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Chapter 7

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The Timing of Merger Activity

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Common Characteristics of Merger Movements

Periods of high economic growth Favorable stock price levels and financial conditions Response to economic, technological, and regulatory changes

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The 1895-1904 Merger Movement

(the first movement)
Mainly horizontal mergers Major changes in economic infrastructure and production technologies
Transcontinental railroad completion resulting in national economic markets Use of electricity and increased use of coal and oil products
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 Motivating factors
Economies of scale Merging for national markets Professional promoters and underwriters

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 Success due to "astute business leadership" (Livermore, 1935)

Rapid technological and managerial improvements Development of new products Entry into new subdivisions of industry Promotion of quality brand names Commercial exploitation of research

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 Failure (Dewing, 1953)

Failure to modernize plant and equipment Increase in overhead costs Lack of flexibility due to large size Inadequate supply of talent to manage large groups of plants

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 End of first merger movement

In 1901, merger activity began downturn as some combinations failed to realize gains In 1903, economy went into recession In 1904, Supreme Court ruled against Northern Securities, establishing that mergers can be attacked by Section One of the Sherman Act

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The 1922-1929 Merger Movement

(the second movement)
Combinations in public utilities, banking, food processing, chemicals, mining Motivating factors
Product-extension IBM, General Foods, Allied Chemical Market-extension food retailing, movie theaters, department stores Vertical mergers metals, mining, oil
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 Facilitating developments
Transportation motor vehicles made both buyers and sellers more mobile Communications national radio advertising facilitated product differentiation Merchandising mass distribution with low profit margins Increased vertical integration due to advantages from technological economies or from reliability of input supply

End of second wave of merges with the onset of a severe economic slowdown in 1929
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Conglomerate Merger Movement of the 1960s

(the third movement)
Decline in relative importance of horizontal and vertical mergers
Changes in the law
Clayton Act of 1914, Section 7, had prohibited mergers only for stock transactions Celler-Kefauver Act of 1950 closed assetpurchase loophole
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 In 1967-68 when the merger activity peaked

Horizontal and vertical mergers declined to 17% Product extension mergers increased to 60% Market extension mergers were negligible Pure conglomerates increased steadily to about 23% of all mergers (or 35% in terms of assets acquired)

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 Acquiring firm characteristics small to medium-sized, adopting diversification strategy outside traditional areas of interest Acquired firm characteristics small to medium-sized, operating in fragmented industries, or on periphery of major industries

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 Defensive diversification to avoid:

Sales/profit instability Unfavorable growth prospects Adverse competitive shifts Technological obsolescence Increased uncertainties in acquirer's industry

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 Examples:
Aerospace industry wide fluctuations in market demand, large abrupt shifts in product mix, excess capacity aggravated by entry of firms from other industries Industrial machinery and auto parts sales instability Railway equipment, textiles, tobacco, movie distribution low growth prospects

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 Other motives
Some mergers reflected personality of chief executive resulting in noncore acquisitions Some conglomerates were formed to imitate earlier conglomerates that appeared to have achieved high growth and high valuations Differential price/earnings (P/E) game No sound conceptual basis source of selloffs in later years Rise of management theory - "good managers can manage anything"
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 End of conglomerate merger wave

Antitrust laws
Congress began to move against conglomerate firms in 1968 Suits filed by the Department of Justice arguing "mutual forebearance"

Punitive tax laws

Tax Reform Act of 1969 limited use of convertible debt to finance acquisitions EPS would have to be calculated on a fully diluted basis as if debt had been converted into common stock

Declining stock prices

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The Deal Decade, 1981-1989

(the fourth movement)
Motivating forces
Surge in the economy and stock market beginning in mid-1982 Impact of international competition on mature industries such as steel and auto Unwinding diversified firms New industries as a result of new technologies and managerial innovations
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 Decade of big deals

Ten largest transactions
Exceeded $6 billion each Summed to $126.1 billion

Top 10 deals reflected changes in the industry

Five involved oil companies increased price instability resulting from OPEC actions Two involved drug mergers increased pressure to reduce drug prices Two involved tobacco companies diversified into food industry
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 Financial innovations
High yield bonds provided financing for aggressive acquisitions by raiders Financial buyers
Arranged going private transactions Bought segments of diversified firms

"Bustup acquisitions"
Buyers would seek firms whose parts as separate entities were worth more than the whole After acquisitions, segments would be divested Proceeds of sales were used to reduce the debt incurred to finance the transaction
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 Rise of wide range of defensive measures as a result of increased hostile takeovers End of fourth merger wave
Government actions
Highly publicized insider trading cases Passage of the Financial Institution Reform, Recovery, and Enforcement Act (FIRREA) in1989 Indictment of Michael Milken and bankruptcy of Drexel Burnham

Development of powerful takeover defenses Economic recession associated with Gulf War
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Strategic Mergers, 1992-2000

Economic trends
Economic recovery after Gulf War Continued rise in stock prices to new highs Recovery of junk bond market as other investment banking firms moved in

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 Major driving forces

Technology
Impact of computer and software applications Impact of microwave systems and fiber optics on telecommunications industry Impact of the Internet creation of new industries and firms, changes in the nature and forms of competitive relationships

Globalization
Technological developments in transportation and communications Europe and other regions moving toward common markets
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 Deregulation
Major deregulations in financial services, telecommunications, energy, airlines, trucking, etc. Massive reorganization of industries

Economic Environment
Rising stock prices Rising P/E ratios Low interest rate levels

Method of payment
Predominant use of stock-for-stock transactions Less reliance on highly leveraged transactions
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 Share repurchases
Used as a signal by successful firms with superior revenue growth and favorable cost structures Credible signal of future success, increased returns to shareholders

Stock options
Important component of compensation to attract innovative, experienced executives Extended to employees throughout the organization

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 Megamergers of the nineties

Top ten transactions of all times occurred in 1998 and 1999 Top ten deals of the nineties totaled about $700 billion Size of M&As in relation to level of economic activity
For period 1993-1999, M&As represented about 12% of GDP In 1999, M&As represented 15% of GDP In the eighties, M&As represented less than 4% of GDP
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Timing of Merger Activity

Empirical evidence does not support merger waves Generalizations on major merger movements
Each major merger movement reflected some underlying economic and/or technological changes

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 Some common financial factors associated with high levels of merger activity
Rising stock prices Low interest rates Favorable term structures of interest rates Narrow risk premia

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International Perspectives
M&A activity in other developed countries of the world has been even higher than in the U.S. Underlying factors
Internationalization of markets Globalization of competition Antimerger laws and regulations such as in the UK and in EEC tightened in the 1980s, but M&A activity increased due to economic, technological, and regulatory changes
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