October 30, 2000

Deals & Deal Makers

Big Mergers of the '90s Prove
Disappointing to Shareholders

By STEVEN LIPIN and NIKHIL DEOGUN
Staff Reporters of THE WALL STREET JOURNAL

New television shows such as "Bull" and "The $treet" are trying to portray the drama of Wall Street, but something a lot closer to reality might be a show with a title such as "When Good Mergers Go Bad."

From Daimler-Benz AG's $40 billion purchase of Chrysler Corp. to AT&T Corp.'s $100 billion-plus in outlays for Tele-Communications Inc. and MediaOne Group Inc., some of the highest profile deals of the 1990s have become major disappointments for acquirers and their shareholders.

These companies and other big buyers of the past decade -- including NationsBank Corp., First Union Corp., Walt Disney Co., WorldCom Inc. and Conseco Inc. -- stumbled in integrating their acquisitions, bought at too pricey levels or didn't understand how the targets' assets would fit with their own business lines. As a result, onetime highfliers have been grounded, in large measures by ill-fated deals often crafted by some of the best and brightest on Wall Street.

Not that that should be a shocking development: For years, academic studies have shown that acquirers' stocks underperform relative to the overall stock market and their own respective industries. The latest batch of deals has produced similar results. According to an analysis by Salomon Smith Barney of U.S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquirers have on average underperformed the S&P 500-stock index by 14 percentage points and underperformed their peer group by four percentage points after the deals were announced.

Yet the poor stock-market reaction has done little to stop M&A in its tracks. So far this year world-wide, there have been more than 30,000 deals valued at $3 trillion in announced mergers, up from more than 27,000 deals valued at $2.54 trillion in the year-earlier period.

And judging by the combined values from both targets and acquirers, mergers do create value. It's just that "the targets' shareholders get all the gains" rather than acquirers' shareholders, said Steven Kaplan, professor of finance at University of Chicago.

In addition to poor integration (as has been the case with Daimler's acquisition of Chrysler) and overpaying (as demonstrated by acquisitions by AT&T and First Union), many deals suffer from unrealistic expectations about synergies and inadequate planning. And of course, fundamentals in the businesses are inextricably linked to the success of the combined company. It would be easier for AT&T to make its bet on cable if its two other big businesses -- consumer long-distance and business services -- were in better shape. At the same time, AT&T probably wouldn't need to do such risky, company-transforming deals if the performance of its core business was OK. Last week, AT&T said it would split into four separately traded entities, in effect unwinding its cable acquisitions.

One common deal pitfall is not dealing with the "softer" issues such as how the two organizations will fit together culturally and whether top talent will stay with the new company. Some top executives at Chrysler, for example, have left or were pushed out of the combined DaimlerChrysler, departures that risk ungluing what holds the organization together. DaimlerChrysler last week reported weaker-than-expected results due to woes in its Chrysler arm, causing a decline in the company's already deflating stock.

"People simply underestimate the human and cultural issues of combining two companies into one, and Chrysler's a great example of that," said David Nadler, chairman of Mercer Delta Consulting LLC. "Part of the magic is in the culture of the organization. If you destroy the culture you've essentially destroyed a lot of what you just paid for."

Meantime, competitors will take advantage of any weakness created by merger indigestion. "Piranhas at other companies are circling to acquire your customers, your suppliers, your employees, in the midst of your effort to try to hold it all together," said Robert Lamb, professor of management and finance at New York University's Stern School of Business.

To be sure, not all the megadeals have been disappointments. Oil deals such as British Petroleum PLC's purchases of Amoco and Arco appear to be doing well, and Citigroup, the combination of Travelers Group and the old Citicorp, has outperformed its peers in the stock market.

Mr. Nadler says a "flawed theory for a deal" is one of the factors that contribute to poor execution of mergers or acquisitions. "At the core of any acquisition proposal, value will be created by common ownership of assets that wasn't done so before. If not, why do it?" he says.

