When 1 + 1 < 2
"We look at it like this:
The big fish eats the small fish and the small fish eats the shrimp. You buy or
get bought. It's a law of economics," Vice Director Shi Jianping of the
Shanghai Rubber Belt Co. told the Wall Street Journal earlier this week.
Merger mania, you see, is sweeping the People's Republic. Soon, instead of
hundreds of small companies all making identical rubber belts there will be one
giant company making all the rubber belts. It'll be just like the market for PC
operating systems in the United States.
As it
happens, Shi Jianping's description of today's China sounds quite a bit like
today's United States. Mergers and acquisitions are back in a big way, and the
new buzzword is "consolidation." Since 1995, M & A activity has risen to
record levels, both in terms of raw numbers and size. Telecommunications,
defense, aerospace, mass media: In all these industries the number of players
has been significantly reduced over the last three years. Emboldened by a new
approach to antitrust law at the Justice Department and Federal Trade
Commission--one that suggests that unless you're doing something that will
immediately raise consumer prices, it's A-OK with them--giant companies that
previously would never have imagined merging have tied the knot. This
rediscovery of the art of the deal makes it seem like the 1980s all over
again.
Except that in some interesting and important ways, it
isn't. In the first place, a much higher percentage of these mergers and
acquisitions are taking place within, rather than across, industries, which is
why we hear a lot more about consolidation and a lot less about synergy or
conglomeration. Instead of USX buying Marathon Oil in a desperate attempt to
diversify into a business it hadn't proved it couldn't run, we have Boeing
buying McDonnell Douglas, British Telecom buying MCI, and Raytheon buying
Hughes Electronics. In addition, the vast majority of M & A activity today
is friendly. The big fish may be eating the small fish, but the small fish seem
more than happy to be eaten. In this new win-win world, there's something
almost unseemly about hostile takeover attempts.
Of course, that only makes it
all the more interesting, and the more telling, when they occur.
Union
Pacific Resources is an independent oil and gas driller, which means it
specializes in getting as much out of a given field's reserves as possible. It
used to be part of Union Pacific Corp., the transportation giant that laid
railway track across the United States. As part of its desire to focus on its
core, UP spun off UPR two years ago. The oil company is blessed with very
little debt, but it's grown relatively slowly since the spinoff, because it
doesn't have many reserves and lacks the wherewithal for massive exploration
projects.
Enter Pennzoil. Or rather, re-enter Pennzoil.
Pennzoil makes ... well, Pennzoil motor oil. It also owns Jiffy Lube--oil
changes/motor oil; is that synergy or consolidation? And it has a growing
oil-and-gas exploration business. Two years ago, Pennzoil approached Union
Pacific with an offer to merge, figuring its extensive reserves would fit well
with UPR's intensive drilling. But Union Pacific rebuffed Pennzoil (actually,
it was more a simple failure to call back than an explicit rejection). And so
Pennzoil turned itself around, selling off less profitable fields, expanding
its exploration business, strengthening Jiffy Lube. Last year the company
turned its first profit since 1993, and earnings for the last quarter were up
sharply--much more sharply than UPR's--over the year before. Not surprisingly,
that's when UPR decided to come a-calling.
A little
more than a month ago, UPR announced a tender offer of $84 a share--a
41-percent premium over Pennzoil's previous closing price--including a
commitment to buy 50.1 percent of Pennzoil's shares at the offer price. If UPR
were to gain control, it would buy up the remaining shares at market price.
More than 60 percent of Pennzoil's shares were tendered by the deadline. Game
over, right?
Not quite. Pennzoil's management and board of directors
vehemently opposed the takeover. They insisted the company's long-term value
was much greater than $84 a share, and that UPR was trying to pick it up before
the effects of the turnaround had been felt by investors. And Pennzoil has a
"poison pill" provision, which means that as soon as 15 percent of the
company's shares are acquired by a hostile bidder, every other Pennzoil
shareholder gets to buy newly issued Pennzoil shares at a substantial discount.
Obviously, that would make any buyout attempt prohibitively expensive.
Now poison-pill plans and
other scorched-earth strategies to frustrate takeovers--like the sale of
valuable assets or the assumption of insane levels of debt--seem to violate the
principle that those who own the company, the shareholders, should be able to
decide what to do with it. If we want shareholders to think like owners and not
speculators, taking away that power hardly seems the answer.
On the
other hand, the way tender offers are structured almost guarantees they'll be
accepted. If you're one of the few shareholders who doesn't tender her stock,
UPR is only going to pay you the market price for your shares, and you have no
guarantee that will be more than $84. What that really means is that any
company with the financial ability to launch a tender offer--and given the ease
with which financing can be found, that means essentially any company--can
bring about the dissolution of its target. A study in the 1980s, in fact, found
that four out of every five tender offers resulted in the target being absorbed
by one firm or another.
For free-market purists, there's nothing wrong
with this. If a company's management hasn't done right by its shareholders,
takeovers are an appropriate remedy. For these believers in the efficient
market, a company's stock price always reflects its true value. There's only
one problem with this: It makes no sense.
In a
market of 10,000 stocks, short-term prices will rise and fall for an infinite
variety of reasons, very few of which have anything to do with a company's real
productivity or value. Dell Computer, for instance, would be at least five
times as hard to acquire today as it was a year ago. But only a fool--or a
Chicago School theorist--would say that Dell is five times as valuable to the
economy today as it was a year ago. Placing the entire future of a corporation
in the hands of arbitrageurs, which is what a tender offer amounts to, is the
worship of property rights run amok. Yet how to come up with a solution that
would protect long-term shareholder rights while making tender offers less
automatically successful? Wasn't it Warren Buffet who suggested a 100 percent
capital gains tax on any investment held less than a year? That might work.
Most scholarly studies of hostile takeovers show they have
little or no impact on productivity, profitability, or on the acquiring
company's long-term stock price. Plenty of wealth is redistributed, but it's
not really clear that any is created. Although bidders tend to portray
themselves as rescuing ailing companies--UPR said it was reacting to "a decade
of broken promises and poor performance" at Pennzoil--in fact they almost
uniformly bid for profitable, healthy companies that the market, for one reason
or another, is undervaluing. The new American vogue for mergers may be making
the economy stronger, though the jury is still out on that question. But in a
hostile takeover, it seems pretty clear, one plus one generally doesn't equal
three. Often, it doesn't even equal two. Hard as it may be to remember in a
bull market, society doesn't get any richer when UPR exchanges its cash for
Pennzoil's shares. Of course, investment bankers, lawyers, and speculators
do.
