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Sultans of Swap

Was last year a record for mergers? Did Maris's home-run mark fall?
Stephen Barr, CFO Magazine
January 1, 1999

Move over, Mark! Move over, Sammy! The corporate fence busters outslugged you both in 1998.

Just as McGwire and Sosa captured the imagination of the baseball world with their record-shattering home-run race, today's M&A masters stunned the business world by belting deal after deal out of the park. Cheered on by raging bull markets, and deterred only slightly by Wall Street's second-half volatility, these corporate power-hitters spent 1998 reshaping companies, remaking industries, and shuffling global assets at an astounding pace.

"You're looking at one of the most dramatic periods of industrial history," says Mark Sirower, visiting professor of mergers and acquisitions at the Wharton School, in Philadelphia. "This is a legendary era. We've broken all-time records."

Certainly, the numbers were staggering, even before Exxon Corp. and Mobil Corp. confirmed their $77.2 billion grand slam in December. The year was expected to end with more than $1.7 trillion in deals announced in the United States, according to Securities Data Corp.--the first time the trillion-dollar threshold has been crossed, and nearly double last year's record $903 billion. The $661 billion tally in the second quarter alone, when the Travelers-Citicorp, Daimler-Benz-Chrysler, and SBC-Ameritech megamergers were unveiled, exceeded every previous year other than 1997. "The Kohlberg Kravis-RJR Nabisco transaction held the record as the largest U.S. deal for over nine years," says Scott Adelson, a managing director at Houlihan Lokey Howard & Zukin, an investment banking firm based in Los Angeles. "In 90 days, eight deals surpassed it, three of which were over twice its size."

Fully 9 of the 10 biggest transactions of all time were forged in 1998--with Exxon-Mobil ranking as, by far, the largest ever. And even though the overall number of transactions edged up by only 0.4 percent, there were substantially more billion-dollar-plus deals than ever before last year. In fact, they made up 46 percent of all mergers announced.

Even renowned investor Warren Buffett swung for the fences with Berkshire Hathaway Inc.'s $21.2 billion acquisition of General Re Corp. in June. Not only did Buffett set aside his long-standing reluctance to use stock for purchases, he also used the word "synergy" to describe his rationale for a deal--something he's criticized acquirers for in the past. "The deal is not significant in and of itself," says Rick Escherich, a managing director in the M&A group at J.P. Morgan & Co. "But people watch Buffett, and when he does something, the market sees behavior that's considered all right."

A Late-Season Spurt,BR> Stock was by far the acquisition currency of choice last year, being used in an incredible 68 percent of deals--the first time the use of stock topped 50 percent. Cash made a modest comeback in the third quarter, when Wall Street's plunge threw a major scare into investors and merger meisters alike. With the junk market essentially closed, bank debt more expensive, and share prices tumbling, companies and their bankers scrambled to revalue and restructure terms to keep deals alive. September was the bottom of the slump, with $51 billion of deals--a mere 3 percent of the 1998 total. And as premiums crept upward, sales by private owners reached their lowest level since May 1997.

But like McGwire with his late-season slugging spurt, dealmakers also surged, with the Dow Jones Industrial Average taking off for 9,000-plus territory again in mid-November. By month's end, a record of nine deals valued at more than $1 billion had been launched in a single day, including three soaring shots--AOL-Netscape, Deutsche Bank-Bankers Trust, and Tyco-AMP.

"All the key drivers of the M&A market remain in place," Escherich says. "The total number [in 1999] may not be as high if we don't see as many megadeals as we saw last spring, but the underlying levels should be fairly comparable if you take out the megadeals."

While M&A activity surged across all industries last year, banking and financial services continued to lead the pack in both the mega- and the middle market (deals of less than $500 million). Up until the fourth quarter, the sector's 244 transactions, valued at $240 billion, represented a 435 percent in-crease from 1997's first nine months. In such an environment, even the $31.7 billion Norwest-Wells Fargo deal seemed almost standard.

Cultures Clash
Rarely a day went by in 1998 without some media mention of the $36 billion Travelers-Citicorp merger. But how those mentions changed. In April, when the deal was announced, the talk was of business titans Sanford I. Weill and John Reed coming together to create Citigroup Inc., a one-stop financial-services supermarket. Six months later, when the deal closed, the talk was far less effusive. On November 1, the new entity's president, Jamie Dimon, Weill's longtime protégé and the presumptive integrator of this mammoth combination, was pushed out in a boardroom coup. Since then, voices have been raised ever more loudly about whether the firms' distinct product lines and cultures can truly mesh to create value. Turf wars and cross-selling conflicts are among the issues to be worked out.

"The basic dilemma is how you put together two very disparate organizations, one of which is itself a collection of disparate organizations," says Sam Hayes, an investment-banking professor at Harvard Business School. Weill's reputation as an acquirer has kept the wolves at bay, but for how long? "It will take a generation to work," Hayes predicts, "if it works."


