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I take this view because acquisitive companies, like besotted grooms, usually have a rather tenuous grasp of reality. They tend drastically to overestimate their own abilities, bring unduly-optimistic expectations into the marriage and make promises which are well beyond their means (and probably their attention spans). In so doing, they disrupt and discombobulate themselves as much their brides. (In this corporate context, the words of that perceptive observer of the human species, Oscar Wilde, take on a new meaning: “one should always be in love. But one should never marry.”)
Further, I suspect that corporate M&As are driven much more by executives’ unchecked egos – and by the desire of their bankers, lawyers and consultants to generate billable hours and hefty fees – than by any principled intention to create real wealth for shareholders. As a result, and because excellent companies are seldom available at sensible prices, acquisitive companies tend either to buy mediocre companies or to pay too much for their acquisitions (or both). Finally, even when a corporate merger or acquisition can be justified by a cold assessment of the facts at hand, it often transpires that marriages between corporations are not made in heaven. Indeed, more than a few have ended in acrimonious and expensive divorces which embitter and impoverish both parties.
Two premises therefore underlie my wariness about corporate “deals,” mergers and acquisitions. First, they are much more difficult – and hence riskier – undertakings than is typically recognised. Second, their costs and benefits are asymmetric: whatever benefits they generate tend to be captured by the sellers of the acquired company and the executives of the acquiring company; and their costs (which are always incurred and are sometimes substantial) are borne disproportionately by the owners of the acquiring company. This circular (and its companion dated 15 June) substantiates these premises and justifies this cautious conclusion.
Today’s M&A Frenzy
If M&As are inherently risky, then the extent of the risk which currently attaches to them is of much more than mere academic interest. This is because their number and size have accelerated at an astonishingly rapid rate during the past decade. According to Steven Rattner, deputy chairman of Lazard Frères, in 1992 the total market value of the mergers and acquisitions conducted around the world was $US58 billion, and by 1999 grew to no less than $US3.0 trillion (the Australian Broadcasting Corp.’s Lateline program, aired on 29 March, cited a figure of $US3.8 trillion). During the 1990s M&A activity thus grew at an compound rate of at least 75% per annum. This activity currently shows few signs of decelerating – if anything, and as attested by the recent spate of “mega-deals” in the Internet, telecommunications and media sectors, it continues to grow.
Although the explosion of M&A activity is a world-wide phenomenon, most of it has occurred in the U.S. Cisco Systems, one of the darlings of the U.S. sharemarket, is an archetype of this phenomenon. More than any other high-tech company, it has grown by acquiring other companies. According to the 8 May edition of Barron’s Online, Cisco acquired one company in 1993, three in 1994, four in 1995, seven in 1996, six in 1997, nine in 1998, 18 in 1999 and 10 so far this year, making a total of 58 acquisitions. Cisco has used its own stock to make acquisitions valued at more than $30 billion.
On 17 January Barron’s Online published a “Fever Chart” which placed the scale of American M&As into historical perspective. Apart from a spike at the turn of the century, between 1900 and 1980 the total value of M&As conducted in the U.S. during any given year was seldom more than 1-2% of that country’s GDP. During the 1980s this total value relative to the size of the economy rose steadily, reached approximately 7% of GDP by the end of the decade and then decreased to 2-3% during the early 90s. Since 1993, however, it has grown without interruption and with unprecedented and astounding velocity. As a result, in 1999 it stood at no less than 19% of U.S. GDP. Clearly, Cisco is not the only acquisitive American corporation.
M&As’ risks are compounded by the excessive and escalating prices of the corporate assets which are currently changing hands. Sky-high valuations which have no historical precedent both embolden acquisitive CEOs and compel them to pursue deals which will maintain their companies’ “momentum” – and thus their lofty trading multiples. Even more troubling, according to Rattner the average premium above-market price paid by the acquiring company for the company it is buying has risen steadily in recent years, and now stands at more than 40%. And sometimes this premium is much greater: in the America Online (AOL)-Time Warner (TWX) merger announced in January, for example, it was no less than 70%. Similarly, the high prices which Cisco pays for other companies “validates” the prices of its previous takeovers and its own sky-high price (currently no less than 190 times earnings). Cisco’s latest acquisition, announced on 5 May, is the “intelligent Web switching” company ArrowPoint Communications. According to Barron’s, “Cisco paid about 90 million of its... shares valued at about $5.7 billion for a company whose market cap a week earlier was $3.7 billion and which went public March 31... at about $1.0 billion.”
