M&A Deals: Show Me

Aware that many mergers haven't paid off in the past, investors don't have the enthusiasm they once did

When Bank of America CEO Kenneth D. Lewis stepped into a Waldorf-Astoria ballroom on Oct. 27 to unveil a $48 billion takeover of FleetBoston Financial Corp., Wall Street's investment bankers could almost imagine he was leading them back to the glory days of 1990s dealmaking. It was, after all, in the same gilded landmark five years ago that his bank, then known as NationsBank Corp., announced a $59 billion deal that fueled the greatest merger mania ever. Back then, investors applauded, confident in the bank's ability to use its deals to drive earnings and its stock price higher. They bid up the bank's shares 5% that day. Not this time. Even before Lewis started to speak just before noon, investors -- fearing he'd vastly overpaid -- sent the stock plunging toward a 10% loss for the day.

Lewis' experience illustrates how much mergers and acquisitions have changed since the boom. Then, investors cheered on executives' grand ambitions. Deals begat deals, and more than $1.5 trillion worth of companies changed hands for three years in a row, according to deal tracker Thomson Financial. Now, the merger market moves in fits and starts. Traders trash the stocks of companies that dare to buy, which discourages others. The chilly receptions help explain why, despite executives' renewed interest in takeovers, the $402 billion of deals annnounced through Oct. 27 was up only 12% from the first 10 months of 2002.

That doesn't mean there won't be periods of frenetic dealmaking. The same day BofA went public with its FleetBoston deal, three other companies announced mega-takeovers, for a total of some $70 billion, the most in any day since February, 2000. It seemed like a manic Monday of old: Health-care-benefits company Anthem Inc. agreed to pay $16.4 billion in stock and cash for Wellpoint Health Networks Inc. UnitedHealth Group Inc. said it will pay $2.7 billion in stock and cash for Mid Atlantic Medical Services Inc. And R.J. Reynolds Tobacco said it will pay about $3 billion in stock for U.S. units of British American Tobacco PLC.

While the deals made big headlines, they did not impress the stock market. Shares of the buyers, except R.J. Reynolds, plunged, just as those of many other dealmakers have this year. Anthem dropped 8%, and UnitedHealth fell 3.4% in a day. Nor did the cluster of deals mark a big change for investment bankers. "These deals do not reflect a profound change in the tone of the M&A market," says Jack Levy, co-head of global M&A at Goldman, Sachs & Co., an adviser in all four deals.


Certainly, the pace of acquisitions could pick up somewhat. Some executives are thinking seriously for the first time in three years about deals to cut costs or adjust to changing industries. "There are many more dialogs going on right now," says Gerald Rosenfeld, CEO of investment bank Rothschild North America Inc. But the new interest is tempered by a lack of convincing revenue growth and by investor skepticism. "This is less a big rebound than a swing back to normal," says Richard J. Peterson, a market strategist at Thomson Financial.

Investor skepticism is well-founded. Study after study has shown that about two-thirds of buyers fall behind their corporate peers in returns to shareholders. In many cases, their shares get knocked down, and it takes years for investors in the "winning" company to get back to the price where they started. It's not that most mergers and acquisitions don't deliver efficiency gains or make strategic sense. Many do. Rather, shareholders of the acquired companies tend to capture all of the gains when deals are struck. Why? Buyers overpay to get deals done, says Mark Sirower, head of North American M&A at Boston Consulting Group. Last year, BusinessWeek studied 302 transactions from June, 1995, to September, 2001, and found that the pattern continued through the boom: Buyers lost 61% of the time.

Judging by their reaction to the spate of recent deals, investors have learned their lesson. They quickly sized up who would bear the costs and get the future benefits. Nowhere was this clearer than with the BofA deal. FleetBoston shares surged 23% the first day, while BofA shares lost 10%. "Wall Street used to give management a free pass when they announced a transaction," says Fred Green, co-manager of the $1.2 billion Merger Fund. That stopped after many deals did not deliver the profits buyers predicted.

The irony, of course, is that executives are hearing two different stories from Wall Street. Analysts and institutional investors discourage them from buying. But investment bankers tell them they can add shareholder value by consolidating. The consolidation argument is playing best right now in financial services and health benefits. Both sectors are fragmented and both deal with a lot of small transactions that are best handled in large volumes through computer systems. That means, in theory at least, there's plenty of room to raise efficiencies and lower costs.

Unfortunately, that doesn't mean acquirers aren't making the same mistakes others made in the 1990s. Anthem Chairman and CEO Larry C. Glasscock told investors that buying Wellpoint to create the nation's largest health-benefits company will cut costs and boost margins through economies of scale. But to get Wellpoint, Anthem had to offer a 20% premium over the market. So the deal will dilute earnings next year -- a key reason Anthem shares sank.

At BofA, Lewis agreed to a high hurdle to win FleetBoston, which had been considering other offers. He gave up some 600 million shares of BofA stock, which was worth 42% more than FleetBoston, based on market prices before the deal was announced. The dilution from the extra stock is expected to cut BofA's earnings per share to $7.10 from $7.27 in 2004 -- and that's assuming he delivers the ambitious $1.1 billion a year in projected cost savings. Rivals will also be trying to take advantage of his push to cut costs by poaching BofA's customers. "As a competitor, it's a big opportunity," says Jay S. Sidhu, CEO of Sovereign Bancorp of Philadelphia. "And I'm a Fleet shareholder, so I'm thrilled."


The criticism has been harsher than Lewis anticipated. "I was disappointed," he told BusinessWeek. He says the deal will produce enough extra earnings to please his shareholders as well as FleetBoston's. BofA has the chance to improve FleetBoston's computer systems, customer service, and product offerings, he says. "We've got this on the upswing [of the business cycle], when both companies are going to do better than the market expects," Lewis says.

That could be, but Lewis faces a tough fight convincing Wall Street. His long-suffering shareholders know just how poorly they did in the wake of the deal announced at the Waldorf in 1998, when his NationsBank bought BankAmerica Corp. and took on its name. While the shares initially rose from $76 to $88, they then began a long slide to $38. It was only in the days before Lewis bid for FleetBoston that they finally climbed back above $80. Now that they're back down to $74, it's no wonder investors are less than wowed by yet another megadeal to digest.

By David Henry in New York, with Mara Der Hovanesian in New York, Dean Foust in Atlanta, and bureau reports

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