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Chapter 7
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The Timing of Merger Activity
©2001 Prentice Hall
Takeovers, Restructuring, and Corporate Governance, 3/e
Weston - 1
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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