Ten Important Lessons From The History Of Mergers & Acquisitions
The history of mergers and acquisitions in the United States is comprised of a series of five distinct waves of activity. Each wave occurred at a special time, and each exhibited some unique characteristics related to the character of the activity, the sources of funding for the activity, and to some extent, differing levels of success from wave to wave. When the quantity, nature, mechanisms, and outcomes of these transactions are viewed in an objective historical context, important lessons emerge.
The first Wave
The primary substantial wave of merger and acquisition activity in the United States occurred between 1898 and 1904. The normal level of about 70 mergers per year leaped to 303 in 1898, and crested at 1,208 in 1899. It remained at greater than 300 every year until 1903, when it dropped to 142, and dropped back again into what had been a variety of normalcy for the period, with 79 mergers, in 1904. Industries comprising the bulk of activity during this first wave of acquisition and natural gas meter merger activity included primary metals, fabricated metal products, transportation equipment, machinery, petroleum products, bituminous coal, chemicals, and food products. By far, the greatest motivation for these actions was the expansion of the business into adjacent markets. In truth, 78% of the mergers and acquisitions occurring during this period resulted in horizontal expansion, and another 9.7% involved both horizontal and vertical integration.
During this era in American history, the business environment related to mergers and acquisitions was much less regulated and much more dynamic than it’s today. There was very little by means of antitrust impediments, with few laws and even less enforcement.
The Second Wave
The second wave of merger and acquisition activity in American businesses occurred between 1916 and 1929. Having become more concerned about the rampant growth of mergers and acquisitions during the first wave, the United States Congress was rather more wary about such activities by the time the second wave rolled around. Business monopolies resulting from the first wave produced some market abuses, and a set of business practices that were viewed as unfair by the American public. Even the Sherman Act proved to be relatively ineffective as a deterrent of monopolistic practices, and so Congress passed another piece of legislation entitled the Clayton Act to reinforce the Sherman Act in 1914. The Clayton Act was somewhat simpler, and proved to be particularly useful to the Federal Government within the late 1900s. However, during this second wave of activity within the years spanning 1926 to 1930, a complete of 4,600 mergers and acquisitions occurred. The industries with greatest concentrations of those activities included primary metals, petroleum products, chemicals, transportation equipment, and food products. The upshot of all of those consolidations was that 12,000 companies disappeared, and greater than $13 billion in assets were acquired (17.5% of the country’s total manufacturing assets).
The nature of the companies formed was somewhat different within the second wave; there was the next incidence of mergers and acquisitions to achieve vertical integration in the second wave, and a much higher percentage of the resulting businesses resulted in conglomerates that included previously unrelated businesses. The second wave of acquisition and merger activity in the United States ended in the stock market crash on October 29, 1929, and this altered – perhaps forever – the angle of investment bankers related to funding these transactions. Companies that grew to prominence through the second wave of mergers and acquisitions in the United States, and that still operate in this country today, include General Motors, IBM, John Deere (now Deere & Company), and Union Carbide.
The Third Wave
The American economy through the last half of the 1960s (1965 through 1970) was booming, and the growth of corporate mergers and acquisitions, especially related to conglomeration, was unprecedented. It was this economic boom that painted the backdrop for the third wave of mergers and acquisitions in American history. A peculiar feature of this period was the relatively common practice of companies targeting acquisitions that were larger than themselves. This period is sometimes referred to because the conglomerate merger period, owing in large measure to the truth that acquisitions of companies with over $100 million in assets spiked so dramatically. Compared to the years preceding the third wave, mergers and acquisitions of companies this size occurred far less frequently. Between 1948 and 1960, for example, they averaged 1.3 per year. Between 1967 and 1969, however, there were 75 of them – averaging 25 per year. Throughout the third wave, the FTC reports, 80% of the mergers that occurred were conglomerate transactions.
Although probably the most recognized conglomerate names from this period were huge corporations such as Litton Industries, ITT and LTV, many small and medium size companies attempted to pursue an avenue of diversification. The diversification involved here included not only product lines, but additionally the industries through which these companies chose to participate. Consequently, most of the companies involved in these activities moved substantially outside of what had been thought to be their core businesses, very often with deleterious results.
