireless telephones, and
satellites are another driving force in recent corporate convergence. The
WorldCom-Sprint merger was attractive to matchmakers because the
companies' long-distance services and Internet networks were included in
the deal. But when antitrust authorities indicated that any new company
would have to divest itself of these operations, the deal-makers rapidly
lost interest. Moreover, as product life-cycles shorten and the cost of
developing new technologies mushrooms, IBM Corp. and Toyota Motor Corp.
increasingly can't afford the time or money for their own research and
development. If they need a new-niche technology-a gizmo to facilitate
computers talking to each other, or a widget to help engines burn
cleaner-they buy the small company that has already invented it. And for
many start-up high-tech companies, which could never afford to bring their
discoveries to market, being gobbled up by a bigger fish is often part of
their initial business plan.


In some industries, of course, the motivation behind recent M&A
activity is simply a traditional quest for economies of scale. Blockbuster
absorbed many of its competitors in the video rental business, and CarMax
is doing the same in the used-car business, because mom-and-pop video and
car operations are not large enough to establish brand recognition or to
maintain sufficient inventories.


At the same time, overcapacity in other sectors has triggered
consolidations. The world is awash in automobile assembly lines: Europe
has twice as many carmakers as the United States; Korea can build 5
million more cars a year than its domestic market can absorb. Daimler's
acquisition of Chrysler and Ford's interest in Daewoo reflect their
efforts to buy competitors' production capacity and to fill holes in the
Daimler and Ford product lines.


Similarly, the Pentagon's reduced demands for hardware in the post-Cold
War world has led the military to encourage defense industry mergers to
curb the number of idle and expensive-to-maintain production facilities
that drive up the cost of new weapons systems.


Finally, intangible factors have created a climate conducive to M&A
activity.


The sudden surge of interest in airline mergers following the announced
United Airlines-US Airways marriage stems from a kind of bandwagon effect.
Moreover, low unemployment, at least in the United States, has sapped
organized labor's resistance to merger deals. Golden parachutes and stock
options have assuaged managements' worries about white-collar layoffs. And
the prolonged American economic expansion has taken the edge off populist
fears about the concentration of wealth attendant with corporate
agglomeration.


Rocky Shoreline


Can the good times for the M&A deal-makers go on forever? Think again.
The number of takeovers was down 13 percent in the first quarter of this
year, possibly reflecting the rising cost of financing deals in the wake
of higher interest rates and the fall off in the U.S. stock market, before
rebounding in the second quarter. Nationalistic opposition recently
blunted efforts by Spain's Telefonica to buy Dutch phone operator Royal
KPN and may have scared off Deutsche Telekom from acquiring Sprint in the
United States. Trustbusters in Brussels and Washington blocked the
WorldCom-Sprint merger and are aggressively pursuing other high-profile
cases, signaling a new scrutiny of corporate marriages.


Other obstacles to future mergers lurk beneath the surface. "Bigger
is better" until it creates ponderous corporate bureaucracies that
are unable to adapt to rapid technological changes. As the cost of
borrowing rises, the debt used to finance past buyouts may sink otherwise
healthy companies. And a hard landing for the American economy could
dampen the enthusiasm of even the most ardent corporate suitors.


Nevertheless, there may still be a lot of life left in this merger boom.
Expected changes in German tax law could next year put into play up to
$237 billion in closely held German companies stock, creating new European
takeover opportunities. And bottom-feeding of distressed companies has
only begun in Japan, Korea, and Thailand. So corporate M&A surfers can
look to hang ten for some time to come.


Bruce Stokes

National Journal