Magazine

There's No Magic in Mergers


It may have been the greatest destruction of shareholder wealth in the nation's history. No, not the Depression. It happened during the boom between 1995 and 2001. In an exclusive analysis, BusinessWeek looked at the gigantic wave of mergers and acquisitions that occurred during the late, great bull market and discovered that the vast majority of investors suffered dearly for the sin of investing in companies that had merger fever.

The only real winners were shareholders of target companies who sold their stock within the first week of the takeover. Most shareholders of the purchasing companies wound up with a new form of buyers' remorse: Within a year, their returns had fallen substantially below those of their industry peers. These are staggering conclusions, which illuminate major flaws in the corporate financial system during the 1990s. BusinessWeek's findings help show why current efforts to clean up corporate governance and financial conflicts of interest on Wall Street are so critical to restoring trust in the system.

What went wrong with mergers? The short answer is that companies wildly overpaid. Then they failed to integrate operations and systems quickly. And they overestimated the gains of the cost-cutting and synergies the mergers would bring. The results? Fully 61% of corporate buyers destroyed their own shareholders' wealth. Companies that paid for mergers solely in stock had the worst results. They overpaid much more readily than buyers using cash. The disappointing deals were distributed throughout all kinds of industries, but especially in technology.

The game at the time, of course, was growth. Goaded by Wall Street investment bankers looking for fat fees, companies with high price-earnings ratios sought to buy companies with lower p-e's to juice up their performance and profits. Serial acquirers bought hundreds of companies to keep the momentum going and to please the Street. Tyco International Ltd. bought more than 700. A merger seemed easier than organic growth. It wasn't. Once the economy hit a bump, once the momentum stalled, things fell apart quickly.

The events of the past two years have been a shattering experience for individual investors. They accepted their losses in the stock market when they appeared to be the normal bursting of a high-risk dot-com and telecom bubble and the usual drop associated with the business cycle. But now, small investors who bought into merger mania feel like suckers. That's one reason why they're avoiding the market. And one more reason why the system has to be cleaned up.


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