It can be crucial to grasp the difference between a diversified company, which is an organization with some subsidiaries in other industries, but a majority of its production or services within one industry category, and a conglomerate, which conducts its business in multiple industries, with none real adherence to a single primary industry base. Boeing, which primarily produces aircraft and missiles, has diversified by moving into areas equivalent to Exostar, an online exchange for Aerospace & Defense companies. However, ITT has conglomerated, with industry leadership positions in electronic components, defense electronics & services, fluid technology, and motion & flow control. While the bulk of companies merged or acquired within the long string of activity leading to the current Boeing Company were almost all aerospace & defense companies, the acquisitions of ITT were way more diverse. The truth is, just since becoming an independent company in 1995, ITT has acquired Goulds Pumps, Kaman Sciences, Stanford Telecom and C&K Components, among other companies.
For the reason that ascension of the third wave of mergers and acquisitions in the 1960s, there has been quite a lot of pressure from stockholders for company growth. With the one comparatively easy path to that growth being the path of conglomeration, loads of companies pursued it. That pursuit was funded differently on this third wave of activity, however. It was not financed by the investment bankers that had sponsored the 2 previous events. With the economy in expansion, interest rates were comparatively high and the factors for obtaining credit also became more demanding. This wave of merger and acquisition activity, then, was executed by the issuance of stock. Financing the activities through the usage of stock avoided tax liability in some cases, and the resulting acquisition pushed up earnings per share regardless that the acquiring company was paying a premium for the stock of the acquired firm, using its own stock as the currency.
Using this mechanism to spice up EPS, however, becomes unsustainable as larger and bigger companies are involved, because the underlying assumption in the application of this mechanism is that the P/E ratio of the (larger) acquiring company will transfer to the natural gas meter whole base of stock of the newly combined enterprise. Larger acquisitions represent larger percentages of the combined enterprise, and the market is usually less willing to present the brand new enterprise the benefit of that doubt. Eventually, when a large number of merger and acquisition activities occur which are founded on this mechanism, the pool of suitable acquisition candidates is depleted, and the activity declines. That decline is largely responsible for the tip of the third wave of merger and acquisition activity.
One other mechanism that was utilized in an analogous way, and with the same result, in the third wave or merger and acquisition activity was the difficulty of convertible debentures (debt securities which might be convertible into common stock), in order to collect within the earnings of the acquired firm without being required to reflect a rise in the number of shares of common stock outstanding. The resulting bump in visible EPS was known as the bootstrap effect. Over the course of my own career, I have often heard of similar tactics referred to as “creative accounting”.
Almost certainly, probably the most conclusive evidence that the majority of conglomeration activity achieved through mergers and acquisitions is harmful to overall company value is the fact that so a lot of them are later sold or divested. For instance, more than 60% of cross-industry acquisitions that occurred between 1970 and 1982 were sold or divested in some other manner by 1989. The widespread failure of most conglomerations has certainly been partly the results of overpaying for acquired companies, but the fact is that overpaying is the unfortunate practice of many companies. In a single recent interview I conducted with a particularly successful CEO within the healthcare industry, I asked him what actions he would most strongly recommend that others avoid when entering right into a merger or acquisition. His response was immediate and emphatic: “Do not become enamored with the acquisition target”, he replied. “Otherwise you will overpay. The acquisition has to make sense on several levels, including price.”
The failure of conglomeration, then, springs largely from another root cause. Based alone experience and the research I have conducted, I am reasonably certain that probably the most fundamental cause is the nature of conglomeration management. Implicit within the management of conglomerates is the notion that management will be done well within the absence of specialized industry knowledge, and that just is not usually the case. Whatever the “professional management” business curricula offered by many institutions of higher learning nowadays, normally there is just no substitute for industry-specific experience.
