Читать книгу Mergers, Acquisitions, and Corporate Restructurings - Gaughan Patrick А. - Страница 28

The third merger wave featured a historically high level of merger activity. This was brought about in part by a booming economy. During these years, often known as the conglomerate merger period, it was not uncommon for relatively smaller firms to target larger companies for acquisition. In contrast, during the two earlier waves, the majority of the target firms were significantly smaller than the acquiring firms. Peter Steiner reports that the “acquisition of companies with assets over $100 million, which averaged only 1.3 per year from 1948 to 1960, and 5 per year from 1961 to 1966, rose to 24 in 1967, 31 in 1968, 20 in 1969, 12 in 1970 before falling to 5 each year in 1971 and 1972.”29

The number of M&As during the 1960s is shown in Figure 2.1. These data were compiled by W. T. Grimm and Company (now provided by Houlihan Lokey Howard & Zukin), which began recording M&A announcements on January 1, 1963. As noted, a larger percentage of the M&As that took place in this period were conglomerate transactions. The Federal Trade Commission (FTC) reported that 80 % of the mergers that took place in the 10-year period between 1965 and 1975 were conglomerate mergers.30

Figure 2.1 Third Merger Wave, Merger and Acquisition Announcements, 1963–1970. The Third Merger Wave Peaked in 1969. The Decline in the Stock Market, Coupled with Tax Reforms, Reduced the Incentive to Merge. Source: Mergerstat Review, 2014.

The conglomerates formed during this period were more than merely diversified in their product lines. The term diversified firms is generally applied to companies that have some subsidiaries in other industries but a majority of their production within one industry category. Unlike diversified firms, conglomerates conduct a large percentage of their business activities in different industries. Good examples are Ling-Temco-Vought (LTV), Litton Industries, and ITT. In the 1960s, ITT acquired such diverse businesses as Avis Rent A Car, Sheraton Hotels, Continental Baking, and other far-flung enterprises, such as restaurant chains, consumer credit agencies, home building companies, and airport parking firms. Although the third merger wave is associated with well-known conglomerate firms such as ITT and LTV, many corporations of varying sizes engaged in a diversification strategy. Many small and medium-sized firms also followed this fad and moved into areas outside their core business.

As firms with the necessary financial resources sought to expand, they faced tougher antitrust enforcement. The heightened antitrust atmosphere of the 1960s was an outgrowth of the Celler-Kefauver Act of 1950, which had strengthened the antimerger provisions of the Clayton Act of 1914. The Clayton Act made the acquisition of other firms' stock illegal when the acquisition resulted in a merger that significantly reduced the degree of competition within an industry. However, the law had an important loophole: It did not preclude the anticompetitive acquisition of a firm's assets. The Celler-Kefauver Act closed this loophole. Armed with tougher laws, the federal government adopted a stronger antitrust stance, coming down hard on both horizontal and vertical mergers. Expansion-minded firms found that their only available alternative was to form conglomerates.

The more intense antitrust enforcement of horizontal mergers was partially motivated by the political environment of the 1960s. During this decade, Washington policymakers, emphasizing the potential for abuses of monopoly power, worked through the FTC and the Justice Department to curb corporate expansion, which created the potential for monopolistic abuses. Prime advocates of this tougher antitrust enforcement were Attorney General John Mitchell and Assistant Attorney General Richard McLaren, the main architect of the federal government's antitrust efforts during the 1960s. In his book Managing, Harold Geneen, then chief executive officer of ITT, has described the difficulty his company had in acquiring companies when McLaren was in office.31 McLaren opposed conglomerate acquisitions based on his fears of “potential reciprocity.” This would occur, for example, if ITT and its other subsidiaries gave Hartford Insurance, a company ITT acquired, a competitive edge over other insurance companies. ITT was forced to compromise its plans to add Hartford to its conglomerate empire. It was able to proceed with the acquisition only after agreeing to divest itself of other divisions with the same combined size of Hartford Insurance and to not acquire another large insurance company for 10 years without prior Justice Department approval. Years later the European Commission would voice similar arguments for opposing takeovers in the 2000s.

With the election of Richard M. Nixon toward the end of the decade, Washington policymakers advocated a freer market orientation. Nixon supported this policy through his four appointees to the U.S. Supreme Court, who espoused a broader interpretation of concepts such as market share. The tough antitrust enforcement of the Justice Department came to an end in 1972, as the Supreme Court failed to accept the Justice Department's interpretation of antitrust laws. For example, in some cases the Supreme Court began to use a broad international market view as opposed to a more narrow domestic or even regional market definition. Consequently, if as a result of a merger, a firm had a large percentage of the U.S. market or a region of the nation but a small percentage of the international market, it could be judged to lack significant monopolistic characteristics. By this time, however, the third merger wave had already come to an end.

