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©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston

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- - - - - - - - Chapter 7 - - - - - - - -

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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• 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

The 1895-1904 Merger Movement

(the first movement)


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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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• 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

The 1922-1929 Merger Movement

(the second movement)


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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 asset-purchase 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 sell-

offs 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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