The Fourth Wave
The primary indications that a fourth wave of merger and acquisition activity was imminent appeared in 1981, with a near doubling of the worth of those transactions from the prior year. However, the surge receded a bit, and really regained serious momentum again in 1984. In accordance with Mergerstat Review (2001), just over $44 billion was paid in merger and acquisition transactions in 1980 (representing 1,889 transactions), compared to greater than $82 billion (representing 2,395 transactions) in 1981. While activity fell back to between $50 billion and $75 billion within the ensuing two years, the 1984 activity represented over $122 billion and a pair of,543 transactions. By way of peaks, the variety of transactions peaked in 1986 at 3,336 transactions, and the dollar volume peaked in 1988 at greater than $246 billion. The entire wave of activity, then, is regarded by analysts to have occurred between 1981 and 1990.
There are quite a few aspects of this fourth wave that distinguish it from prior activities. The first of those characteristics is the arrival of the hostile takeover. While hostile takeovers have been around because the early 1900s, they truly proliferated (more by way of dollars than by way of percent of transactions) during this fourth wave of merger and acquisition activity. In 1989, for instance, more than 3 times as many dollars were transacted because of contested tender offers than the dollars associated with uncontested offers. Some of this phenomenon was closely tied to another characteristic of the fourth wave of activity; the sheer size and industry prominence of acquisition targets during that period. Referring again to Mergerstat Review’s numbers published in 2001, the typical purchase price paid in merger and acquisition transactions in 1970, for example, was $9.8 million. By 1975, it had grown to $13.9 million, and by 1980 it was $49.8 million. At its peak in 1988, the average purchase price paid in mergers and acquisitions was $215.1 million. Exacerbating the situation was the quantity of large transactions. The number of transactions valued at more than $100 million increased by more than 23 times between 1974 and 1986, which was a stark contrast to the typically small-to-medium size company based activities of the 1960s.
Another factor that impacted this fourth wave of merger and acquisition activity within the United States was the arrival of deregulation. Industries reminiscent of banking and petroleum were directly affected, as was the airline industry. Between 1981 and 1989, five of the ten largest acquisitions involved a company within the petroleum industry – as an acquirer, an acquisition, or both. These included the 1984 acquisition of Gulf Oil by Chevron ($13.3 billion), the acquisition in that very same year of Getty Oil by Texaco ($10.1 billion), the acquisition of Standard Oil of Ohio by British Petroleum in 1987 ($7.8 billion), and the acquisition of Marathon Oil by US Steel in 1981 ($6.6 billion). Increased competition in the airline industry resulted in a severe deterioration within the financial performance of some carriers, because the airline industry became deregulated and air fares became exposed to competitive pricing.
An additional look at the ontology of the ten largest acquisitions between 1981 and 1989 reflects that relatively few of them were acquisitions that extended the acquiring company’s business into other industries than their core business. For example, among the many five oil-related acquisitions, only two of them (DuPont’s acquisition of Conoco and US Steel’s acquisition of Marathon Oil) were out-of-industry expansions. Even in these cases, one might argue that they’re “adjacent industry” expansions. Other acquisitions among the highest ten were Bristol Meyers’ $12.5 billion acquisition of Squibb (same industry – Pharmaceuticals), and Campeau’s $6.5 billion acquisition of Federated Stores (same industry – Retail).
The ultimate noteworthy aspect of the “top 10” list from our fourth wave of acquisitions is the characteristic that is exemplified by the actions of Kohlberg Kravis. Kohlberg Kravis performed two of those ten acquisitions (both the largest – RJR Nabisco for $5.1 billion, and Beatrice for $6.2 billion). Kohlberg Kravis was representative of what came to be known throughout the fourth wave as the “corporate raider”. Corporate raiders resembling Paul Bilzerian, who eventually acquired the Singer Corporation in 1988 after participating in numerous previous “raids”, made fortunes for themselves by attempting corporate takeovers. Oddly, the takeovers did not have to be ultimately successful for the raider to profit from it; they merely needed to drive up the price of shares they acquired as part of the takeover attempt. In lots of cases, the raiders were actually paid off (this was called “greenmail”) with corporate assets in exchange for the stock they’d acquired within the attempted takeover.
