Let's Make a Deal
By John Greenwald.
"I suppose you read in the paper today that General Electric just bought RCA. But it's O.K., nothing's going to change, because I just bought GE"
--Johnny Carson
A good enough opener, John, but the punch line must hurt a bit: not even your salary is big enough to play in this game.
Mergers have become such a happening in America that they are trendy grist for late-night comedy--never mind that a lot of folks do not find them very funny. But the public has every reason to wonder just what is going on, as dozens of the country's biggest businesses woo, wrangle and battle for one another in the strongest outbreak of the urge to merge in U.S. history. Is the current rash of mergers good for American business? For stockholders? For the country? And just how far can it go before it goes too far?
In New York City last week, the trend reached another milestone when General Electric bought RCA for more than $6 billion in what is the biggest acquisition ever of a nonoil firm. Just blocks away, W.R. Grace, the chemical producer and retail-store giant, said it would buy back almost $600 million of its stock in a move to fend off a possible takeover. In Houston, Texaco found itself fighting for its life after a judge affirmed that the third-largest U.S. oil producer would have to pay more than $11 billion in damages for derailing a 1984 merger between Pennzoil and Getty. And in New Jersey, GAF, a middle-size maker of chemicals and building materials, launched a $4 billion takeover bid for Union Carbide, saying that it would break up the much larger company and sell nearly half of its operations.
Those moves were the latest in the spectacular spate of mergers, acquisitions and takeover wars that have transformed the U.S. economy in recent months and become matters of grave concern in American boardrooms, courtrooms and legislatures. In 1985 companies were acquired, wholly or in part, at the frantic rate of eleven a day. When the dollar value of those deals is finally totted up, it is certain to surpass the record $125 billion reached in 1984. Says Democratic Representative Timothy Wirth, who chairs a House subcommittee that has been studying acquisitions: "These mergers and takeovers are having as profound an impact on the American economy as the advent of the great railroads, the airplane and the telephone."
The acquisitions are reshaping virtually every corner of the corporate landscape. While megadeals were once limited mainly to oil and other natural- resources giants, they are now affecting companies ranging from moviemakers to missile manufacturers. Says Felix Rohatyn, a senior partner in the investment banking house Lazard Freres and a principal architect of the GE and RCA merger: "In my 35 years of business, I have never seen anything remotely approaching this year's tidal wave of takeovers, mergers and buyouts of every size and shape, including both very good and sound ones and extremely ill- conceived ones."
The most troubling effect of the consolidations has been the creation of a huge and worrisome mountain of debt. In the past two years nearly $200 billion in stock has vanished from corporate treasuries and been replaced with IOUs that must be paid. By the end of the third quarter, American firms had built up $1.4 trillion in debt. In the same period corporate debt has increased more than 10% annually. These big borrowings, moreover, are part of a trend that has seen almost every sector of the U.S. economy become a rapidly growing debtor. From the $200 billion federal budget deficit to the $530 billion in outstanding consumer credit, America has become a buy-now, pay-later nation.
The corporate blue bloods that have been bought or agreed to be acquired in 1985 include many of the biggest names in U.S. business. In the food industry, Nabisco was consumed by R.J. Reynolds, General Foods fell prey to Philip Morris, and Beatrice is going private in a leveraged buyout, a defensive tactic against a takeover that allows executives to use borrowed money to acquire a firm. R.H. Macy, one of the most celebrated U.S. retailers, is putting together a similar plan. In entertainment, the American Broadcasting Co., whose treasures include Dynasty, is now the crown jewel of the Capital Cities Communications empire. In transportation, Corporate Raider Carl Icahn is flying off with TWA.
The corporate merger craze has taken some strange turns. Thwarted in a headline-making, five-month bid to take over CBS for $5.4 billion, Cable King Ted Turner consoled himself by buying a Hollywood studio instead. He paid $1.5 billion for MGM/UA Entertainment, whose library of 2,200 films includes such classics as Gone With the Wind and Singin' in the Rain.
