Whither Global M&A?
The current economic crisis fast begets the next wave of global mergers and acquisitions. What’s to be done?
There has been an upheaval in the global corporate and economic landscapes over the past few decades. Today, China has the largest holdings of foreign reserves of any country – approximately $2 trillion. General Motors, Citicorp, Bank of America and AIG used to be among the largest companies in the world by market value. All four are now on life support as wards of the US government. By comparison, Mittal, the India-based steel company, a non-entity thirty years ago, is today the largest steel company in the world. Indeed, many companies headquartered in Brazil, Russia, India and China (BRIC) have joined the list of largest global companies over the past thirty years.
Dramatic changes will continue to characterize the evolution of the corporate and economic landscapes – some, of them, naturally, via the vector of mergers and acquisitions (M&A). But the nature and timing of these changes will depend on how we extricate ourselves from the current crises, as well as by the new rules which will be put in place both unilaterally and multilaterally by nations. While the current focus of regulatory change appears to be the financial sector, there are two key areas which are getting precious little attention, but will doubtless play a critical role going forward: anti-trust policies and foreign ownership. Existing trends in both of these areas indicate that the next merger wave will encounter strong resistance.
There appears to be a steady rhythm to merger waves. Like waves on a beach, they rise to a peak and then crash to the ground, with regularity. The height, amplitude and velocity of ocean waves depend on a myriad of environmental factors. The same is true of merger waves.
In some respects, the M&A game has changed dramatically in a very short period of time; and in other respects, it is déjà vu all over again. It was only twenty-five years ago that Kohlberg, Kravis & Roberts (KKR) completed the first $1 billion acquisition by a private equity (PE) firm. Three years later, KKR completed the largest leveraged buyout – the $25 billion acquisition of RJR Nabisco. This was the high-water mark of the 1980s buyout boom.
What seemed to be an astronomical transaction in 1988 has since, of course, become commonplace. KKR regained its title for being involved in the largest leveraged buyout by a PE firm when it partnered with TPG Capital and Goldman Sachs to complete a $45 billion acquisition of TXU, a regulated utility and power producer, in 2007. But this acquisition does not rank among the largest acquisitions of the past 10 years – a period during which the telecommunications and pharmaceutical sectors have been the hotbed of mega-deals, followed by the energy, financial services and resource sectors. There have been four $100 billion-plus transactions: the Vodafone/Airtouch acquisition of Mannesmann; the AOL merger with Time Warner; the Pfizer acquisition of Warner-Lambert; and the Royal Bank of Scotland et al. acquisition of ABN AMRO Bank. What would have been the largest acquisition of all time (a takeover of Rio Tinto by BHP Billiton) failed, a ‘victim’ of the economic downturn going back to the late summer of 2008.
The 1980s buyout boom was driven by strong post-1982 economic growth, the creation and growth of the junk bond market – which provided the funding for the leveraged buyouts – and rising equity values. Black Monday (October 19, 1987) – when stock markets around the world crashed – the collapse of the junk bond market, and the demise in 1990 of Drexel Burnham Lambert – the major player in this market – together with rising interest rates and a recession in 1990-91 caused the 1980s M&A wave to crash.
The combination of economic recovery, lower interest rates and lax enforcement of anti-trust laws spurred the next M&A wave in the latter half of the 1990s. The three largest deals of all time were completed in 2000 and 2001, just as this wave was subsiding. During the 1990s, the global telecommunications, oil and gas, electronics hardware and financial sectors were reshaped by M&A.
The collapse of the technology bubble, higher interest rates and the 2001 recession took the winds out of this M&A boom. But, as economic recovery began in 2003, and interest rates were reduced to record low levels by the US Federal Reserve, M&A activity again took off. Debt financing was readily available, as the global financial markets were awash with liquidity – courtesy of the US Federal Reserve – and no company seemed to be too large to be a target.