Another term that came into the lexicon of the business community during this fourth wave of acquisition and merger activity is the leveraged buy-out, or LBO. Kohlberg Kravis helped develop and popularize the LBO concept by creating a series of limited partnerships to acquire various corporations, which they deemed to be underperforming. In most cases, Kohlberg Kravis financed up to 10 percent of the acquisition price with its own capital and borrowed the remainder through bank loans and by issuing high-yield bonds. Usually, the target company’s management was allowed to retain an equity interest, in order to supply a financial incentive for them to approve of the takeover.
The bank loans and bonds used the tangible and intangible assets of the target company as collateral. Because the bondholders only received their interest and principal payments after the banks were repaid, these bonds were riskier than investment grade bonds in the event of default or bankruptcy. As a result, these instruments became generally known as “junk bonds.” Investment banks such as Drexel Burnham Lambert, led by Michael Milken, helped raise money for leveraged buyouts. Following the acquisition, Kohlberg Kravis would help restructure the corporate, sell off underperforming assets, and implement cost-cutting measures. After achieving these efficiencies, the corporate was usually then resold at a big profit.
Increasingly, as one reviews the waves of acquisition and merger activity which have occurred in the United States, this much seems clear: While it is feasible to profit from the creative use of financial instruments and from the clever buying and selling of companies managed as an investment portfolio, the real and sustainable growth in company value that is on the market through acquisitions and mergers comes from improving the newly formed enterprise’s overall operating efficiency. Sustainable growth results from leveraging enterprise-wide assets after the merger or acquisition has occurred. That improvement in asset efficiency and leverage is most frequently achieved when management has a fundamental commitment to the ultimate success of the business, and isn’t motivated purely by a fast, temporary escalation in stock price. This is expounded, in my opinion, to the sooner observation that some industry-specific knowledge improves the likelihood of success as a new business is acquired. People who find themselves committed to the long-term success of an organization are inclined to pay more attention to the small print of their business, and to broader scope of technologies and trends within their industry.
There have been a few other characteristics of the fourth wave of merger and acquisition activity that must be mentioned before moving on. Initially, the fourth wave saw the primary significant effort by investment bankers and management consultants of assorted types to offer advice to acquisition and natural gas meter merger candidates, with a view to earn professional fees. Within the case of the investment bankers, there was an additional opportunity around financing these transactions. This opportunity gave rise, in large measure, to the junk bond market that raised capital for acquisitions and raids. Secondly, the character of the acquisition – and particularly the character of takeovers – became more intricate and strategic in nature. Both the takeover mechanisms and paths and the defensive, anti-takeover methods and tools (eg: the “poison pill”) became increasingly sophisticated throughout the fourth wave.
The third characteristic on this category of “other unique characteristics” in the fourth wave was the increased reliance on the a part of acquiring companies on debt, and maybe even more importantly, on large amounts of debt, to finance the acquisition. A significant rise in management team acquisition of their own firms using comparatively large quantities of debt gave rise to a brand new term – the leveraged buy-out (or LBO) – within the lexicon of the Wall Street analyst.
The fourth characteristic was the appearance of the international acquisition. Certainly, the acquisition of Standard Oil by British Petroleum for $7.8 billion in 1987 marked a change within the American business landscape, signaling a widening of the merger and acquisition landscape to encompass foreign buyers and foreign acquisition targets. This deal is significant not only because it involved foreign ownership of what had been considered a bedrock American company, but in addition due to the sheer dollar volume involved. A number of factors were involved on this event, such because the fall of the US dollar against foreign currencies (making US investments more attractive), and the evolution of the global marketplace where goods and services had become increasingly multinational in scope.
