Bad Reasons to Merge (Listen Up, Verizon)
So another giant telecoms company has announced that it's merging with AOL. Time to pop out that Red Hot Chili Peppers CD and party like it's 2000.
Will this merger work out better than the last one? Or is this yet another opportunity for AOL to trade overvalued stock in a declining business for more valuable stock in a business with more legs?
To answer that question, it might be helpful to go back to the original merger, and think about why companies should merge.
I'm not asking why companies do merge. Companies merge for all sorts of reasons, many of them bad -- say, because the CEO thinks he would cut a more impressive figure if he were running a larger company. But why should companies merge?
If you answered "to get your hands on a valuable asset, like a cable network or an ad technology," then I'm sorry, but you will not be advancing to the final round. Don't feel bad. You're not alone. Many people, including CEOs, think this is a good reason to merge. The folks at Time Warner thought that this was a good reason to merge. However, back in 2000, when the AOL/Time Warner merger was still a gleam in Gerald Levin's eye, my technology strategy professor Austan Goolsbee explained why this was not so .
It's easy to see why a potential buyer would think: "I hate to keep paying this person exorbitant fees for their services. I'd rather own it myself." But look at it from the seller's perspective. What is he going to charge you to buy this valuable asset?
That's right: The net present value of the profits he'd get from all those future fees, less some discount because he gets all the money today, instead of having it doled out in dribs and drabs. You don't actually make money on this transaction; you just change the timing.
So it's not enough to say that Verizon is interested in getting AOL's content and video technology to put more content out over its pipes. That was approximately the justification for the the Time Warner deal, and look how well that turned out. Verizon could just partner with AOL to use its technologies and content. Why buy the administrators, IT staff and sales staff too?
There are some reasons that merging may be a good idea, and they can be boiled down to a few categories:
1. Economies of scale: If your businesses are fairly similar, you may be able to reduce overhead by merging. (Read: layoffs.) Or putting the two companies together may give you more pricing power. (Read: frowny face at the Bureau of Competition, the Federal Trade Commission's antitrust department.) You may be able to buy inputs more cheaply, or consolidate smaller operations into larger, more profitable ones.
2. There are barriers to a partnership. Maybe regulators hover over every contract, making the process costly and uncertain. Maybe there are lots of little decisions and alterations that constantly need to be made, making negotiations impractical. Or maybe one party has to invest in co-specialized assets -- think auto suppliers who have to buy a machine that is only good at making parts for a single type of car. Those sorts of arrangements are tricky, because once you've invested in the machine, it's easy for the automaker to come along and say: "I am altering the deal. Pray I don't alter it any further." Companies are understandably reluctant to enter into these kinds of relationships, so you may need to resolve the difficulty by bringing the supplier in-house.
3. You can manage their assets better than they can. This could mean that you're just better at management than the company you're buying. There are a lot of basically sound, but badly managed, companies out there. It could also mean that you have some sort of special sauce that is going to get a whole lot more value out of their assets than they can. Note, however, that many more acquiring firms believe this to be true, than find it actually is.
Which of these conditions does the AOL-Verizon proposal fulfill? The answer, as far as I can see, is none.
The calculus for any two companies must factor in the very large costs of a merger. All your systems, from IT to accounting, have to be tied together. Priorities, products and processes that may have served very good ends at the old firm create difficulties at the merged entity. The casualties of vicious turf wars litter the landscape, hurting morale and bleeding off some of your best staff. Culture clash is often considerable, because the folks at both companies have been somewhat selected for the fact that they like and approve of that company's internal culture and processes. You have only to read about Michael Arrington's frustrations with AOL's expense system to get the flavor of what I mean. All of this will divert the time and energy of your employees from building products and making profits to building a new organizational structure that everyone can live with.
In the case of AOL-Time Warner, the costs pretty clearly outweighed the benefits. The main benefit of an AOL-Verizon merger would be for AOL shareholders, who will get a nice price for stock in a firm with a cloudy future. But I'm not clear on how much Verizon is going to get out of this deal. Probably not as much as the company puts into it.
Goolsbee, as many of you will know, went on to become Council of Economic Advisers chairman under President Obama.
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