CBS's plight, post-Turner, shows how escaping a raider can still leave a company seriously wounded. To evade Turner, CBS spent some $1 billion to buy back 20% of its shares. Now the company is selling profitable TV affiliates and its toy division to repay its debt. To further cut costs, CBS fired 74 news-division employees in a single "Thursday massacre" and offered early retirement to 2,000 people.
The acquisition binge, however, overjoys Wall Street, where it has helped drive stock prices to record highs. In recent weeks the Dow Jones industrial average has scaled one peak after another. Last week was the busiest in the history of the New York Stock Exchange, as the Dow jumped 58.03 points, to close at 1535.21. "The windfall profits from merger offers have sent a fever through the market," said Byron Wien, a Morgan Stanley analyst. In a recent study, the Goldman Sachs investment banking firm estimated that corporate takeovers have been responsible for nearly three-quarters of all stock gains since January 1984. Acquisitions have raised the value of target companies' shares an average of 30%. In one mighty leap, stock of Houston Natural Gas jumped from $46.865 to $67.125 in two days last May after an announcement that InterNorth was acquiring the pipeline company.
Mergers are rewriting the very language of American business. In the heat of a takeover battle, a "white knight" may be summoned to buy a company and rescue it from a corporate raider. Or the target may swallow a "poison pill" by taking on a huge load of debt or some other obligation that makes it less attractive. Nearly every company has by now spread "shark repellent" to ward off would-be attackers. Such protection may take the form of requiring a 75% vote of shareholders to approve a merger or of buying back a company's stock to boost its price. Even mighty Exxon, the world's largest industrial company, with annual sales of more than $90 billion, has bought more than $4 billion of its own stock since 1983 in order to ward off sharks. If all else fails, a desperate firm may resort to a "lockup" agreement, which calls for the company to sell some of its most valuable assets to a white knight for an enticingly low price.
The consolidation binge is far more than simply a business phenomenon. The mergers and takeovers are reaching deep into the daily lives of individuals, families and communities. Acquisitions often mean layoffs and shifting of corporate headquarters. Employees who keep their jobs can find themselves working for new bosses and performing unfamiliar duties. There is almost always a clash of corporate cultures when two firms get together, before they / learn each other's ways. Just the transfer of executives from one town to another can have a hurtful impact. Says Donald Henry, a Connecticut lawyer who watched last January when Canada's Belzberg family acquired Scovill Inc. and later sold its Waterbury offices: "The senior people who staff a headquarters are also leaders in their community, which suffers a severe shock when they depart." Change is an integral part of business life, but much of recent merger action seems to be just disruptive motion rather than movement toward better-run companies.
The billion-dollar megadeal is no longer just an American phenomenon. In recent months it has spread abroad, where it was once virtually unknown. In Britain, Argyll, a fast-growing food and supermarket company, launched a $2.8 billion takeover bid this month for Distillers, the Scottish liquor giant whose products include Johnnie Walker whisky and Gordon's gin. On the same day, Imperial Group, another British firm, agreed to acquire United Biscuits for $1.9 billion in a merger that will create a consumer-products concern with annual sales of about $10 billion. In Japan, U.S.-based Trafalgar Holdings and a British partner have launched a $1.4 billion takeover bid for Minebea, a manufacturing conglomerate, in an effort to become the first outsiders to acquire a Japanese firm.
Gargantuan combinations are basically creations of the 1980s. Though it seems hard to believe amid today's merger-a-minute mania, only twelve transactions valued at more than $1 billion took place between American firms from 1969 to 1980. In 1985, by contrast, the pace has been torrid: companies have agreed to more than 30 deals worth at least $1 billion, according to Martin Sikora, editor of Mergers & Acquisitions, a quarterly publication that tracks consolidations. He adds, "There were more deals than ever in the $5 billion category."
The growth of large mergers coincides with the term of the Reagan Administration, which has been much more favorable than its predecessors to corporate couplings. There is a general impression in both business and Government circles that any merger today will win Washington's approval. Democratic Senator Howard Metzenbaum of Ohio says, "The climate created by the Administration encourages companies to expand through merger rather than through their own growth." A Washington wag has dubbed this the "let them eat each other" policy.
