-------- Chapter 7 --------

The Timing of Merger Activity

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 Common Characteristics of
Merger Movements
Periods of high economic growth
Favorable stock price levels and
financial conditions
Response to economic, technological,
and regulatory changes

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 The 1895-1904 Merger
Movement
(the first movement)
Mainly horizontal mergers
Major changes in economic infrastructure
and production technologies
Transcontinental railroad completion
resulting in national economic markets
Use of electricity and increased use of coal
and oil products
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 Motivating factors
Economies of scale
Merging for national markets
Professional promoters and underwriters

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 Success due to "astute business
leadership" (Livermore, 1935)
Rapid technological and managerial
improvements
Development of new products
Entry into new subdivisions of industry
Promotion of quality brand names
Commercial exploitation of research

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 Failure (Dewing, 1953)
Failure to modernize plant and equipment
Increase in overhead costs
Lack of flexibility due to large size
Inadequate supply of talent to manage large
groups of plants

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 End of first merger movement
In 1901, merger activity began downturn as
some combinations failed to realize gains
In 1903, economy went into recession
In 1904, Supreme Court ruled against
Northern Securities, establishing that
mergers can be attacked by Section One
of the Sherman Act

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 The 1922-1929 Merger
Movement
(the second movement)
Combinations in public utilities, banking,
food processing, chemicals, mining
Motivating factors
Product-extension IBM, General Foods,
Allied Chemical
Market-extension food retailing, movie
theaters, department stores
Vertical mergers metals, mining, oil
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 Facilitating developments
Transportation motor vehicles made both
buyers and sellers more mobile
Communications national radio advertising
facilitated product differentiation
Merchandising mass distribution with low profit
margins
Increased vertical integration due to advantages
from technological economies or from reliability of
input supply
End of second wave of merges with the onset
of a severe economic slowdown in 1929
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 Conglomerate Merger
Movement of the 1960s
(the third movement)
Decline in relative importance of
horizontal and vertical mergers
Changes in the law
Clayton Act of 1914, Section 7, had prohibited
mergers only for stock transactions
Celler-Kefauver Act of 1950 closed asset-
purchase loophole

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 In 1967-68 when the merger activity
peaked
Horizontal and vertical mergers declined to
17%
Product extension mergers increased to 60%
Market extension mergers were negligible
Pure conglomerates increased steadily to
about 23% of all mergers (or 35% in terms of
assets acquired)

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 Acquiring firm characteristics small to
medium-sized, adopting diversification
strategy outside traditional areas of
interest
Acquired firm characteristics small to
medium-sized, operating in fragmented
industries, or on periphery of major
industries

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 Defensive diversification to avoid:
Sales/profit instability
Unfavorable growth prospects
Adverse competitive shifts
Technological obsolescence
Increased uncertainties in acquirer's
industry

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 Examples:
Aerospace industry wide fluctuations in
market demand, large abrupt shifts in
product mix, excess capacity aggravated
by entry of firms from other industries
Industrial machinery and auto parts
sales instability
Railway equipment, textiles, tobacco,
movie distribution low growth prospects

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 Other motives
Some mergers reflected personality of chief
executive resulting in noncore acquisitions
Some conglomerates were formed to imitate
earlier conglomerates that appeared to have
achieved high growth and high valuations
Differential price/earnings (P/E) game
No sound conceptual basis source of sell-
offs in later years
Rise of management theory - "good
managers can manage anything"
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 End of conglomerate merger wave
Antitrust laws
Congress began to move against conglomerate
firms in 1968
Suits filed by the Department of Justice arguing
"mutual forebearance"
Punitive tax laws
Tax Reform Act of 1969 limited use of
convertible debt to finance acquisitions
EPS would have to be calculated on a fully
diluted basis as if debt had been converted
into common stock
Declining stock prices
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The Deal Decade, 1981-1989
(the fourth movement)
Motivating forces
Surge in the economy and stock market
beginning in mid-1982
Impact of international competition on
mature industries such as steel and auto
Unwinding diversified firms
New industries as a result of new
technologies and managerial innovations
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 Decade of big deals
Ten largest transactions
Exceeded $6 billion each
Summed to $126.1 billion
Top 10 deals reflected changes in the
industry
Five involved oil companies increased price
instability resulting from OPEC actions
Two involved drug mergers increased
pressure to reduce drug prices
Two involved tobacco companies diversified
into food industry
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 Financial innovations
High yield bonds provided financing for
aggressive acquisitions by raiders
Financial buyers
Arranged going private transactions
Bought segments of diversified firms
"Bustup acquisitions"
Buyers would seek firms whose parts as separate
entities were worth more than the whole
After acquisitions, segments would be divested
Proceeds of sales were used to reduce the debt
incurred to finance the transaction
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 Rise of wide range of defensive measures
as a result of increased hostile takeovers
End of fourth merger wave
Government actions
Highly publicized insider trading cases
Passage of the Financial Institution Reform,
Recovery, and Enforcement Act (FIRREA) in1989
Indictment of Michael Milken and bankruptcy of
Drexel Burnham
Development of powerful takeover defenses
Economic recession associated with Gulf War

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Strategic Mergers, 1992-2000

Economic trends
Economic recovery after Gulf War
Continued rise in stock prices to new highs
Recovery of junk bond market as other
investment banking firms moved in

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 Major driving forces
Technology
Impact of computer and software applications
Impact of microwave systems and fiber optics on
telecommunications industry
Impact of the Internet creation of new
industries and firms, changes in the nature and
forms of competitive relationships
Globalization
Technological developments in transportation
and communications
Europe and other regions moving toward
common markets
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 Deregulation
Major deregulations in financial services,
telecommunications, energy, airlines, trucking, etc.
Massive reorganization of industries
Economic Environment
Rising stock prices
Rising P/E ratios
Low interest rate levels
Method of payment
Predominant use of stock-for-stock transactions
Less reliance on highly leveraged transactions

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 Share repurchases
Used as a signal by successful firms with superior
revenue growth and favorable cost structures
Credible signal of future success, increased
returns to shareholders
Stock options
Important component of compensation to attract
innovative, experienced executives
Extended to employees throughout the
organization

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 Megamergers of the nineties
Top ten transactions of all times occurred in
1998 and 1999
Top ten deals of the nineties totaled about
$700 billion
Size of M&As in relation to level of
economic activity
For period 1993-1999, M&As represented about
12% of GDP
In 1999, M&As represented 15% of GDP
In the eighties, M&As represented less than 4%
of GDP
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 Timing of Merger Activity

Empirical evidence does not support

merger waves
Generalizations on major merger
movements
Each major merger movement reflected
some underlying economic and/or
technological changes

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 Some common financial factors associated
with high levels of merger activity
Rising stock prices
Low interest rates
Favorable term structures of interest rates
Narrow risk premia

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 International Perspectives
M&A activity in other developed countries
of the world has been even higher than in
the U.S.
Underlying factors
Internationalization of markets
Globalization of competition
Antimerger laws and regulations such as in the
UK and in EEC tightened in the 1980s, but M&A
activity increased due to economic, technological,
and regulatory changes
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