Exit merger mania. Enter bargain-basement time. Today some perfectly sound companies (like Tesco, Unilever, BAT and WPP), and even more imperfect ones, on both sides of the Atlantic, are going for a relative song - valued in the market for less than their annual turnover.
Conservative businessmen have long regarded a pound for a pound of sales (or a dollar for a dollar) as top whack. But the turnover yardstick has always been blithely ignored by managers on the takeover rampage. General Electric was happily hoping to pay $42 billion for Honeywell, 168% of its sales: and for a deeply troubled company.
In contrast, you can (in theory) buy great General Motors for less than a fifth of sales value. Bargain-hunters are scarce, however, for the same reason that explains the bargains. Shares have slumped. So bidders can no longer use highly valued paper to buy their heart's desires. That sound sensible, but is utter tosh. If the relationship between the equities is unchanged at the lower price levels, so is the deal.
But in this area of management tosh reigns supreme. Above all else, managers get stimulated to throw their paper around by the seductive sight of soaring shares and the heady scent of wheels and deals. Warren Buffett, the world's finest investor, has written about the 'animal spirits' which surge in the CEO breast, and become 'contagious'. Drawing on experience in 19 boardrooms, Buffett observes that 'the conversation turns to acquisitions and mergers much more when the competitors of the particular company are engaging in those'.
When the merger music stops, as now, so do the contagious animal spirits. Buffett, however, has characteristically gone against the depressed crowd, picking up some of the bargains in the basement - like Johns Manville, the building products veteran (bought, note, for just below its $2.2 billion of sales). His earlier purchases of entire companies for Berkshire Hathaway have been brilliantly successful. Almost all flouted the conventional unwisdom. For an excellent start, Buffett only buys if targets meet his demanding criteria. He almost always pays cash, not shares, because he hates giving away significant chunks of his own company in return for lesser value.
That poor exchange is inevitable. The equity bidder must generally pay a premium for the acquisition, while its own equity gains no such benefit. Buffet also restricts himself to debt-free companies with proven management, good track records, solid businesses and satisfactory returns on equity - paragons that, moreover, are sensibly priced at or below 'intrinsic value' (calculated on a meticulous financial formula). He never has integration problems because he leaves the good managements and their good businesses strictly alone to generate further goodness.
Reverse all these sound rules, and you get the standard big company acquisitions and the explanation of their doom. Buyers generally lack effective criteria, bid in shares, assume debt, and ignore the quality of the target management and its businesses. That's because of a belief of sublime idiocy: that their own superb management will make silk purses out of sows' ears. Thus deluded, the acquirers often proceed to demoralise, devalue and decimate the sitting (and sweating) management: in the process, they often turn silk into pigflesh.
Honeywell's buy of Allied Signal is an awful example of overpaying when some of the buy's good, solid businesses are about to liquefy. Allied's previous success depended too heavily on the retiring CEO, Lawrence Bossidy, whose make-your-numbers-or-else style proved wildly incompatible with Honeywell's long-termism. The clashes between managers of the odd couple weakened Honeywell, and Allied's profit falls made the group vulnerable. Enter GE, which promptly compounded the clashes, barging in to demand mountainous data, rocking the leaky boat, and making it painfully clear who, post-consummation, would crack the whip.
GE's motivation was typical of merger-manic strategies. First, it wanted to reinforce its strength in airborne electronics by eliminating competition. Second, CEO Jack Welch's animal spirits were aroused - he wanted to snatch Honeywell from the rival United Tehnologies. Third, the deal, the biggest industrial merger ever, promised a thunderous climax to Welch's illustrious career, and prolonged it for an extra, possibly triumphant year.
Personal motives and strategic ambitions are not strangers. Rather, 'strategy' is often the excuse for misguided decisions driven by ambition. Buffett never pursues a strategic acquisition, and recently vetoed one (of Quaker Oats), favoured by the management of Coca-Cola, which wanted to keep the prize from the hated Pepsi. Suffering shareholders in Marconi, the former GEC, must devoutly wish that a boardroom Buffett had similarly scotched Lord Simpson's $6 billion purchase of two US makers of telecommunications equipment.
His strategy of swapping Lord Weinstock's cash-rich conglomerate for electronic super-stardom has exploded in his face. You can always argue a logical case for acquisition strategies like this. But the proof of the pudding lies in the usual place. Anyway, more is involved than logic. Remember those animal spirits. Major acquisition is a gigantic corporate virility symbol. The buying leaders parade themselves as visionaries, whose masterstrokes (seldom criticised initially, externally or internally) build prestige, power and very possibly pay.
These forces do grotesque favours for the investment bankers, who are suffering from fee-withdrawal symptoms, poor fellows, in the present merger drought. But the acquisitive forces do little or nothing for customers, who are supposed to be the start-all and end-all of 21st century management. Merger-makers customarily aver that their unions will bring customer blessings. Their promise rings hollow in an age when technology has reduced or eliminated economies of scale, and when size is proving inimical to service excellence.
In truth, mega-deals risk damage to customers, shareholders, employees (jobs threatened), lesser managers (likewise) and ultimately even the merger-makers themselves (viz.Lord Simpson). Serve the latter right, no doubt. But laissez-faire, or lax, regulation shares the blame. That's why Europe's Mario Monti, in spurning GE/Honeywell, has struck a blow for all parties - except those ravenous bankers.