If mergers and acquisitions are innately risky propositions, if their current level is unprecedented and if inflated asset prices further exacerbate their risks, then the dangers which they pose to the shareholders of acquisitive companies have never been greater than they are today.
Characteristic #1: An Abundance of Effusive, Superlative and Vague Words
Most corporate mergers and acquisitions undertaken during the Nineties and Naughties have two characteristics. First, they typically release vast quantities of hyperbole about the extraordinary, unprecedented and absolutely revolutionary significance of the merger, how incredibly formidable the combined entity will be, how others must either react vigorously or be swept irretrievably aside, etc. They also disgorge huge volumes of oral and written fog whose effect is to distract attention from the fact that the logic and evidence required to substantiate the merged entity’s alleged invincibility (to say nothing of the appropriateness of the merger or acquisition in the first place) virtually never accompanies its announcement. The press release announcing the “mega-merger” of America Online and Time-Warner Communications provides an excellent example of this abuse of reason and the English language.
Superlative, ambiguous and unsubstantiated assertions seem to be uttered in approximately equal amounts by executives, journalists and commentators. As Alan Abelson wrote in Barron’s Online on 17 January with respect to AOL-TWX: “an unfortunate side effect of the proposed mammoth merger has been the cascade of instant commentary it touched off. We say unfortunate because we hate to see innocent trees killed to such a trivial end. For most of the observations proffered were vacuous, ludicrous, fatuous and self-serving.”
That this is hardly an exclusively American phenomenon was demonstrated by the takeover-merger announced on 20 March (and called off by one of the parties on 5 May) by two prominent Australian technology firms, Solution 6 (SOH) and Sausage Software (SAS). SOH and SAS are two of Australia’s most acquisitive companies. During the past 12 months, SAS has made at least 10 acquisitions and SOH has completed approximately 15 (I’m unsure about these figures because these “deals” have emerged in such rapid succession that it’s difficult to keep track of them). Also in the week of 20-24 March, for example, SOH announced its intention to acquire Telstra’s eConnect subsidiary, Telstra’s 30% stake in PlesTel, Telstra Financial Management Services and the extension of its $150m offer for the American software developer Elite Information Group). SAS’s chief executive, who would have joined the enlarged SOH’s Board, emphasised at its announcement that the takeover-merger will not sate the Board’s appetite: “we will be very acquisitive, we’ll be able to go out with a bigger market value and therefore better leverage to do global deals.” SOH’s chief executive concurred: “in a high-growth company you are always going to be challenged about your ability to manage... our job is to demonstrate that we can make acquisitions and get them on board. [and] if anything we are going to step up the pace.”
Business columnist Robert Gottliebson, writing in The Australian on 21 March, gushed without reservation: “the biggest growth business in the world is helping established companies adapt their operations to business-to-business electronic commerce. That’s what’s driving the merger between Solution 6 and Sausage Software. If it succeeds, the enlarged Solution 6 operation has the opportunity to become one Australia’s great drivers of wealth.” (Gottliebson did not speculate about what might happen if the merger had not succeed. Given his and others’ proclivity towards superlative language – as well as the evidence set out in the circular dated 15 June – one might at least entertain the possibility that if it had proceeded and subsequently turned sour, Solution 6 might have been remembered as one Australia’s great destroyers of wealth).
Similarly, SOH’s CEO described business-to-business transactions as the most highly valued in e-commerce. “This is the most highly valued category, and there’s not another company in the world that would have such a complete set of e-business consulting support, design support and implementation. The merged entity would be one of only about three companies in the world able to deliver these opportunities. We have got quite a demonstrable capability...” Similarly, SAS’s CEO stated that “this will start to ignite our local industry and give Australia a greater voice and more credibility globally.” Moreover, “this move allows us to leapfrog ahead of the market by 12 months. In the market today, you can’t be a small business trying to make its way by growing organically – you have to be aggressive, acquire core assets and grab leadership. We now have the horsepower to be able to do that.”
For reasons set out in the circular dated 15 June, this effusion of woolly words and absence of hard numbers makes me nervous. But in this instance, at least, the point is moot: on 5 May 2000 came the announcement that “the Board of Sausage Software Limited (Sausage) advises that as a result of recent events, including market volatility [which more than halved the price of SAS shares], it regards the current bid by Solution 6 as unacceptable. In the Board’s view it significantly undervalues the Company. On the current proposal the Board does not believe it could recommend the merger terms to its shareholders. Further, the Sausage Board has been advised by shareholders who together control more then 20% of the ordinary shares in the Company that they will not be accepting into the current offer from Solution 6.”
...continued in Part II
 
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