Have Dealmakers Wised Up?

Acquiring companies seem to be taking a closer look -- and paying less

With big names, big dollars, and big payouts, deal-making is back on Wall Street. Following a runup of deals toward the end of last year, U.S. companies announced more than $144 billion worth of mergers and acquisitions in the first 40 days of 2005 -- the fastest start since 2000, according to Thomson Financial Inc. (TOC ). SBC Communications' (SBC ) $16 billion deal for AT&T (T ) on Jan. 31 was followed just days later by Qwest Communications International's (Q ) $6.3 billion bid for MCI. The same week, Metlife Inc. (MET ) said it will pay $11.5 billion in cash and stock for Travelers Life & Annuity, now owned by Citigroup (C ). And Procter & Gamble Co. (PG ) unveiled a deal to buy Gillette Co. (G ) for $57 billion in stock, with a $20 billion stock buyback to follow. As adrenaline-pumped CEOs face flashing cameras, it sure looks like deal fever is raging again.

Is it time for investors to worry? The list of failed deals from the late 1990s still resonates loudly in their collective memory. Daimler Benz's (DCX ) $39 billion purchase of Chrysler and Conseco's $7 billion deal for Greentree Financial were spectacular busts for their shareholders. And while America Online Inc.'s (AOL ) $166 billion acquisition of Time Warner Inc. saved AOL shareholders from the even worse losses suffered by other Internet stock holders, it proved an epic mismatch that wiped out tens of billions of dollars of wealth, including all of Time Warner's takeover premium. The risks of the megadeal were underscored again on Feb. 9 when CEO Carleton S. Fiorina resigned under pressure from Hewlett-Packard Co. (HPQ ) After pushing for the $19 billion acquisition of Compaq Computer Corp. in 2002, Fiorina failed to achieve the promised growth and profitability.

The latest round of dealmaking could be different. Many of today's acquirers appear to have learned important lessons from the failures of the past. The recent spate of deals suggests that executives and directors are approaching takeover targets with a lot more care than in years past. They're giving more thought to strategic fit, paying lower premiums, and spending more time and attention on integration. "We haven't seen anything wild yet," says Hugh "Skip" McGee, head of investment banking at Lehman Brothers Inc. (LEH ).

Of course, the odds are still against these mergers. Many studies over the past decade show that the majority of M&A deals result in worse returns for shareholders of acquiring companies than for their competitors. BusinessWeek investigations in 2002 and 2004 showed that 61% of big deals hurt the buying company's shareholders. Half of them also leave customers dissatisfied.


Still, dealmakers are behaving differently these days. Buyers are generally offering smaller premiums. And many potential acquirers are barely bidding at all: Top executives at companies including IBM (IBM ), Citigroup, and American Express have largely sworn off or passed on megadeals. Instead they're using M&A to focus on their core businesses, buying relatively small companies while divesting poorly fitting units. With all the changes, says Jack Levy, co-chair of M&A at Goldman, Sachs & Co. (GS ): "I've got to believe there will be a higher success rate."

It's too early in this M&A cycle to make that call with certainty -- plenty of overpriced, poorly thought out deals could still pile on. But at least some of today's caution is likely to stick. Reforms imposed by Congress and regulators have made corporate boards more mindful of their responsibilities, including the reviewing of deals. That has directors stepping up to challenge CEOs to prove that deals will pay off. "Boards are being much more careful," says Mark L. Sirower, leader of the M&A strategy practice at PricewaterhouseCoopers.

So far, investors like what they're seeing. SBC shares held their own as news leaked that it was looking to buy AT&T. MetLife stock slipped just a half of one percent when it said it was buying Travelers. And when Johnson & Johnson (JNJ ) said on Dec. 16 that it was paying $25 billion for medical- device maker Guidant Corp. (GDT ), its stock rose 4%.

The big reason investors aren't hammering buyers' stocks: Most acquirers have become cautious about not overpaying. Gone are the the 30% to 40% premiums regularly paid in the past, much less the 50%-plus premiums that were common in 1999 and 2000. SBC offered AT&T virtually no premium over its market price, while Exelon paid just a 16% premium for Public Service Enterprise Group (PEG ). Exelon's stock rose about 5% on the deal, a sign that investors figure it isn't paying the sellers so much that it's giving away all of the $400 million in annual cost savings it expects by combining the companies.

This new sense of moderation extends beyond the price of deals. Some companies are staying away from the deal market altogether if they don't see a perfect fit. So far, Verizon Communications (VZ ) has held back as SBC snatches AT&T and Qwest pursues MCI. Some now follow the practice of private buyout firms that quietly interview a target company's customers, suppliers, and lenders before agreeing to a price, says David Harding, a director at Bain & Co. and co-author of the book Mastering the Merger.

Dealmakers' caution isn't all internally driven. New accounting rules for acquisitions and director-independence provisions in the Sarbanes-Oxley Act of 2002 are prompting boards to question deals early. More directors are asking for detailed appraisals of individual assets that would be bought, says Paul Barnes, a managing director at Standard & Poor's Corporate Value Consulting.

Another plus is that executives are often more intent on sticking with existing business strategies instead of chasing new markets. J&J's purchase of Guidant, for instance, is part of a consistent strategy to build up its line of cardiac devices. And IBM hasn't bought a company to make a big, bold entry into a new market since its 1995 purchase of Lotus Development Corp. Yet it has acquired 40 other companies since then in smaller deals to fill product gaps and consolidate weak rivals.

Other companies are adjusting their M&A tactics. General Electric Co. (GE ) is cutting back on how many small deals it does. One reason: The costs and time required to integrate are high regardless of a deal's size. "Integration doesn't come naturally," argues Pamela Daley, GE's vice-president for corporate business development. Others are changing more dramatically. Citigroup's strategy of building a financial supermarket through M&A was turned on its head when it announced on Jan. 31 that it will sell its Travelers insurance business to MetLife. Says Citigroup's new CEO, Charles Prince: "The days of doing big consolidating transactions that completely transform the company are behind us."

Buyers are also giving careful new attention to the critical issue of integration. A decade ago integration often meant slashing and burning, but these days managers are going to great lengths to keep the acquired company's customers happy. Bank of America Corp. (BAC ) lost droves of customers in its 1997 buy of Barnett Banks Inc. (BAC ) when it quickly closed branches and rushed to combine computer systems. Now, BofA is taking an extra year to integrate the $47 billion purchase of FleetBoston Financial Corp. it closed in 2004. The payoff: BofA added 184,000 new checking accounts at Fleet in the first eight months after the merger.

Similarly, Cingular Wireless transformed 1,000 AT&T Wireless stores across the country to Cingular stores overnight late last year and gave AT&T customers instant access to Cingular's gear and networks. That helped Cingular quickly reduce AT&T Wireless' notoriously high churn rate.

As the latest round of mergers gains steam, many of these lessons may yet be forgotten by cocky corporate buyers. But for now these wheelers and dealers don't look as reckless as those of the past.

By David Henry in New York, with Dean Foust in Atlanta, Emily Thornton in New York, and bureau reports

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