The big-buck merger era was heralded by T. Boone Pickens, chairman of Mesa Petroleum, a small energy producer in Amarillo, Texas. Pickens was one of the first to realize that the low stock prices of oil and gas firms made many of them remarkable bargains. He saw that the companies could be worth far more if they were broken up and their assets sold separately. In a dazzling series of raids that earned Mesa nearly $1 billion in windfall profits, Pickens drove up the stock of one oil company after another by threatening to buy them and dismantle their properties. He then profited greatly when his target fled to a white knight for safety and his shares were bought back at a higher price. In his biggest winning, Pickens and friends collected $760 million last year when Gulf, whose stock had been trading for about $41 a share when Pickens launched a bid for it, finally sold out to Chevron for $80 a share, or $13.3 billion, history's largest merger.
The Gulf episode proved to speculators that virtually any company, no matter the size, was vulnerable to a takeover. All a raider needed to get rich in a hurry was a gambler's nerves and access to enough borrowed cash to make an offer. Put another way, America's corporate elite suddenly found that there was no longer safety in big numbers.
The ease with which companies are being bought and sold has been fueled in part by the rising power of some once obscure players of high finance. Among the most prominent are arbitragers, or speculators who snap up stock when an acquisition is announced, in the hope that the deal will go through. Their willingness to take big risks can give arbitragers like Ivan Boesky, who heads his own company, enormous influence over the fate of a company. Says Andrew Sigler, chairman of Champion International: "Within hours or days a major portion of your stock can be in arbitragers' hands, and your company is in play." In other words, it is up for grabs.
A determined arbitrager who has acquired 25% or more of a firm's stock usually sides with a raider during a takeover battle. Arbitragers, of course, can lose millions when a deal falls through and leaves them stuck with stock that plunges in value. That happened to Boesky and others last December in a Pickens-led battle for Phillips Petroleum. The Pickens raid drove the Oklahoma firm's stock from $37 to $56 and attracted a covey of investors in search of a quick killing. But Pickens abruptly withdrew his offer, causing the speculators to sustain huge losses. Chief among them was Boesky, whose company lost, by some estimates, more than $40 million.
Firms like Drexel Burnham Lambert, which specialize in helping takeover artists float junk bonds, are another powerful new Wall Street force. Junk bonds are corporate IOUs issued by companies without established credit records, and are therefore considered risky. In the past two years some $27 billion in junk bonds have been issued. Both raiders and corporate executives who wish to take their companies private use them to raise the needed money. "Junk bonds completely changed the nature of the game," says Michael Dingman, president of Allied-Signal, a high-tech giant formed last summer in the friendly merger of the two manufacturing concerns.
Michel Bergerac, the ousted chairman of Revlon, would surely agree. Revlon spent nearly five months trying to elude Pantry Pride, a Florida supermarket chain that is about one-third Revlon's size, but the cosmetics king was finally acquired for $2.7 billion in November. Though Bergerac's pain at seeing his company bought was eased by a $36 million parting settlement, or golden parachute, he still talks like a bitter man. "The whole thing was crazy," he says. "Here we built a great American corporation. Then through this process the stock ended up in the hands of arbitragers, who forced the sale of the company. And junk-bond financing made it all possible."
Takeover artists, arbitragers, junk bonds and all the other elements of merger finance have created a mood of high uncertainty in corporations. Rather than planning new products or considering new markets, many executives are spending their time looking around at whom they might take over or who may try to take them over. In a less frenetic period, RCA might not have been so eager to find a merger partner. The motto of these executives could be borrowed from the legendary baseball pitcher Satchel Paige: "Don't look back. Something might be gaining on you."
The consolidation craze has created opportunities for sudden Croesus-style riches. For aiding Pantry Pride in its fight for Revlon, financial advisers and lawyers stand to gain more than $100 million. The winners include Drexel Burnham, which sold the junk bonds to finance the deal and is earning an estimated $60 million.