Thus, many observers such as Mr. Kaplan of the University of Chicago believe successful deals are ones that result in significant cost savings from eliminating overhead and overlapping operations, as opposed to "revenue enhancement" from cross-selling and other less-concrete synergies.

Not all chief executives agree. In the 1990s, few industries underwent as much consolidation as the banking business, but the results have created big losses for shareholders in big acquirers such as First Union and Bank One Corp. One of the few deals that has panned out well is Norwest Corp.'s $34 billion merger with Wells Fargo Corp. At the time, though, Wall Street criticized Richard Kovacevich, who was CEO of Norwest and became chief of the combined company, for not setting aggressive cost-cutting projections.

Investors want to see synergies, but Mr. Kovacevich said his decision to merge with Wells Fargo had little to do with economies of scale. "It was economies of skill, not economies of scale," he said. It helped that the two companies had different strengths -- Norwest was known as a high-service, customer-oriented bank that offered an array of services, while Wells Fargo was known as superbly efficient with a strong technology platform. Most big companies, Mr. Kovacevich argues, already have economies of scale and too much cost-cutting will yield poor products and poor service, which will hurt business.

Whenever a CEO says it's all about "scale" and size, be careful, say some observers. A major reason deals fail is the "rationale and motivation of the deal," according to Mr. Kovacevich. "One mistake is what I call the ego mistake -- people get together because they want to be big, bigger and biggest. They use the excuse, or rationale, that it's driven by economies of scale."

The rationale of "economies of scale is supported by a company's investment banker, but investment bankers don't have a clue about running a company," said Mr. Kovacevich.

Mergers that succeed are often those where the two companies negotiate various issues, from management teams, organizational structure, technology systems, before the deal is announced, said Harry Quarls, senior vice president at Booz-Allen & Hamilton, McLean, Va. Once a deal is announced, it's important to move quickly with changes so employees aren't distracted. "Speed is more important than precision -- it's more important to address the uncertainty than come up with the absolute right answer," said Mr. Quarls.

Successful acquirers such as General Electric Co. and Cisco Systems Inc. have "swat teams" and detailed preparatory work on acquisitions before the deals are done. Predeal planning is crucial to the success of the deal, says Mr. Lamb of New York University. GE has long favored niche acquisitions by the individual business units, and Chairman Jack Welch's usual role is to give a final thumbs up or thumbs down at the end of the deal preparation.

That's why Mr. Lamb believes GE's pending $45 billion purchase of Honeywell International Inc. may be riskier than the scores of prior deals.

Mr. Welch moved quickly to launch a counterbid for Honeywell after news leaked that it was talking to GE rival United Technologies Inc. In most ways, the Honeywell deal, half as large as all the deals combined done under Mr. Welch, contradicted GE's standard procedure. Though executives in the aircraft engine unit had pushed for the purchase, the decision and much of the work came from Mr. Welch's New York office.

GE had assembled data on Honeywell over time, but didn't deeply investigate its books before Mr. Welch launched the bid -- though several key executives spent much of the weekend combing Honeywell's financial records. It's especially rare for GE to buy a company that requires integration across its several units, in this case four -- aircraft engines, plastics, industrial systems and power systems.

In an interview eight days ago, Mr. Welch said he had "more pages" on Honeywell than on most deals. He was also helped because the terms of United Technologies' bid had leaked, he said, so we "could figure out how much gunpowder they had."

At his news conference a week ago announcing the deal, Mr. Welch noted that "we're always looking at what's out there. We do it every day for a living, so we have a pretty good understanding of this business and we have a pretty good understanding of where it was going."

Still, while Wall Street largely applauded the deal, some observers found the move out of character for GE. "This was far different from the careful, thought-out premerger planning" GE is known for, said Mr. Lamb of New York University. "This was not GE in its traditional mechanism. ... The question of whether it will click is more doubtful."

-- Matt Murray contributed to this article.

Write to Steven Lipin at steve.lipin@wsj.com¹ and Nikhil Deogun nik.deogun@wsj.com²

For information about subscribing, go to http://wsj.com