This time, however, acquisitions covered a wider range of sectors, much like in the 1980s, and sovereign funds and BRIC-based companies began to play a larger role. During this period, M&A activity further reshaped the telecommunications and financial services sectors, as well as the resource, utility and pharmaceutical sectors.
The global meltdown of financial institutions and the ensuing global recession have evidently curtailed the latest M&A boom. But history does repeat itself, and within a short period of time, a new boom will surely be underway – even if there has always been a very high failure rate for mergers, and PE and other firms have written off hundreds of billions of dollars on their latest rounds of acquisitions.
JDS Uniphase, at one time a leading Canadian company in the telecommunications networking sector, wrote off $50 billion in goodwill in 2001 on a number of the acquisitions it made during the 1990s wave. Time Warner has written off tens of billions of dollars on its merger with AOL. Alcatel-Lucent, the troubled French-American telecommunications equipment maker, has written off in excess of $10 billion following its creation through merger. GM is trying to divest itself of two of its acquisitions – Hummer and Saab. Pfizer has been the acquirer in three of the largest acquisitions in the pharmaceutical industry of the past 10 years. These three acquisitions have cost Pfizer almost $240 billion. Yet Pfizer’s market value today is only $90 billion – classic M&A value destruction. Royal Bank of Scotland’s $100 billion acquisition of Dutch bank ABN AMRO, the biggest financial services deal ever, has turned out to be a nightmare for all the parties involved. And the list goes on and on.
High failure rates are endemic in global M&A because most acquisitions serve as a poor excuse for CEOs to display leadership. Oftentimes, the herd effect dominates, as one CEO completes a takeover, thus prompting rival CEOs to follow like lemmings going over a cliff. Indeed, there are very few CEOs who are visionaries and try to grow their companies by being innovative and entrepreneurial. And, as John Kay has pointed out (in The Art of the Deal), the winner’s curse has led to disappointing M&A outcomes.
The seeds of the next M&A boom are being sewn in the current financial and economic crises. Many companies in financial distress – AIG, Citigroup, Rio Tinto, Teck Cominco and GM – are being forced to dispose of assets. Excess capacity has become pervasive across all industries and countries. The collapse of equity prices has greatly depressed the valuations of most companies – even ones with good prospects, going forward. The firms with solid balance sheets and access to capital will be tempted to acquire one or more of their competitors at ‘bargain basement’ prices. And financial advisors, who stand to collect enormous fees, will once again convince CEOs that there are enormous synergies to be realized through a particular merger or acquisition. Like investors in ‘toxic’ assets and Bernie Madoff’s infamous fund, short-sightedness and delusion will drive CEOs into believing that one plus one can in fact far exceed two.
The stage is therefore set for the next wave, and despite the dismal track record for M&A, as the global economic and financial environments improve, the lemmings will be back at work. Having said this, the next M&A wave will face two major impediments: first, more active anti-trust enforcement, and second, a growing backlash against acquisitions made by BRIC companies and sovereign funds. And indeed, just as the US, Canada and Western European countries will try to protect their own industry champions, so too will China, India and Russia. Xenophobia is not the purview of the West alone.
During the George W. Bush years, the US Justice Department and the Federal Trade Commission (FTC) did not play an aggressive role in challenging M&A. But the expectation is very clearly that Justice and the FTC will become much more aggressive under the new Obama Administration.
Mergers aimed at eliminating excess capacity and competitors – horizontal mergers – are the most problematic for anti-trust enforcers, since they supposedly lead to greater market concentration. Furthermore, large transactions often lead to large job losses, as the acquiring firm attempts to reduce costs to make the acquisition a success. In today’s economic and political climate, there is little tolerance for large companies trying to become more profitable by firing their workers. And while governments are unlikely to try to stop a merger strictly on the basis that it increases unemployment, this concern will almost certainly influence the anti-trust enforcers, especially since they are subject to political pressures.
