The Urge To Merge

$100 billion in mergers this week! What’s going on?

Christmas, the season of candy canes and mistletoe, mergers and acquisitions. Almost every day this week has brought the announcement of another mega-merger: On Monday, PeopleSoft finally succumbed to Oracle’s relentless courting; on Wednesday, phone companies Nextel and Sprint entered a $35 billion merger, and Johnson & Johnson agreed to buy medical device-maker Guidant for $24 billion; on Thursday, it was software-maker Symantec buying Veritas in a $13.5 billion deal.

To optimists, the outbreak of corporate nuptials signals a return of Keynesian animal spirits to the market. According to this logic, savvy CEOs wouldn’t be using their cash or stock to acquire if things weren’t going well. And merger sprees frequently light fires under the individual stocks and sectors involved. In other words, Buy!

To pessimists, such gigantic mergers can function as flashing yellow lights. The biggest month ever for mergers was January 2000, when $237 billion in deals were struck, including the ill-fated AOL-Time Warner marriage. We all know what happened a few months after January 2000. In other words, Sell!

The reality, however, may be somewhere in between. Huge as they are, today’s mega-mergers are more noteworthy as defensive actions than as aggressive moves. There are three basic ways a large business can grow: by selling more of the same products to more customers and at higher prices, by creating new lines of business from scratch, or by purchasing growth through mergers and acquisitions. For companies operating in struggling industries, the last path makes the most economic sense. And this week’s deals are, by and large, taking place in struggling industries.

Take Oracle’s marriage to PeopleSoft. For several years, the software industry has been plagued by excess capacity and slow growth. In the 1990s, oodles of software companies obtained huge amounts of capital, created new products, and hired huge sales forces. When bubble-era forecasts failed to materialize, the companies found themselves bitterly fighting over a small pie. Oracle’s revenues for the year ending in May 2004 were below the total for the year ending May 2000. Oracle CEO Larry Ellison has made no secret of his desire to consolidate the industry, the better to eliminate competition and increase pricing power. Indeed, PeopleSoft resisted Oracle’s overtures so fiercely in part because it feared Oracle would simply shut it down and force its customers to use Oracle products.

Sprint and Nextel are responding to the telecom industry’s troubles. Even after the bankruptcies of WorldCom and Global Crossing, and the consolidation of AT&T Wireless and Cingular, there are still too many companies fighting over the same customers. The fixed-line business is profitable but wasting. Cell phone companies bent on growth must engage in fierce promotional cost-cutting or spend billions to convince people they need phones that can take photos and play music. Sprint and Nextel are hoping to find an easier path to greater profits: cost-cutting. In their merger announcement, Sprint and Nextel said that by doing everything from using fewer cell sites to slashing jobs, they could save more than $12 billion.

Johnson & Johnson is playing a different form of defense by spending $23.9 billion in cash and stock to acquire Guidant, which makes stents, pacemakers, and other cardiovascular devices. J & J is a three-headed hybrid, with significant businesses in consumer products, pharmaceuticals, and medical devices. But prescription drugs account for almost 50 percent of the company’s sales. And so the Guidant deal can be seen as a relatively painless way—the purchase price represents only 13 percent of J & J’s market capitalization—for the company to cushion itself from the volatility of the pharmaceutical business.

Only one of these mega-mergers seems offensive. Symantec, which makes security software, has made a transformative deal by agreeing to acquire Veritas, which sells storage software. Essentially, the company is doubling in size and entering a new line of business by using its appreciated stock as a currency. But even this deal has a defensive component. The two companies face significant competition from big firms in their core markets. Symantec does battle with McAfee, Computer Associates, and, potentially, Microsoft, Slate’sparent company. Veritas slugs it out with behemoths EMC Corp. and IBM. The theory behind this merger seems to be that the two smaller frigates lashed together will have a better chance against the battleships.

So far, investors have reacted tentatively to most of these giant deals. It could be because they’re looking backward and incorporating the bitter experience of mergers gone bad into present-day values. Or it could be that they’re looking forward and wondering whether the mergers will alter the basic dynamics in some extremely difficult industries. Either way, the only group of people for whom the mega-mergers have been unambiguously good news are the investment bankers, who collect their fees whether the mergers succeed or not.