Management Science and Conglomerates

The rapid growth of management science accelerated the conglomerate movement. Schools of management began to attain widespread acceptability among prominent schools of higher education, and the master of business administration degree became a valued credential for the corporate executive. Management science developed methodologies that facilitated organizational management and theoretically could be applied to a wide variety of organizations, including corporations, government, educational institutions, and even the military. As these management principles gained wider acceptance, graduates of this movement believed they possessed the broad-based skills necessary to manage a wide variety of organizational structures. Such managers reasonably believed that they could manage a corporate organization that spanned several industry categories. The belief that the conglomerate could become a manageable and successful corporate entity started to become a reality.

Industry Concentration and the Conglomerate Wave

Because most of the mergers in the third wave involved the formation of conglomerates rather than vertical or horizontal mergers, they did not appreciably increase industrial concentration. For this reason, the degree of competition in different industries did not significantly change despite the large number of mergers. Some 6,000 mergers, entailing the disappearance of 25,000 firms, took place; nonetheless, competition, or market concentration, in the U.S. economy was not greatly reduced. This clearly contrasts with the first merger wave, which resulted in a dramatic increase in industry concentration in many industries.

Shareholder Wealth Effects of Diversification during the Conglomerate Wave

In Chapter 4 we critically examine diversification strategies and their impact on shareholder wealth. However, while we are discussing the conglomerate wave, it is useful to briefly address some research that has attempted to assess the impact of these types of deals on shareholder wealth. Henri Servaes analyzed a large sample of firms over the years 1961–1976.32 He showed that over this time period, the average number of business segments in which firms operated increased from 1.74 in 1961 to 2.7 in 1976. He then examined the Q ratios (ratios of the market value of securities divided by the replacement value of assets) of the companies in his sample and found that diversified firms were valued at a discount – even during the third merger wave when such diversifying deals were so popular. He found, however, that this diversification discount declined over time. Servaes analyzed the assertion that insiders derive private benefits from managing a diversified firm, which may subject the firm to less risk although at a cost that may not be in shareholders' interests. If managers derive private benefits that come at a cost to shareholders (the discount), then this may explain why companies with higher insider ownership were focused when the discount was high but began to diversify when the discount declined. At least they did not pursue their private benefits when it was imposing a cost on shareholders.

Some research shows that the stock market response to diversifying acquisitions in the conglomerate was positive.33 Matsusaka found that not only did the market respond positively, but also the response was clearly positive when bidders agreed to keep target management in place and negative when management was replaced as in disciplinary takeovers. While this may have been the case, this does not mean that the market's response in this time period to these diversifying deals was correct. When one considers the track record of many of these deals, it is easy to conclude that they were flawed. Later research covering more recent time periods shows that the market may have learned this lesson, and such deals do not meet with a favorable response.

Price-Earnings Game and the Incentive to Merge

As mentioned previously, investment bankers did not finance most of the mergers in the 1960s, as they had in the two previous merger waves. Tight credit markets and high interest rates were the concomitants of the higher credit demands of an expanding economy. As the demand for loanable funds rose, both the price of these funds and interest rates increased. In addition, the booming stock market prices provided equity financing for many of the conglomerate takeovers.

The bull market of the 1960s bid stock prices higher and higher. The Dow Jones Industrial Average, which was 618 in 1960, rose to 906 in 1968. As their stock prices skyrocketed, investors were especially interested in growth stocks. Potential bidders soon learned that acquisitions, financed by stocks, could be an excellent “pain-free” way to raise earnings per share without incurring higher tax liabilities. Mergers financed through stock transactions may not be taxable. For this reason, stock-financed acquisitions had an advantage over cash transactions, which were subject to taxation.

Companies played the price-earnings ratio game to justify their expansionist activities. The price-earnings ratio (P/E ratio) is the ratio of the market price of a firm's stock divided by the earnings available to common stockholders on a per-share basis. The higher the P/E ratio, the more investors are willing to pay for a firm's stock given their expectations about the firm's future earnings. High P/E ratios for the majority of stocks in the market indicate widespread investor optimism; such was the case in the bull market of the 1960s. These high stock values helped finance the third merger wave. Mergers inspired by P/E ratio effects can be illustrated as follows.

Let us assume that the acquiring firm is larger than the target firm with which it is considering merging. In addition, assume that the larger firm has a P/E ratio of 25:1 and annual earnings of $1 million, with 1 million shares outstanding. Each share sells for $25. The target firm has a lower P/E ratio of 10:1 and annual earnings of $100,000, with 100,000 shares outstanding. This firm's stock sells for $10. The larger firm offers the smaller firm a premium on its stock to entice its stockholders to sell. This premium comes in the form of a stock-for-stock offer in which one share of the larger firm, worth $25, is offered for two shares of the smaller firm, worth a total of $20. The large firm issues 50,000 shares to finance the purchase.

This acquisition causes the earnings per share (EPS) of the higher P/E firm to rise. The EPS of the higher P/E firm has risen from $1.00 to $1.05. We can see the effect on the price of the larger firm's stock if we make the crucial assumption that its P/E ratio stays the same. This implies that the market will continue to value this firm's future earnings in a manner similar to the way it did before the acquisition. The validity of this type of assumption is examined in greater detail in Chapter 14.

