After a runaway decade of blockbuster mergers consummated in the name of shareholder value, new evidence suggests the first rarely leads to the second.
U.S. mergers and acquisitions in the 1990s smashed all records for both number and size of deals–roughly 46,000 deals, with a value of more than $4.8 trillion–as companies paid homage to the idea that bigger is not only better, but a necessity to compete and survive.
Yet a Tribune analysis of many of the biggest national and local mergers during the decade showed that most have failed to pay off. Nearly seven in 10 surviving companies lagged their industry peers in stock performance two years after the deals were completed–some dramatically.
It’s not a matter of a fickle stock market failing to reward visionary chief executives: The study, developed in conjunction with consulting firm A.T. Kearney, found merged companies with underperforming stocks also tended to lag in other financial measures, including sales and profit growth and return on equity.
The latest wave of deals worries even laissez-faire experts such as Thomas Lys, a noted mergers expert at Northwestern University’s J.L. Kellogg Graduate School of Management in Evanston.
“I don’t think it’s healthy,” he said of the huge wave of deals driven by the roaring stock market of the late 1990s. “Is there any evidence that great wealth has been created? No.”
After the excesses of the ’80s–and some spectacular failures–mergers in the ’90s were supposed to be different: Acquirers promised to choose targets more strategically, avoiding mismatched conglomerates, and shied away from costly hostile takeover battles.
But what did Corporate America buy with that astonishing amount of money? In many cases, nothing but trouble: Even as the latest wave of deals transformed the corporate landscape and disrupted many lives, it failed to generate the promised returns, the Tribune-Kearney study shows.
The study analyzed in detail more than 50 of the largest mergers and acquisitions from January 1990 through September 1999. It found that 69 percent of the surviving companies lagged their industry average in total shareholder return in the two years after the deals closed–or, for a handful that hadn’t been closed for a full two years, through mid-February. Only 31 percent outperformed their industry peers.
The study primarily measured performance two years after deals closed to allow companies to integrate their operations and produce meaningful results, while minimizing the effects of other significant events, including subsequent mergers, that would skew the stock price.
Company executives frequently say these giant deals are designed to pay off in the long haul, arguing that it takes time for the market to reward their strategy, making it too soon to fully assess many of the biggest mergers of the ’90s. Nonetheless, among the deals in the study that have had the longest track records, shares of about 70 percent of surviving companies also underperformed industry peers a full five years after the deals closed. Several former acquirers have been bought out themselves in still-bigger deals, or embarked on new takeovers designed to improve results.
Such findings are an especially bitter pill for Chicago, which saw many local icons–Amoco, Ameritech and First Chicago, to name a few–erased in corporate takeovers in recent years. In fact, the performance of local mergers fared slightly worse: Among the deals in the study with Chicago-area firms, roughly three-quarters of surviving companies lagged industry peers in shareholder return.
The study expands upon earlier work by Kearney and other researchers on stock performance after mergers, and gives a more comprehensive look at the biggest deals of the latest, record-setting era, including analysis of other financial measures that are rarely studied.
For several of the mergers examined, the news worsened as time passed: In the first year after deals closed, nearly half of the surviving companies in the study outperformed their peers. Given the overall track record, Kearney officials were a bit surprised that it took as long as two years for the stock market to turn down on so many deals.
“The market is forgiving for a longer period of time than I would’ve anticipated,” said Mick Siegel, a vice president in the firm’s Chicago office. “It’s a longer honeymoon than I would’ve thought.”
And yet, the subsequent failure rate has done little to slow the stampede of deals, which exploded over the back half of the decade, setting record after record. From 1997-2000, U.S. companies were involved in more than 34,000 mergers and acquisitions, Los Angeles-based deal tracker Mergerstat said, with an equity value of more than $4.6 trillion–nearly equal to the combined annual gross domestic products of Japan and Germany as the decade came to a close.
No question, nearly every merger created at least some winners.
Those include the investment bankers who put the deals together and top corporate executives who ended up either leading bigger enterprises, walking away with expanded fortunes or shooting up the career ladder with a reputation as dealmakers. Shareholders of target companies often trade in underperforming stakes at a lucrative short-term premium–although that, too, can erode in stock-for-stock deals.