And chew on this: Mitchell Madison Group, a global-strategies con- sultancy in Toronto, rates banking deals as the poorest-performing combinations of any sector, underperforming their un-merged peers by 13 percent. That's compared with the 3 percent by which an acquirer has tended to underperform in the mergers in terms of the total return to shareholders in billion-dollar transactions in the 1990s, of those Mitchell Madison rated between 1990 and 1996. The firm has found telecommunications and insurance among the best-performing sectors, even though, overall, only 44 percent of mergers qualified as winners by the peer-comparison yardstick.

"In the early bank deals, there were tons of opportunities to take out duplicate operations," says Mitchell Madison partner Ken Smith. "With the more- recent announcements, the prices have those easy cost savings built in, and they must put more emphasis on the harder issues of technology and revenue growth. The problem is, acquirers in the banking industry have generally been unable to create value for shareholders in excess of the industry [average], and now the bar is moving up."

Puzzling Over AT&T and TCI
Like Citigroup, AT&T Corp. carted out the supermarket metaphor when it announced its $48 billion acquisition of Tele-Communications Inc. (TCI) in June. Distinct from 1998's pure telecom mergers--SBC-Ameritech and Bell Atlantic- GTE, in which the combination created a bigger entity looking a lot like the two smaller ones--the AT&T deal promises to combine different technologies as well as operating styles.

Many observers still wonder how the deal will play out. The same can be said for AT&T's plans to create three stock issues: shares for the parent, as well as "tracking stocks" for its consumer business and for TCI's programming division. "The market has found that aspect hard to deal with," observes J.P. Morgan's Escherich.

More-positive reaction greeted AT&T's July announcement of a joint venture with British Telecommunications. This landmark alliance, valued at just under $50 billion, creates the world's largest global telecom company, at least for now.

Dealmakers hit numerous cross-border home runs in 1998, too, including three monstrous shots--Daimler-Chrysler, British Petroleum-Amoco, and Deutsche Bank- Bankers Trust--that fostered expectations of further worldwide consolidations. The $9.7 billion Deutsche-BT deal will create the world's largest financial-services firm as measured by assets, and will give the German bank a foothold in U.S. underwriting. Daimler-Chrysler, a $41 billion deal, is expected to generate some $1.4 billion in synergistic savings (with former Chrysler CFO Gary Valade doing his share as head of purchasing of the new entity). And by year-end, of course, BP-Amoco, at $48 billion the largest international transaction ever, seemed merely a prelude to the monumental reshuffling of oil giants started by Exxon and Mobil.

The three deals also cast the spotlight on the tax rules that have to be met in such cases, says Robert Willens, a merger accounting expert at Lehman Brothers Inc. If the shareholders in the U.S. company receive more than 50 percent of the merged company's stock in an exchange, the stock is no longer tax-free. Daimler-Chrysler came close at 43 percent.

That deal was also interesting because Chrysler, to qualify for a pooling treatment, had to reissue stock repurchased in the previous two years. Rather than do a public offering in the summer, when the market was tanking, Chrysler reissued the stock to its pension plan, which qualified as an independent third party.

Deals Undone
Since 1995, the volume of hostile bids has been falling--as has the success rate of such deals. Yet July's $10 billion AlliedSignal offer for AMP Inc. proved that companies are not afraid to raid. AMP was able to use Pennsylvania law to hold AlliedSignal at bay until November, when AMP found a white knight in Tyco International Ltd.--an active and innovative acquirer that agreed to pay $11.3 billion. But otherwise, most dealwatchers conclude, AlliedSignal would have prevailed months earlier.

Plenty of friendly deals collapse, too, of course. And "you can learn as much from the deals that don't go through as from the ones that do," says J.P. Morgan's Escherich. If that's so, merger watchers have had twice the education in 1998--a banner year for aborted mergers as well.

Among the billion-dollar busts were Tellabs-Ciena, Cendant-American Bankers Insurance Group, and American Home Products- Monsanto--the latter a $35 billion deal believed to be the largest ever to be pulled after an agreement was signed. Falling stock prices were only partly to blame for the AHP-Monsanto collapse. It also was hurt when the top two executives, who planned to run the combined entity together, couldn't agree on key issues--despite an initially favorable stock-market response to the deal.

Among the top 10 deals that survived, a majority provided for both sides' bosses to retain top executive posts. That included a $43 billion NationsBank-BankAmerica deal that left BankAmerica CEO David Coulter as heir apparent to NationsBank CEO Hugh McColl--until the merged entity reported huge losses from overseas trading and sharply lower earnings. Coulter left soon after.

Such power sharing invites nasty finger pointing, and leaves control issues hanging uncomfortably, some experts think. "I'm cynical about proposals for sharing power," says Ken Hodge, a vice president at Mercer Management Consulting, who calls them "transitional structures that are expedient in terms of getting those deals done."




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