The Fifth Wave
The fifth wave of acquisition and merger activity began immediately following the American economic recession of 1991 and 1992. The fifth wave is viewed by some observers as still ongoing, with the obvious interruption surrounding the tragic events September 11, 2001, and the recovery period immediately following those events. Others would say that it ended there, and after the couple of years ensuing, we are seeing the imminent rise of a sixth wave. Having no strong bias toward either view, for purposes of our discussion here I will adopt the primary position. Based on the worth of transactions announced over the course of the respective calendar years, the dollar volume of total mergers and acquisitions in the US in 1993 was $347.7 billion (an increase from $216.9 billion in 2002), continued to grow steadily to $734.6 billion in 1995, and expanded still further to $2,073.2 billion by 2000.
This group of deals differed from the previous waves in several respects, but arguably a very powerful difference was that the acquisitions and mergers of the 1990s were more thoughtfully orchestrated than in any previous foray. They were more strategic in nature, and better aligned with what appeared to be relatively sophisticated strategic planning on the a part of the acquiring company. This characteristic seems to have solidified as a primary feature of major merger and acquisition activity, a minimum of in the US, which is encouraging for shareholders searching for sustainable growth rather than a quick – but temporary – bump in share price.
A second characteristic of the fifth wave of acquisitions and mergers is that they were typically more equity-based than debt-based in terms of their funding. In many cases, this worked out well because it relied less on leverage that required near-term repayment, enabling the new enterprise to be more careful and deliberate concerning the sell-off of assets as a way to service debt created by the acquisition.
Even in cases where both of those features were prominent aspects of the deal, however, not all have been successful. Actually, a few of the biggest acquisitions have been the largest disappointments over recent years. For instance, just before the announcement of the acquisition of Time Warner by AOL, a share of AOL common stock traded for about $94. In January of 2005, that share of stock was worth about $17.50. Within the Spring of 2003, the typical share price was more like $11.50. The AOL Time Warner merger was financed with AOL stock, and when the expected synergies did not materialize, market capitalization and shareholder value both tanked. What was not foreseen was the devaluation of the AOL shares used to finance the purchase. As analyst Frank Pellegrini reported in Time’s on-line edition on April 25, 2002: “Sticking out of AOL Time Warner’s rather humdrum earnings report Wednesday was a really gaudy number: A one-time lack of $54 billion. It’s the most important spill of red ink, dollar for dollar, in U.S. corporate history and nearly two-thirds of the corporate’s current stock-market value.”
The fifth wave has also become known as the wave of the “roll-up”. A roll-up is a process that consolidates a fragmented industry through a series of acquisitions by comparatively large companies (typically already within that industry) called consolidators. While the most widely recognized of those roll-ups occurred within the funeral industry, office products retailers, and floral products, there have been roll-ups of serious magnitude in other industries equivalent to discrete segments of the aerospace & defense community.
Finally, the fifth wave of acquisitions and mergers was the first one during which a very large percentage of the full global activity occurred outside of the United States. In 1990, the quantity of transactions within the US was $301.3 billion, while the UK had $99.3 billion, Canada had $25.3 billion, and Japan represented $14.2 billion. By the year 2000, the tide was shifting. While the US still led with $2,073 billion, the UK had escalated to $473.7 billion, Canada had grown to $230.2 billion, and Japan had reached $108.8 billion. By 2005, it was clear that participation in global merger and acquisition activity was now anyone’s turf. According to barternews.com: “There was incredible growth globally in the M&A arena last year, with record-setting volume of $474.3 billion coming from the Asian-Pacific region, up 46% from $324.5 billion in 2004. Within the U.S. M&A volume rose 30% from $886.2 billion in 2004. In Europe the figure was 49% higher than the $729.5 billion in 2004. Activity in Eastern Europe nearly doubled to a record $117.4 billion.”
The Lessons of History
Many studies have been conducted that target historical mergers and acquisitions, and an amazing deal has been published on this topic. Most of the main target of these studies has been on more contemporary transactions, probably owing to factors such because the availability of detailed information, and a presumed increase within the relevance of more recent activity. However, before sifting through the collective wisdom of the legion of more contemporary studies, I believe it is important to look at least briefly to the patterns of history which can be reflected earlier in this text.