On a grander scale, many economists agree that to grow and maintain U.S. competitiveness, businesses naturally must become bigger and more efficient.
But just as clearly, mergers create big losers: The most obvious are the workers whose jobs are eliminated–especially older workers, women and minorities, who disproportionately bear the brunt of layoffs, according to government data.
Customers often suffer through service interruptions, and communities lose part of their fabric when faraway masters swallow up committed corporate citizens.
So if these huge deals usually fail to benefit even the shareholders of the acquiring firms, why do so many smart CEOs keep bellying up to the merger table?
“Why do people get married? It’s the triumph of hope over experience,” quips John Rau, who was chief executive of Chicago Title Corp. when it agreed to be acquired by Fidelity National Financial Inc. in 1999.
Experts said several factors, including hubris on the part of empire-building CEOs and pressure to grow to head off global competition, keep investment bankers busy arranging more deals.
Shareholder advocate Nell Minow blames “perverse” compensation incentives that encourage CEOs to seek out a takeover, with little downside penalty if a deal doesn’t work out.
“CEO employment contracts have ridiculously low thresholds that trigger golden parachutes,” she said. “If somebody buys 15 percent of the stock, a CEO can bail out and get the parting gifts.”
More simply, size just seems to matter.
“If you’re bigger, it’s tougher to be acquired,” Rau said. “It’s competitive positioning over the very long run. Size tends to allow people to maintain competitiveness.”
And as maturing U.S. markets hunger for continued growth, many companies simply run out of room to achieve it any way but through acquisitions, said Michael P. Thomas, a principal with consulting firm BBK of Southfield, Mich., which specializes in the auto industry.
“It’s in the nature of business organizations to have the desire to grow. It’s fundamental,” Thomas said.
William Smithburg–the former Quaker Oats Co. executive who oversaw both the company’s ill-fated $1.7 billion Snapple acquisition and its highly successful Gatorade purchase–understands the size issue well.
Now on the board of Northern Trust Corp., Smithburg said both Quaker and Northern were tagged as acquisition candidates 20 years ago. Northern has remained independent–though its stock price periodically jumps when takeover rumors crop up–while Quaker has not.
“A CEO’s job is not to remain independent. It is to build value,” Smithburg said, adding that he believes Northern has enough size and scale to keep delivering strong returns to shareholders.
“Mergers are like any business deal,” Smithburg said. “It’s an investment of time, people and money. Some work out, and some don’t.”
So why do so many deals go awry?
For starters, many should never have been done in the first place.
“A lot of times, deals are done for the wrong reasons, to mask other deficiencies in the company,” Kearney’s Siegel said. “Then, of course, the likelihood of success is lower.”
Rau, a longtime Chicago executive and former business school dean, says mergers put management talent to the test.
“To do a merger, you have a big premium just to get back to even, and without hard-nosed business decisions, you won’t get it back,” said Rau, who agreed in the Chicago Title case to be acquired by a smaller firm at a substantial premium, saying it would have been very difficult to generate such shareholder returns if he had been the acquirer.
Many other deals look good on paper, but wither as vastly different organizational cultures, distribution channels and personal agendas surface.
Sometimes, those differences can be overcome. If they can’t, they can doom a deal.
The DaimlerChrysler deal, initially heralded as a natural fit between two equal partners, quickly turned into a German company dealing with a U.S. unit with out-of-control costs.
“They took their eye off their costs,” said former Chrysler executive Gerald Greenwald, who later ran UAL and recently co-wrote a book on management.
As Daimler wooed Chrysler into the deal, the German executives paid too little attention to the current financial situation, as Greenwald sees it.
“Anytime you hear `merger of equals,’ run the other way,” he said. Acquirers breathless to get a deal done will often make promises or overlook potential trouble spots during due diligence, he said.
The current economic slowdown may do more to slow the pace of deals than mounting evidence on failure rates, but most observers believe plenty of industries are still ripe for continued consolidation–look at all the fragmented suppliers in the tier just below the household brand names, for example. Investment banks and consulting firms are also beefing up their presence in Europe, considered ripe for the next round of takeovers.
And as the blockbuster mergers of the last several years work themselves out, they may create a new round of spinoffs and re-acquisitions as companies continue to refine their growth strategies.
In the poetic words of Smithburg: “M&A is here to stay.”
