HORRIBLE MERGER

Nicholas von Hoffman on

the takeover fever that has struck America

New York AMERICA'S third largest airline was sold the other day but it was a one-day story outside the business pages. Eastern, a troubled giant two and a half billion dollars in debt, lost its long, independent existence for a quick $600 million and few gave the event much heed. It was the merger of the month but the months come and go quick- ly. In the last couple of years it's estimated that the value of 6,000 or so more impor- tant mergers and acquisitions comes to over a half a trillion dollars.

The skyline of the American economy has been transformed by these deals. Old names and trusted entities have dis- appeared in ever larger corporate con- glomerates with no public outcry or clear understanding of what may be at stake for the society in this wholesale agglomerating.

The Eastern merger was somewhat atypical in that the airline was bought by another airline whose management has a solid track record in the air transport business. There is reason to hope that some good in terms of operating efficiency may come of the Eastern transaction, which is more than can be said of many of `It's the bouncer.' the largest mergers of the past few years.

Although billions are riding on these mergers the executives of the acquiring company often have no idea how to run their acquisitions. Last spring General Motors, a mass-production assembly line organisation, paid five billion dollars for Hughes Tool, a high-tech electronics con- cern whose output is short production runs of complex, handmade hardware for the military. The organisational cultures of the two companies are profoundly different. GM goes in for time clocks and social control in grey Midwestern cities where their engineers and accounting people toil elbow to elbow at gunmetal-coloured 1950s desks. Hughes Tool is based in the heart of California's brie and chablis country, in places like Santa Barbara and Malibu, where ties are seldom worn and people drive smaller, high-performance, non-GM products to work.

When the deal was closed, GM execu- tives filled the air with blah-blah about how Hughes would one day help GM build cars with automatic laser-guided steering sys- tems. In the event, when GM executives came out to California for their first meetings with their Hughes Tool opposites they acted the parts of intimidated oafs. Some of them, unable to understand what the Hughes people were saying, fell asleep in the staff meetings, others tried to im- press Hughes hi-techies by referring to cars as electro-mechanical systems and dash- boards as the driver-data interfaces.

In 1984 GM spent $2.5 billion to buy Electronic Data Systems (EDS), a compu- ter processing company. It too was going to bring this old-time blue-collar manufactur- ing giant into the next century ahead of its competitors by installing automated com- puter controlled systems for everything from warehousing to manufacture. Actual- ly attaining these efficiencies has proved to be significantly harder than writing press releases about them.

Thus far, at least, GM's acquisitions have been expensive but not calamitous, which is more than you can say for Mobil Oil's purchase of Marcor, the proprietors of Montgomery Ward, once but no longer the nation's number two general merchan- dice retail chain. Mobil paid $1.8 billion for Marcor, pumped another $600 million into it and now, after ten years of disastrous ownership, it has taken a half-billion-dollar write-down on the operation and is hoping to sell the smoking hulk. Only a company as big as Mobil could take losses like these without having to cut the dividend, but the social and economic waste is there regard- less.

Exxon, which has as dismal a history as Mobil when it tries to make money outside the oil business, plunked down a billion dollars to buy Reliance Electric a few years ago because it was under the mis- apprehension that Reliance had a revolu- tionary, small, energy-saving motor. It did, but as everybody in the electric industry knew, they cost so much to build you couldn't sell them.

Sometimes executives do buy another company because they see how the merged operation can do more and be more successful than either firm could be separ- ately, but they are more likely than not to be smaller, carefully thought out corporate marriages. The big ones, however, are often the product of fad, fashion and megalomania.

A few years ago, for instance, the fad idea in the oil industry was to put your excess cash in mining companies. Standard Oil of Ohio rushed out to pay over $2 billion for Kennecott Copper. Their timing was impeccable — no sooner had Standard Oil taken title than the price of copper went through the floor into the basement where it rests to this day. Next, people went out and paid fancy prices for oil companies because it cost less to buy other people's oil than drill for it yourself. That was true until the price of oil fell into the same basement that copper had already visited.

There was a period when the executives acquiring companies explained their purch- ases by the doctrine of 'synergy'. This was a quasi-religious concept which held that, by a process unknown to either chemistry or economics, putting two business organisations together releases certain metaphysical forces so that the single combined company is larger and more profitable than the two smaller ones mak- ing it up. Thanks to the track record of the resultant ill-managed, higgledy-piggledy organisations, synergism now occupies the same place in business that élan vital holds in biology. Only twice-born Christians and the more bloodthirsty Shi'ite Muslims be- lieve in it any more.