So what of international anti-trust policy – just as we anticipate this next inevitable wave of M&A? Every country has three options for managing this next wave, and they are not mutually exclusive.
Each country can continue to refine its own antitrust policies, including enforcement practices. Of course, this option perpetuates the current hodgepodge of global rules.
The major countries – possibly the G20 nations – could attempt to develop a single global set of rules with a single enforcement agency – the second option. This would be an improvement over the current situation, but is unlikely to materialize. The US, and probably the EU as well, are unlikely to relinquish their autonomy in this area to some international agency.
Or, in the alternative, each country could dismantle its anti-trust policies, starting with the merger rules – the third option. This is my preferred option, but it is even less likely to materialize than the second option.
Joseph Schumpeter long ago recognized the importance of the pursuit of monopoly power and profits as the primary driver of innovation and risk-taking. However, anti-trust policy patently does not appear to be a positive force for the process of creative destruction – Schumpeter’s “essential fact” of capitalism, and a process that typically produces large productivity gains for the economy. Anti-trust policy cannot encourage competition. Indeed, only the desire to succeed and to gain a competitive advantage can do so. As Schumpeter argued, there is no reason to fear the creation of monopolies, unless, of course, they are the creation of government – national champions.
If, instead of wasting time trying to enforce their anti-trust laws, policy-makers had spent their time reforming corporate governance practices, we might have witnessed fewer of the disastrous corporate meltdowns (Enron, financial institutions and sub-prime loans) which spawned the massive economic losses that have clearly been felt well beyond the institutions directly at fault.
While the argument in favour of dismantling anti-trust is impeccable, the prospects of this happening are, alas, manifestly minimal – particularly in the current environment, where the surviving leading companies in many sectors might be headquartered in one of the BRIC countries.
This, of course, begs the question: if most mergers are unsuccessful, would strict enforcement of merger rules not be good for the economy? Answer: Do we really want governments to get deeply involved in protecting CEOs from their own folly?
This leads to my second major concern – the backlash against acquisitions by foreign companies. The Canadian government resisted the proposed takeover of Noranda by a Chinese company. The US government vetoed the proposed acquisition of Unocal by another Chinese company, and prevented Dubai Ports from acquiring six major American ports as part of its takeover of P&O, a British firm. China recently blocked the takeover of one of its domestic firms by Coca-Cola. Germany, France, Russia and China are all building up their national champions in a number of sectors by multiple means: by forcing mergers; by providing various types of financial assistance; by preventing acquisitions by foreign companies; and by restricting investments by foreign sovereign funds.
Jean-Jacques Servan-Schreiber highlighted the paranoia of Europe in the 1960s in the face of the possible takeover of their economies by American multinationals. And in the 1980s, Europe and the US feared that their major companies would fall under the control of the Japanese. Today, the fear extends to all countries, and in respect of all foreign companies.
There is much concern today that the severe global recession might lead to protectionist measures, as each country tries to protect jobs and/or responds to the protectionist policies of other countries. But this fear involves the protectionist measures of the past – quotas and preferential domestic procurement policies. The greatest real protectionist threats emanate from the massive subsidies (i.e., bailouts) that every major country is providing to many of its key companies; the attempts to strengthen national champions and protect them from foreign takeovers; and the foreign investment barriers, which are fast becoming more widespread.
The G20 should be initiating a process to eliminate barriers to foreign investments, and to ensure that there is a level playing field for all companies, regardless of the location of their headquarters. Instead, members will use their time and resources trying to build up and protect their national champions. True to form: the latest G20 meeting had nothing to say about this form of protectionism.
Canada has tried on a number of different occasions to create national champions and protect Canadian companies from foreign takeovers. However, on every international comparison of productivity and innovation, Canada continues to rank poorly. Many of the Western European countries have been even more aggressive in creating these policies, and, predictably, their performance has been no better than that of Canada. Creative destruction should be allowed to play out!
Fred Lazar is an associate professor of economics at the Schulich School of Business, York University.