Institutional investors are also big gainers. Some 80% of trading on the stock market is done by institutions. Their major concern is to get the highest possible return on investments, and a quick corporate takeover is often the way. Institutions are often eager to sell out to arbitragers for large profits once a merger fight begins. To such investors, notes one veteran Wall Street watcher, "a corporation is no longer a company, it's just a deal."
The mammoth gains that megamergers create have aroused suspicions that some players may be getting advance word of pending deals and profiting from inside information. For example, ABC stock jumped from $66 a share to $105 earlier this year in the month before the announcement of its acquisition by Capital Cities. General Foods rose from $70 a share to $120 before it was bought by Philip Morris. Last Wednesday the price of RCA stock jumped $10.375, to $63.50, hours before the merger was announced.
But while such run-ups are easy to spot, the source of possible leaks is devilishly hard to trace. Any of the dozens of lawyers, bankers and investment advisers who work on deals can pass information along to colleagues, friends and relatives. A secretary who types a prospectus or contract can do the same. It may thus be virtually impossible to keep news from seeping out once a raider begins lining up financing for a deal, or two firms start talking merger.
Nonetheless, regulators still seek to gain greater control over confidential information. Gary Lynch, enforcement director of the Securities and Exchange Commission, worries about what he calls "an unsettling proliferation of rumor activity in the marketplace." Says Lynch: "We have opened an unusually large number of investigations recently." Last week the SEC and two exchanges were studying the sudden jump in RCA stock before the merger announcement.
Insider trading is about the only aspect of the merger marathon that bothers the Reagan Justice Department. Just a decade ago, a proposed joining of two leviathans like GE and RCA would have drawn an immediate challenge. But under the benign gaze of the Reagan White House, bigger most often means better. Charles Rule, Deputy Assistant Attorney General in the antitrust division, notes that recent years have brought "a sea change in public opinion regarding the costs and benefits of regulation," including antitrust laws. Says Rule: "After years of experience with the Great Society, we discovered that more Government doesn't make society all that great. Indeed, it often makes it worse."
Congress talks about curbing some of the merger activity, but it has not taken any action. While some 50 bills to regulate acquisitions were introduced in 1985, none has made it out of committee. Complains Wirth, who tried and failed a year ago to restrict some takeover practices: "The economic ideologues at the White House are dominating what debate there is within the Administration, and they believe the market can do no wrong."
Nonetheless, some officials are taking measures to slow down or control the corporate wheeling and dealing. The Federal Reserve Board has been concerned about the financial impact of consolidations and is seeking to make it tougher to float junk bonds. Under a ruling likely to take effect in January, the Fed would limit the size of many junk-bond issues to 50% of the amount offered for a company. The move could cause a slowdown in takeovers and buyouts, at least until ingenious Wall Street moneymen devise new methods of raising funds.
The New York State legislature last week passed a bill that will also raise barriers to unwanted takeovers. Under it managers of New York-based companies could block hostile moves for up to five years. Said Governor Mario Cuomo, who has announced that he will sign the legislation: "This will definitely slow down some hostile takeovers. Our experience has been that while some takeovers are designed to create a more efficient organization, many others are just rip-offs."
Any attempts to curtail corporate consolidations will be opposed by many Wall Streeters and takeover specialists. They argue that such action will only safeguard the jobs of incompetent company executives. Says Pickens: "What the Fed and Cuomo are doing is wrong. It will just further entrench entrenched management. They will finally get all doors closed so that they can go about their business as usual."
Takeovers may be good for Pickens, but are they good for the U.S. economy? A long-running debate is going on about that in business and academic circles. The discussion is vehement on both sides and will probably never be finally resolved.
On the one hand are corporate raiders and many economists, who argue that takeovers and mergers help to make businesses more efficient. The threat of a takeover can be an effective way of dislodging inept managers. To Carl Icahn, the typical chief executive is merely "a nice guy, a good drinking buddy." Sir James Goldsmith, a feared acquisitor who gained control of the Crown Zellerbach paper company last summer, told Congress that he has freed firms from "the dead hand of the bureaucrat" who produced only "complacency, ossification and decline."