Napoleonic delusions account for some acquisitions. It was inflation and the impe- rial daydreams of Harold Geneen, its chairman, which turned ITT into an enor- mous, sprawling, nonsensical organisation, a managerial nightmare, none of whose hundreds of parts seemed to have any reasonable connection with each other. The books looked good as long as inflation made any purchase of hard property look good, but since the Emperor's retirement and the dropping of the inflation rate ITT has been a troubled corporation of declin- ing profitability, trying to sell off money- losing subsidiaries as it attempts to figure exactly what business it's in.

Of late the popular rationale for going out and spending great gobs of money to acquire another firm is that it is cheaper to buy the company already selling a product with a broadly established national brand name than to take the risk of spending many millions trying to introduce a new brand on the vast continental American market. As a consequence there has been a recent gobbling up and concentration in the food, beverage and other industries which sell via advertising and brand recog- nition primarily in giant-sized supermar- kets. However, overall demand for these products is restricted to population growth so that the acquiring companies may find it very difficult to pay for these acquisitions.

The truth of the brand name theorem remains to be proven but what has been shown is that a heavy premium must be paid to buy up all the shares of a publicly traded company. If a company's stock is selling for $60 a share and you want to buy all of them, you can bank on having to pay $80 or $90 to attain 100 per cent own- ership. In recent sales the R. J. Reynolds Company, a cigarette company, paid almost $500 million or 3.2 times book value to get ownership of Nabisco Foods. Proc- tor and Gamble, the Cincinnati soap giant, paid a billion and a quarter dollars or more than two and a half times the book value for Richardson-Vicks, a maker of cold and sore throat remedies. Thus one class of people who consistently come out of mer- ger and acquisition deals with fat wallets and happy smiles are the shareholders of

`Kill 'im!'

the acquired company.

Shareholders of the acquiring company often do far less well. Having watched the long-term outcomes of this parade of ac- quisitions the stock market is leery of the profit prospects of the surviving company. There are exceptions, of course. Wall Street, smitten perhaps by General Motors' name and history, has continued to support the price of its stocks and, more generally, the great, wild and happy bull market in New York has, temporarily at least, made a lot of acquisition decisions look better than many a shrewd judge thinks they are.

People holding the bonds of either party to a merger have been taking a terrible beating. Except for a very few cash-rich companies these acquisitions are accom- plished by borrowing money, pots and pots of it, thereby creating terrible looking debt-equity ratios and degrading the quali- ty of previously sold bonds. The Wall Street firms which rate the quality of industrial bonds have been consistently downgrading bond issues by companies involved in mergers.

What worries the bond raters and other thoughtful people is how companies with this huge new debt are going to pay it back. The first answer to that question is cutting costs and increasing efficiency so that mergers typically bring with them wholesale firings, but even after that's done, debt service takes terrible bites out of the cash flow. The result can mean cutting back on research and product development so that the ultimate cost of the merger may be the surviving company S future. In other instances the margin re- maining after payment is made on the debts is so small that the minority of investment analysts who are able to resist the enthusiasms of the moment point out that, come the next recession, be it ever s0 mild, a number of these companies are going to have to default on their debt payments. We've already had several cele- brated cases of merger-happy companies who couldn't keep up the payments and were forced to declare bankruptcy. The hundreds of billions for these ac- quisitions have been lent by pension funds' insurance companies and mutual funds so that, if and when the day of default comes, many people who can't afford it may he injured. In the early Eighties some pension funds got into trouble and had to cut benefits somewhat, but there has been 0° experience of widespread failures among these fiduciary institutions and, needless to add, there are no stand-by plans to be Put into effect in case of such an emergency. A company need not have mortaged tr future to buy another firm to cripple itself with debt — some companies have in- capacitated themselves fending off buy- outs by unwanted suitors. When a manage- ment wants to resist an uninvited buy-00t' it resorts to 'restructuring assets', which

,,

means doing such things as borrowing huge amounts of money to give the stockholders a bonus and load the company up with so much debt that nobody could- possibly borrow yet more to buy it and hope to break even. That is what has happened to once mighty Union Carbide, which is now having to sell off its most profitable parts to pay for the money it borrowed to fight off an unwanted take-over. The company is now in such disarray some analysts are saying they don't think the corporation can survive.

The merger movement finds its impetus among investment bankers, lawyers, accountants and others inside the corpora- tion and out who stand to make millions on these deals but who seldom have anything to do with making whatever it is the company sells. They make such measures as return on capital or price-equity ratios their only standard for making business decisions. They don't care to know that a successful corporation is a complex human organisation.

After having spent so many billions and contracted a debt larger than that of all the third world, few of the companies involved in these transactions are more profitable or efficient. In fact most appear to be less so. What America may have lost in dynamism, production and entrepreneurial energy has yet to be figured.