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Same Old Feeding Frenzy, Different Bait


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SAME OLD FEEDING FRENZY, DIFFERENT BAIT

Dealmania is back. At least that's the buzz on Wall Street, where mergers-and-acquisitions wizards are honing their "highly confident" letters and getting reacquainted with their late-night pizza-delivery services. Deals announced in the past few weeks alone have included two of the largest-ever cable-TV buys, a railroad gigamerger, and a $13 billion hookup in the cellular industry. Overall, M&A activity in the U.S. is up a sizzling 46% over last year, on track to post the third-biggest total in history. "We're at the start of the next great merger wave," says Joseph H. Flom, the guru of Wall Street takeover lawyers.

But unlike past cycles, which started off with reasonable prices and later escalated into insanity, the latest frenzy has already pushed acquisition prices into the stratosphere. The extreme example is Eli Lilly & Co.'s $4 billion deal on July 11 to purchase PCS Health Systems, which at 130 times earnings was so pricey that even Wall Street veterans were left with mouths agape. But even outside the superhot media, telecom, and health-care sectors, deal prices are near all-time highs. Statistics compiled by Securities Data Co. show that buyers on average are paying higher multiples of cash flow for midsize-to-large acquisitions this year than anytime since 1986 (chart).

Are things again getting out of hand? Not necessarily, say many investment bankers. First, the high prices are partly a reflection of higher stock market values. And low interest rates have made companies more affordable. Bankers also argue that the latest round of takeovers is very different from the stereotypical late-1980s transaction, undertaken by a financial buyer who was looking to cut costs and turn a quick buck. "The deal business has changed," contends Mike Overlock, head of M&A at Goldman, Sachs & Co. "It's a strategic business: Companies are buying other companies because it makes sense in the competitive marketplace."

Companies acquiring in their own industry, this argument goes, can extract more value from their target and thus can pay more. What's more, many of the most expensive recent mergers are in industries being rocked by shifts in technology or structure. For instance, media companies dazzled by visions of a multimedia future are scrambling to position themselves. Anybody who doesn't get in on the dealmaking now, goes this theory, is destined to be roadkill on the Information Highway.

MANAGERIAL EMPIRES. Still, many outsiders aren't convinced by such arguments. Their view: Plenty of today's deals could prove both misguided and overpriced. In industries such as telecommunications and health care, companies are betting that the future will be very different--and that their crystal balls are accurate. "Talking about the Information Highway or some such intangible idea makes a deal defensible, but it doesn't bring in the cash," says Roy C. Smith, professor of finance at New York University and a former Goldman Sachs partner. "I haven't seen a lot of cases where the early movers were the biggest winners. It's awfully hard to understand the valuations they're putting on some of these deals."

The recent tendency for many companies to pay for acquisitions with stock is also a sign that many deals won't pay off, say some academics who cite similarities to the 1960s merger wave. "It allows managerial empire-building to run amok, because managers don't see any cost of making mistakes," says Michael C. Jensen, professor at Harvard business school. If a company takes on debt to make an acquisition and the deal turns sour, Jensen argues, it runs into financial trouble, and top executives get booted. But if an equity deal sours, the stock price simply underperforms, and nobody can be sure why. "You're much more likely to find unwise acquisitions in this market," says Jensen.

COMBINED DROP. In studying past mergers, academics also have found that the initial stock market reaction to a deal often gives a crude indication of its ultimate success. If an acquiring company's stock tanks after the announcement, that could mean the deal was overpriced or strategically off base. Although this indicator has frequently been wrong, it signals that companies such as Merck, Viacom, and Lilly may have just bought expensive mistakes.

Indeed, the market's reaction to Lilly's PCS deal was so negative that it has knocked $2.7 billion from Lilly's market value, while adding only $1.1 billion to the value of McKesson Corp., PCS's parent. It's rare for the combined values of both companies in a merger to drop, says Steven N. Kaplan, a professor at the University of Chicago business school. "And a drop of this magnitude is very, very unusual," he notes. His conclusion: "It ain't a good deal."

High prices are altering the dealmaking landscape in another way: Most of the leveraged-buyout firms that dominated the late-1980s acquisitions scene are being priced out of today's deals. "In auction situations, we're being outbid by strategic buyers who are willing to accept lower rates of return," says J. Tomilson Hill, a general partner at Blackstone Group, a Wall Street investment bank with a $1.3 billion dealmaking fund.

That's just one sign that the latest dealmania is different from that of the 1980s. Some companies seem to have learned a lesson from the '80s bidding wars and are dropping their takeover quests when a higher offer emerges. And at least equity-led deals won't result in as many painful financial restructurings, which, after that orgy of debt-laden excess, cost so many their jobs. But bargains--forget about 'em.Mark Maremont in Boston


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