Casting a view backward over this long history of mergers and acquisitions then, observing the relative successes and failures, and the distinctive characteristics of every wave of activity, what lessons will be learned that would improve the probabilities of success in future M&A activity Here are ten of my very own observations:
1. Silver bullets and statistics. The successes and failures that we have now reviewed through the course of this chapter reveal that virtually any type of merger or acquisition is subject to incompetence of execution, and to ultimate failure. There isn’t any combination of market segments, management approaches, financial backing, or environmental factors that may guarantee success. While there is no “silver bullet” that can guarantee success, there are approaches, tools, and circumstances that serve to heighten or diminish the statistical probability of achieving sustainable long-term growth through an acquisition or merger.
2. The ACL Life Cycle is fundamental. The businesses who achieve sustainable growth using acquisitions and mergers as a mainstay of their business strategy are people who move deliberately through the Acquisition / Commonization / Leverage (ACL) Life Cycle. We saw evidence of that activity within the case of US Steel, Allied Chemical, and others over the course of this review.
3. Integration failure often spells disaster. Failure to achieve enterprise-wide leverage through the commonization of fundamental business processes and their supporting systems can leave even the biggest and most established companies vulnerable to defeat in the marketplace over time. We saw a number of examples of this example, with the American Sugar Refining Company perhaps the most representative of the group.
4. Environmental factors are critical. As we saw in our review of the first wave, factors such because the emergence of a robust transportation system and strong, resilient manufacturing processes enabled the success of many industrial mergers and acquisitions. So it was more recently with the arrival of data systems and the Internet. Effective strategic planning normally, and effective due diligence specifically, should always include a radical understanding of the business environment and market trends. Often times, acquiring executives become enamored with the acquisition target (as mentioned in our review of third wave activity), and ignore contextual issues in addition to fundamental business issues that ought to be warning signs.
5. Conglomeration is challenging. There have been repeated examples of the challenges associated with conglomeration in our review of the history of mergers and acquisitions in the United States. While it is possible to survive – and even thrive – as a conglomerate, the odds are substantially against it. Those acquisitions and mergers that most often achieve achieving sustainable long-term growth are the ones involving management with significant industry-specific and process-specific expertise. Remember the observation, during the course of our review of fourth wave activity, that “essentially the most conclusive evidence that the majority of conglomeration activity achieved through mergers and acquisitions is harmful to overall company value is the fact that so a lot of them are later sold or divested.”
6. Commonality holds value. Achieving significant commonality in fundamental business processes and the knowledge systems that support them offers an opportunity for genuine synergy, and erects a substantive barrier against competitive forces within the marketplace. We saw this a number of times; Allied Chemical is particularly illustrative.
7. Objectivity is important. As we saw in our review of the influence of investment bankers vetoing questionable deals during second wave activities, there’s considerable value within the counsel of objective outsiders. A well-suited advisor will not only bring a clear head and fresh eyes to the table, but will often introduce important evaluative expertise as a result of experience with other similar transactions, both inside and outdoors of the industry involved.
8. Clarity is critical. We saw the importance of clarity across the expected impacts of business decisions in our review of the application of the DuPont Model and similar tools that enabled the ascension of General Motors. Applying similar methods and tools can provide valuable insights about what financial results could also be expected as the results of proposed acquisition or merger transactions.
9. Creative accounting is a mirage. The kind of creative accounting described by another author as “finance gimmickry” in our review of third wave activity does not generate sustainable value in the enterprise, and in fact, can prove devastating to companies who use it as a basis for their merger or acquisition activity.
10. Prudence is important when selecting financial instruments to fund M&A transactions. We observed quite a lot of cases where inflated stock values, high-interest debt instruments, and other questionable choices resulted in tremendous devaluation within the resulting enterprise. Perhaps probably the most illustrative example was the recent AOL Time Warner merger described in the review of fifth wave activity.
Many of these lessons from history are closely related, and are likely to reinforce each other. Together, they supply an important framework of understanding about what types of acquisitions and mergers are most likely to succeed, what methods and tools are likely to be most useful, and what actions are most more likely to diminish the corporate’s capability for sustainable growth following the M&A transaction.