Mindless Merging
So much for the idea that
small is beautiful. If you thought the advent of the Internet, the spread of
cheap and efficient information technology, and the growing fragmentation of
the consumer market were all going to help smaller companies thrive at the
expense of the slow-moving giants of the Fortune 500, apparently you were
wrong. In the wake of the three giant mergers--Citicorp-Travelers,
NationsBank-BankAmerica, and Banc One-First Chicago--in the banking industry
over the last two weeks, the conventional wisdom has quickly adjusted. Bigger,
it seems, is now definitely better.
The
banking mergers follow a year that saw $1 trillion in merger and acquisition
activity in the United States alone. It's easy to overestimate the significance
of that number, which is inflated by the high price of most U.S. stocks. In
fact, over the last two decades, M&A activity has stayed relatively
constant as a percentage of the value of the stock market as a whole. What's
really important is not the size of the M&A boom but the fact that
merge-bent companies are forging ahead undaunted despite all the evidence that
the vast majority of acquisitions do not add value to the economy as a whole.
Don't bother them with the facts. They're ready to buy.
What we're witnessing is a wonderful exercise
in two-track thinking by the people running U.S. corporations and by the
shareholders investing in them. On the one hand, there's a general rejection of
the old Fordist, vertically integrated corporation. From Sara Lee divesting
itself of its manufacturing operations to the Big Three auto companies
outsourcing their parts production to Marriott running hotels that other people
actually own, the idea of doing as little real work as you have to is much
applauded by Wall Street today. On the other hand, though, there's also a
general acceptance of the corporation that promises to do everything, such as
Time Warner and Viacom in media or the new Citigroup, with its financial
supermarket, in banking. For a short time--I think it was when IBM started
laying off tens of thousands of workers--it seemed that the ideas of economies
of scale and scope had been permanently discredited. Apparently not.
In and
of itself, this is no bad thing. Economies of scale--which mean that a product
becomes cheaper to produce the more of it you make--do exist in industries such
as automobile and semiconductor production. And economies of scope--which mean
that it's cheaper to produce or distribute many different products rather than
just one--obviously exist in supermarkets and Wal-Marts, as well as arguably in
a company such as GE. If a supermarket just sells milk, it will probably be
less successful than if it sells milk, eggs, cereal, bread, and so on.
Saying that size sometimes matters, though, is
not the same as saying it always matters. And even if size does have its
benefits, a merger may not be the best or lowest-cost way to reap them. Look at
the arguments in favor of the Citigroup merger. In the first place, Citigroup
will now be the "largest financial institution in the world," which will make
it able to acquire other companies and make expensive investments. But Citicorp
and Travelers were already huge. Perhaps Citicorp couldn't afford that slamming
new computer system before it was part of Citigroup, and now it'll be able to
shop with impunity, but somehow I doubt it.
Citigroup will also be more "diversified," which means that its earnings every
year won't depend as much on volatile sectors, as Travelers' did on the trading
of Salomon Bros. and Citicorp's did on income from Asian markets. But if
shareholders in Citicorp wanted to diversify, all they had to do was buy shares
in Travelers, and vice versa. They're not any more protected now than they
would have been then.
In essence, after all, what the Citigroup
merger involves is Travelers shareholders trading half their shares--actually
it's a little more than half, since Travelers officially acquired Citicorp--in
Travelers for shares in Citicorp. The idea that that swap created value in
itself is nonsensical. The deal is justified only if the merged entity will
grow faster, and be more profitable, than the two separate ones would have
independently. And so we come to synergy.
In the
Citigroup case, the synergy is supposed to come from the two companies selling
each other's products. Now you'll be able to get property insurance from
Travelers when you take out a mortgage from Citibank, or your Travelers agent
will be able to badger you into getting a Citibank credit card after he's done
badgering you about life insurance. Citigroup will be your one-stop-shopping
place, your financial supermarket.
As nearly everyone has already pointed out, the
record of financial supermarkets is dismal. Sears failed with Dean Witter,
Citicorp failed in the late 1980s when it tried to expand operations, and Sandy
Weill--head of Travelers--failed miserably when Shearson joined with American
Express. And the concept of one-stop shopping does seem oddly ill-suited to
financial services. It's not just that, at least in the United States, there's
no evidence that people prefer national banks to local ones (if anything,
there's a long history of distrust of large banks). It's also that people take
their financial decisions more seriously than they do their choice of toilet
paper, and that they are unlikely to pick up a home mortgage just because their
insurance agent is hawking it. At a time when people comparison-shop for almost
everything, Citigroup's privileging of convenience seems oddly outdated.
Even if
cross-selling makes sense, though, it's not clear why Citicorp and Travelers
had to merge. Citicorp could have agreed to market Travelers insurance or
Salomon brokerage services, and vice versa, without actually becoming one
company. For the deal to make sense, the costs of working together in a
contractual relationship would have to be greater than the costs of merging.
But the record in this regard is not comforting. In fact, if there's one thing
that is unequivocally true about M&A activity, it's that companies
dramatically underestimate how much it will cost and how long it will take to
make two companies--with their attendant managerial hierarchies, corporate
cultures, and computer systems--into one.
That's hardly surprising when one considers how
little time companies take before agreeing to merge. The Citigroup deal, from
beginning to end, took less than five weeks. The $60 billion
NationsBank-BankAmerica deal took three weeks, and the companies did "due
diligence" in three days. How due, exactly, could that diligence have been?
It's true that if a company lets a potential merger candidate look too closely,
and the deal then falls through, it may have given away its secrets for
nothing. But when you realize that people take more time to decide what car
they're going to buy than Weill and Citicorp's John Reed took to decide on a
$70 billion deal, a little uneasiness might be in order.
The truth is that
everything--from the way investment banks are compensated to the rubber-stamp
role of boards of directors to the dominance of publicity-hungry CEOs--is set
up to make mergers attractive. And it's hard work to determine the success of
mergers, because you have to compare the performance of the new company against
the projected performance of the previously independent companies. That makes
it easier just to assume success in the absence of complete disaster. But the
chairman of a large Midwestern bank put it best when he recently said, "You get
big because you're better. You don't get better because you're big."
