Left at the Altar

Why some mergers just don't make it.
Linda CormanJune 1, 1998

Amid boom times for mergers and acquisitions, a less-ap-pealing reality has emerged: the increasing number of deals that fall through before they close. The number is hard to pin down, but at least 25 friendly merger agreements worth $1 billion or more have been an-nounced and then withdrawn since early 1997, according to Securities Data Co. That’s a drop in the bucket, perhaps, next to the volume and value of deals that do close. But for companies whose hopeful anticipation turns to frustrated dismay, the experience can be quite disruptive.

“You spend a lot of money with no results,” warns Frank Bergonzi, CFO of Rite Aid Corp., in Harrisburg, Pennsylvania. Although he knew the government would express antitrust concerns when Rite Aid announced a $2.9 billion merger agreement with Revco in November 1995, Bergonzi expected a green light even if it meant divesting about 50 stores. With $10 billion in combined revenues and net income exceeding $230 million, the new company would still command some 13 percent of a highly competitive drugstore retailing market. But the merger partners were stunned instead to find that regulators had adopted a new way to calculate overconcentration in the industry. By this reckoning, the two drug retailers would have to sell hundreds of stores as a consequence of merging.

Fearing a lengthy and futile court battle aimed at rescuing the merger, Rite Aid elected to abandon it in April 1996. Bergonzi estimates that the ordeal consumed $16 million in legal fees, professional fees, and travel expenses, to say nothing of the incalculable value of countless hours of management distraction and a resulting dip in the company’s stock price. Yet Bergonzi feels no cause for regret. “We had done our homework,” he says. “We tried to get a sense of where antitrust was going. There had never been a drugstore acquisition of that magnitude. There was no way of knowing [how the government would decide]. Business is made up of calculated risk.”

Deals fall apart for many reasons, from minor disagreements over combined names, to regulatory roadblocks, to shoddy bookkeeping. More often than not, they are called off because expected gains disappear as due diligence proceeds. After announcing the cross- Atlantic merger between British Telecommunications and MCI Communication, MCI reported a startling $700 million loss. Fearful British Telecom shareholders pressed British regulators to unlock the merger agreement, and the deal collapsed.

For whatever cause, failure to consummate an an-nounced deal ex-tracts more than fees and expenses. Confidence may take a beating and reputations may suffer. “You don’t want to be quoted in a failed-deal article,” warns investment banker Steven Wolitzer, who heads the M&A practice for Lehman Brothers Inc., in New York. For targets, failure to close the deal often leaves an impression that due diligence has uncovered something untoward– whether or not that’s the case, says investment banker Jerry Rosenfeld, senior managing director of NMS Capital, a division of NationsBanc Montgomery Securities, in New York. The target also is vulnerable to losing key employees, observers say. Sensing unrest, other firms often scoop them up.

Failure to merge may count as a mixed blessing for prospective buyers. On the one hand, Rosenfeld observes, the prospective buyer gains points for due diligence. On the other hand, backing out may erode credibility the next time an opportunity comes along. “If you do it too often, people start to raise their eyebrows [and ask]: ‘Do these guys know what they’re doing?’” says Carnival Cruise Lines Inc. chief operating officer Howard Frank, who held the Miami-based company’s CFO post until January 1. In mid 1997, Carnival made a $1.3 billion bid for Celebrity Cruise Lines. Celebrity elected, however, to honor a previous agreement to sell to Royal Caribbean.

“The fact that a company is willing to enter into a merger means that maybe it does not feel it is sufficiently large to be competitive,” says managing director William Rifkin of Merrill Lynch. When a deal collapses, Rifkin says, it can’t reflect well on the company that proposed it or on the company’s prospects.

Still, stoic attitudes tend to prevail when merger plans go awry. “Obviously, there’s an emotional letdown,” admits Rite Aid’s Bergonzi. Blaming uncertain markets or inscrutable regulators, however, few CFOs concede missteps on the way to the altar. “I don’t think we could have done any more work on the front end,” says John K. Crawford, CFO of Nashville-based PhyCor, which assembles groups of medical doctors that share administrative burdens and negotiate agreements with hospitals and insurance companies.

