Looking back, we can see that mergers and acquisitions came in waves that crested, typically, during periods of intense economic activity. The 1920s, for example, brought a wave of business consolidation that was comparable, in some respects, to the great merger movement of 1897 to 1904. These waves, moreover, typically produced a public backlash motivated by fear that giant corporations were taking over the economy. The backlash against the merger movement in the twenties was strengthened by the belief that the existence of widespread monopoly had contributed to the Great Depression. The postwar period witnessed several waves of mergers. In all of them the use of debt played an important role in financing the wave of mergers.
In the first post-World War II wave of mergers, the dominant form was the conglomerate, which combined companies that produced unrelated commodities or services.
Between 1964 and 1972, the peak of the wave, about 80 percent of all mergers were conglomerations. This type of merger’s fundamental purpose was to reduce the adverse effects of the business cycle or unexpected shocks in individual markets by diversifying the activities the company undertook. A characteristic of the conglomerate was its management organization. A small, elite headquarters staff attended to general matters such as financial planning, capital allocations, legal, and accounting tasks.
Ling-Temco-Vought (LTV), one of the first and most celebrated conglomerates, began in 1958 as a small firm called Ling Electronic, with annual sales of less than $7 million. During the next 10 years, Ling acquired or merged with Temco Aircraft, Chance-Vought, Okonite, Wilson and Company, Wilson Sporting Goods Company, the GreatAmerica Corporation, and some 24 other companies. Its revenues in 1968 were nearly $3 billion. When LTV acquired the Jones and Laughlin Steel Company in 1969, the merger meant that two corporations in the list of the nation’s 100 largest companies were combining to make LTV the fourteenth-largest company in the United States. But the coming years witnessed a decline. A government antitrust case, and divestitures gradually shrank the company, and eventually the residual firm, a steel maker, filed for bankruptcy.
In the late 1970s and early 1980s, merger activity accelerated again. The number of merger and acquisition announcements increased by more than 30 percent between 1975 and 1985, and the value of merged firms rose (at 1975 prices) from $12 billion to $90 billion. New terms such as junk bonds and leveraged buyouts and new personalities such as T. Boone Pickens, Carl Icahn, and Michael Milken dominated the financial pages.
In the typical case, corporate raiders such as Pickens and Icahn targeted a firm they believed to be undervalued. They then issued junk bonds (high risk and, hence, high yield bonds), offering some combination of these bonds and cash to the holders of the stock of the firm being acquired. Milken (of the investment banking firm of Drexel Burnham Lambert) was instrumental in bringing together entrepreneurs who wished to use junk bonds in takeovers with buyers. Milken contended, based on the historical record of junk bonds, that these bonds rarely proved to be as risky in the long run as conventional wisdom would have it. What he and his buyers often forgot was that through his own actions, Milken had so reshaped the market that his crop of junk bonds could not correctly be compared with those issued in the past.
How could acquiring firms afford to pay more for a common stock than it currently sold for in the market? Ultimately, each leveraged buyout (leverage is the ratio of debt to equity) depended on the belief that income generated by the firm acquisition could be increased by an amount sufficient to cover the interest on the new debt and still leave an ample return for shareholders. The many ways of increasing income included replacing incompetent management, exploiting underutilized holdings of natural resources, and reducing “excessive” contributions to pension funds.
Defenders of leveraged buyouts and junk bonds argued that these techniques increased economic efficiency. Critics argued that leveraged buyout artists simply stripped firms of valuable assets for short-term gains and deceived foolish purchasers of junk bonds. The critics charged, moreover, that the debt-to-equity ratio for many of the resulting firms was dangerously high and that they would be unable to meet their interest payments during the next recession.
The fall of the junk bond market was as rapid as its ascent. In 1986, Drexel became a target in the ongoing investigation of insider trading by arbitrager Ivan Boesky.117 In 1989
Drexel was forced to dismiss Milken, who later served time in jail for his part in the scandal. A few months later, Campeau Corporation, a large issuer of junk bonds in the retail field, encountered a liquidity crisis, sending the junk bond market into a tailspin. Legislation prohibiting U. S. savings institutions from holding junk bonds also contributed to the slide, although only a few savings banks had ever acquired large positions in junk bonds. In 1990 Drexel, which itself held a large inventory of junk bonds, declared bankruptcy. The issuing of new junk bonds and their use in corporate takeovers had ended for a time. In retrospect, the spectacular rise and fall of the junk bond market was in part a symptom of the high inflation and volatile financial markets of the late 1970s and early 1980s, which sent investors in search of new and more flexible forms of finance.
The leveraged buyout did not die with the crash of the junk bond market. It emerged again during the third wave of postwar mergers that began in the early 1990s. This time, companies sought to achieve economies of scale by merging with or acquiring companies that filled out their “core competencies.” The union of Chemical Banking and Chase Manhattan in 1996 produced a leaner firm with a much larger share of the New York consumer market. The largest merger in American history to date was the merger of America Online (AOL) with Time Warner in 2000. At the time it was hoped that the combination of Time Warner’s media companies with AOL’s access to the Internet would create a far more creative and efficient entity. In subsequent years, however, the merged company struggled, and in 2009 the merger was dissolved. During this wave, private equity firms such as Kohlberg Kravis Roberts, the Carlyle Group, and Bain Capital acquired controlling interests in firms, often through leveraged purchases, with the goal of taking long-term positions and using their knowledge of the industry in which the acquired firm was located to increase profitability, for example, by bringing in new management. Private equity investments peaked shortly before the financial crisis of 2008.
World History