The threat of takeover has also forced managements to take steps to boost their stock prices, which benefits all their investors. Says Robert Greenhill, a managing director for the investment banker Morgan Stanley: "Corporate America has realized it had to get much more in tune with its shareholders."
Many corporate consolidations, of course, make good business sense. They are most likely to succeed when one company buys another for its complementary products or skills. Procter & Gamble, which acquired Richardson-Vicks for $1.24 billion in October, wanted the company for its popular brands, including Oil of Olay and NyQuil. Recalled an insider: "It was less expensive for P&G to buy into a line of new products than to develop them on its own." The experience and marketing skills of the two firms should go well together.
Another promising megadeal was the decision last June by General Motors to buy Hughes Aircraft, a leading producer of high-technology equipment, for $5.2 billion. The agreement followed GM's 1984 acquisition of Electronic Data Systems, a premier data-processing firm. The world's largest automaker hopes to use the skills of its two new units to move into special areas of technology, especially with the Saturn project, which aims to build a small car that can compete with Japanese models. EDS is designing computer software that will link all aspects of Saturn operations from the showroom to the shop floor, while Hughes will develop electronic systems for GM cars.
Critics of mergers and takeovers, on the other hand, charge that hostile consolidations disrupt management and force companies to think mainly of short-term profits rather than of how to become more effective competitors in U.S. and foreign markets. Even the short-term run-up in stock value that frequently occurs in merger situations may not be to the long-term benefit of a company, since it may overstate the firm's actual worth. Martin Lipton, a Wall Street lawyer who specializes in helping companies defend themselves against raids, denounces them "as financial transactions for the profit of the takeover entrepreneurs." He adds sharply, "They do not create jobs. They do not add to the national wealth. They merely rearrange ownership interests and shift risk from shareholders to creditors." Concurs Peter Jones, retired senior vice president of Levi Strauss and now an instructor at the University of California, Berkeley: "While we in America devote a major part of our material and human resources to promoting and fighting mergers and hostile takeovers, we are becoming less and less competitive with Japan and all the new Japans."
The growth of debt to finance mergers, takeovers and other moves is perhaps the most dangerous side of the recent rush to consolidate. Federal Reserve Chairman Paul Volcker has warned that the borrowing is not "compatible over time with economic and financial stability." Warren Buffett, an investor with large holdings in Capital Cities and other firms, is blunt: "One day junk bonds will live up to their name." Many economists and businessmen believe that the U.S. cannot have a strong economy if it is based on companies burdened by too much debt.
The record of past big mergers is not very encouraging. In a study of acquisitions made between 1974 and 1982, Swarthmore Economist Frederick Scherer found that 40% failed to last. Some major deals made over the years turned into king-size turkeys. Gulf & Western, once among the largest and most acquisitive conglomerates, has sold in the past three years some $3.5 billion worth of properties acquired during the 1960s and '70s. These range from a cigar company to a former site of Madison Square Garden in New York City. Says Chairman Martin Davis: "I just don't think you can manage all these businesses well." The ITT conglomerate that Harold Geneen put together in the 1960s is also being dismantled.
Even if mergers are by and large beneficial to the U.S. economy, however, the current merger frenzy seems to have gone too far. Takeover strategy is taking up vast amounts of management's energy and attention. Instead of running their businesses, some executives are spending their time worrying about financial plays. Says Berkeley's Jones: "As considerable as is the drain of money and other resources into mergers and acquisitions, I regard the drain on management time and talent as perhaps even more important."
Ultimately, of course, each merger or takeover or leveraged buyout must be judged on its own merits. There are good mergers, and there are bad ones. The true danger of the current rash of mergers is that it will distract corporations from the real business of business. American firms, facing ever tougher competition both at home and abroad, need to look beyond the short- term search for a merger partner or takeover target and get back to making products and services for tomorrow's customers.
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With reporting by Frederick Ungeheuer/New York