A proposed merger between PhyCor and local rival MedPartners would have increased revenues by 25 percent and earnings by another 25 percent, partly on the anticipated strength of sharp cuts in overhead. Proprietary concerns ruled out extensive due diligence before the merger announcement–a precaution intended to keep sensitive information from flowing too freely between competitors. Had the companies been more forthcoming sooner, they might have been spared some embarrassment. As it turned out, according to Crawford, PhyCor concluded that the business combination was not in the best interest of PhyCor shareholders.

Next to surprises in a target company’s business prospects, deals unravel most often because the government intervenes for antitrust reasons. Regulators ended hopes of a proposed merger between office-product retailers Staples and Office Depot, which surprised Framingham, Massachusetts-based Staples Inc. CFO John Mahoney. “If someone told us in September 1996 [when the deal was announced] that we’d wind up going to court, that we’d spend a lot of our time and resources [dealing with the FTC], I might have said, ‘Maybe we shouldn’t pursue this.’”

In April 1997, AirTouch Communications Inc. an- nounced a $5 billion merger with US West. Four months later, it withdrew from the deal because the transaction was not granted the tax-free status the companies sought. Had AirTouch and US West announced its merger just 24 hours earlier, it would have received the tax-free treatment. The day prior to the announcement, legislation to eliminate the type of tax-free transaction (a Morris Trust) the companies were planning was introduced. From then on, companies could no longer be grand-fathered under the old rules.

“Don’t get hung up on the last detail, the last dollar. Move,” says Mohan Gyani, CFO and executive vice president of AirTouch, in San Francisco. “Time is often your biggest enemy.” Gyani says AirTouch and US West got hung up on what in retrospect was an insignificant difference in price. Although the deal was renegotiated and closed in April of this year, the prolonged transaction meant an ex-tended period of uncertainty for employees, says Gyani.

Moving patiently, however, may allow time for undesirable flaws to surface. James L. Starr was CFO of Sierra Health Services when that firm announced, in November 1996, a $1 billion merger with Physician Corp. of America.

Fortunately, Starr says, his company waited for Physician’s December 31, 1996, financial statement before closing the deal. The quarterly statement revealed that Physician had a much higher workers’ compensation liability than Las Vegas, Nevada-based Sierra had anticipated, and the deal was canceled. “Prudence paid off,” says Starr, who became CFO of The Edison Project in April.

In early 1997, Homestake Mining Co. abandoned its $2.1 billion bid for Santa Fe Pacific Gold. The transaction would have created a company with a market value of close to $4 billion, roughly twice Homestake’s market cap at the time.

But before Homestake and Santa Fe closed, Numont Mining swooped down with a loftier bid. Mulling the collapsed deal afterward, Lead, South Dakota-based Homestake’s CFO, Gene G. Elam, advises counterparts to look beyond financial statements to the market’s view of an acquisition. “You should have a feel for how the market views the company’s strategy for growth. You should be able to anticipate the market’s reaction.”

Would better due diligence have fostered a different outcome? Not as Elam sees it. By his lights, Home-stake determined the highest price it could pay that would make the deal beneficial to its shareholders. It would not have been in the shareholders’ interest to match Numont’s price. “The trick is to have the discipline to hold to whatever that number is,” says Elam.

Linda Corman is a freelance writer in New York.

———————————————– ——————————— A Silver Lining
Pundits often express a dim assessment when announced mergers don’t materialize. That’s the price for abandoning promised synergies and cost savings. But when the historical record is examined, maybe shareholders should be relieved. Mergers and acquisitions that do close seldom live up to expectations, according to Mark L. Sirower, author of The Synergy Trap: How Companies Lose the Acquisition Game. In April, Sirower noted, Dana Corp. snared Echlin after a bid by SPX Corp. SPX shares gained $1 on the news, while Dana lost $3 a share.

Aside from deals that regulators scuttle, deals that don’t go through because final details can’t be worked out probably rescue shareholders from a worse fate, says mergers- and-acquisitions analyst Rick Escherich of J.P. Morgan. “When trying to merge two cultures, it’s better to find out beforehand that they won’t merge.” If economic considerations kill a deal but favor some type of combination, says Escherich, shareholders usually will pressure managers to cut a better deal somewhere else. In the larger picture, most prospective deals fizzle. “Announced deals are just the tip of the iceberg,” says Escherich. “Hundreds of transactions never get to the final agreement.

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