Based on the assumption that the P/E ratio of the combined firm remains at 25, the stock price will rise to $26.25 (25 × $1.05). We can see that the larger firm can offer the smaller firm a significant premium while its EPS and stock price rise. This process can continue with other acquisitions, which also result in further increases in the acquiring company's stock price. This process will end if the market decides not to apply the same P/E ratio. A bull market such as occurred in the 1960s helps promote high P/E values. When the market falls, however, as it did at the end of the 1960s, this process is not feasible. The process of acquisitions, based on P/E effects, becomes increasingly untenable as a firm seeks to apply it to successively larger firms. The crucial assumption in creating the expectation that stock prices will rise is that the P/E ratio of the high P/E firm will apply to the combined entity. However, as the targets become larger and larger, the target becomes a more important percentage of the combined firm's earning power. After a company acquires several relatively lower P/E firms, the market becomes reluctant to apply the original higher P/E ratio. Therefore, it becomes more difficult to find target firms that will not decrease the acquirer's stock price. As the number of suitable acquisition candidates declines, the merger wave slows down. Therefore, a merger wave based on such “finance gimmickry” can last only a limited time period before it exhausts itself, as this one did.

With its bull market and the formation of huge conglomerates, the term the go-go years was applied to the 1960s.34 When the stock market fell in 1969, it affected the pace of acquisitions by reducing P/E ratios. Figure 2.2 demonstrates how this decline affected some of the larger conglomerates.

Figure 2.2 Third Merger Wave, Conglomerate P/E Ratios 1960, 1970. The End of the Third Merger Wave Was Signaled by the Dramatic Decline in the P/E Ratios of Some of That Era's Leading Conglomerates. Source: Peter O. Steiner, Mergers: Motives, Effects and Policies (Ann Arbor: University of Michigan Press, 1975), 104.

Accounting Manipulations and the Incentive to Merge

Under accounting rules that prevailed at the time, acquirers had the opportunity to generate paper gains when they acquired companies that had assets on their books that were well below their market values. The gains were recorded when an acquirer sold off certain of these assets. To illustrate such an accounting manipulation, A. J. Briloff recounts how Gulf & Western generated earnings in 1967 by selling off the films of Paramount Pictures, which it had acquired in 1966.35 The bulk of Paramount's assets were in the form of feature films, which it listed on its books at a value significantly less than their market value. In 1967, Gulf & Western sold 32 of the films of its Paramount subsidiary. This generated significant “income” for Gulf & Western in 1967, which succeeded in supporting Gulf & Western's stock price.

Some believe that these accounting manipulations made fire and casualty insurance companies popular takeover targets during this period.36 Conglomerates found their large portfolios of undervalued assets to be particularly attractive in light of the impact of a subsequent sale of these assets on the conglomerate's future earnings. Even the very large Hartford Insurance Company, which had assets of nearly $2 billion in 1968 (approximately $13.9 billion in 2014 dollars), had assets that were clearly undervalued. ITT capitalized on this undervaluation when it acquired Hartford Insurance.

Another artificial incentive that encouraged conglomerate acquisitions involved securities, such as convertible debentures, which were used to finance acquisitions. Acquiring firms would issue convertible debentures in exchange for common stock of the target firm. This allowed them to receive the short-term benefit of adding the target's earnings to its EPS valuation while putting off the eventual increase in the acquirer's shares outstanding.

Decline of the Third Merger Wave

The decline of the conglomerates may be first traced to the announcement by Litton Industries in 1968 that its quarterly earnings declined for the first time in 14 years.37 Although Litton's earnings were still positive, the market turned sour on conglomerates, and the selling pressure on their stock prices increased.

In 1968, Attorney General Richard McLaren announced that he intended to crack down on the conglomerates, which he believed were an anticompetitive influence on the market. Various legal changes were implemented to limit the use of convertible debt to finance acquisitions. The 1969 Tax Reform Act required that convertible debt be treated as equity for EPS calculations while also restricting changes in the valuation of undervalued assets of targets. The conglomerate boom came to an end, and this helped collapse the stock market.

Performance of Conglomerates

Little evidence exists to support the advisability of many of the conglomerate acquisitions. Buyers often overpaid for the diverse companies they purchased. Many of the acquisitions were followed by poor financial performance. This is confirmed by the fact that 60 % of the cross-industry acquisitions that occurred between 1970 and 1982 were sold or divested by 1989.

There is no conclusive explanation for why conglomerates failed. Economic theory, however, points out the productivity-enhancing effects of increased specialization. Indeed, this has been the history of capitalism since the Industrial Revolution. The conglomerate era represented a movement away from specialization. Managers of diverse enterprises often had little detailed knowledge of the specific industries that were under their control. This is particularly the case when compared with the management expertise and attention that are applied by managers who concentrate on one industry or even one segment of an industry. It is not surprising, therefore, that companies like Revlon, a firm that has an established track record of success in the cosmetics industry, saw its core cosmetics business suffer when it diversified into unrelated areas, such as health care.