Mergers Today, Trouble Tomorrow?Kevin Kelly and Richard A. Melcher
Telecommunications. Defense. Railroads. Pharmaceuticals. Retailing. Health care. Banking. Entertainment...
The list seems endless. A stampede of deals, unmatched in number and scale since the heyday of junk-bond-financed takeovers in the late 1980s, is sweeping through Corporate America. On Aug. 29, drugmaker SmithKline Beecham PLC announced it would plunk down $2.93 billion for Eastman Kodak Co.'s over-the-counter products unit. The very next day came a real blockbuster: Lockheed Corp. agreed to combine with Martin Marietta Corp., forming a defense giant with sales of $23 billion.
Add those two to the heap, and corporate dealmeisters have engineered close to $210 billion worth of mergers and acquisitions so far this year, according to Securities Data Co. Driven by massive technological change, international competition, deregulation and--above all--the incessant demand to cut costs, announced transactions by yearend should approach the 1988 record of $336 billion. Even greater consolidation is likely in the years ahead. Proclaims Harvard business school professor Michael C. Jensen: "We're going through a third industrial revolution," marked by efforts to eliminate excess capacity.
The M&A whirlwind calls to mind past eras of consolidation: the merger-rich 1920s, the conglomerate-building 1960s and 1970s, the leveraged-buyout-crazed 1980s. And it raises many of the same questions. Will combinations within industries reduce competition and drive up prices? Could mergers undermine innovation? Should the federal government be taking more aggressive antitrust measures? And, most vexing of all, do these deals really work?
This dealmaking era is undoubtedly different than previous ones. Increased size, for instance, no longer ensures a company the ability to monopolize. Indeed, global competition has dramatically reduced the ability of companies to control pricing in any national market. And low barriers to entry--such as cheap capital and excess capacity--along with rapid technological change, render any dominant market position fragile.
Take the tire industry. Despite huge consolidation during the late 1980s, the three largest companies, which control more than half of the market, have largely been unable to enforce price hikes. In that industry and others, says outgoing Continental Bank Corp. Chairman Thomas C. Theobald, "the opportunity to monopoly-price is pretty damn limited."
Instead, companies are more likely to combine these days to gain a place in highly competitive national or international markets. BankAmerica Corp.'s $1.9 billion acquisition of Continental, set to close on Aug. 31, already has given it access to Midwestern customers. Reliance Electric Co. cited its need for muscle to conquer foreign markets as one motivation for its $1.39 billion merger with General Signal Corp., announced Aug. 30. Says Reliance Treasurer John D. Hutson: "It should be easier for a $3.5 billion company to move overseas than a $1.5 billion company."
The new competitive environment may explain the Clinton Administration's low antitrust profile. In health care and defense, the Administration is encouraging consolidation to wring out costs. Still, "we'll do something if we see a merger that will adversely affect market share and that may hurt consumers down the road," declares Steven C. Sunshine, the Justice Dept.'s deputy assistant attorney general for antitrust.
Indeed, federal antitrust agencies insist they are becoming more aggressive. Last year, the Justice Dept. intervened in 20 mergers, up from an average of 8 to 10 in the Bush years. One concern: vertical integration. That's what's driving the Federal Trade Commission's examination of pharmaceutical giant Eli Lilly & Co.'s pending $4 billion combination with drug distributor PCS Health Systems Inc. But the feds didn't act in similar purchases by rivals Merck & Co. and SmithKline. Now, regulators have become anxious that drugmakers could exercise undue control over the market for their product by controlling major distributors.
HARDER THEY FALL? Regulators concern themselves less with a deal's actual effectiveness. Historically, though, it has proved exceedingly difficult to pump up profits by merging. University of Chicago finance professor Steven N. Kaplan says 49% of acquisitions made between 1971 and 1982 were divested, many because they failed to work. USAir Group Inc., for instance, snatched up regional rivals during the 1980s, expecting to gain some measure of pricing control and to boost profits from increased
volumes. Instead, the difficulty of combining operations and the advent of nimbler rivals has forced the carrier to restructure.
Heightened shareholder involvement, plus new technology that will help companies wring new efficiencies, may make this round of dealmaking different. Take hospital giant Columbia/HCA Healthcare Corp. The 196-hospital chain, the product of two mergers in the past year, already is enjoying the benefits of consolidation. Chief Operating Officer David T. Vandewater notes that efforts to slash supply costs--a result of added purchasing power--helped boost operating margins during the first half of 1994 to 20.2% from 19.5% in last year's second quarter.
Food wholesalers report similar benefits. In June, the nation's second-largest grocery wholesaler, Fleming Cos., agreed to buy the third-largest, Scrivner Inc., for $1 billion. Fleming Executive Vice-President Gerald G. Austin expects to cut $90 million from the companies' combined selling and administrative costs by 1997--savings that will fall to Fleming's bottom line. The transaction should also boost Fleming's borrowing power so it can invest in technology and new facilities.
Will the new Lockheed Martin Corp. reap similar gains? It will be years before we know for sure what that merger and others will yield. What we do know is that there will certainly be others. In airlines. Publishing. Food. Consulting. Computers. . . .