Duke University Alumni Magazine

CAUTION: MERGE AHEAD BUSINESS GETS BIGGER BY KIM KOSTER Illustrations by Walter Stanford The rate of mergers and acquisitions has accelerated throughout the past decade, yielding bigger and bigger firms. But companies and consumers alike might do well to ask: Is bigger always better?

t has become a staple of science-fiction writers who create futuristic, dystopic societies. It grows inexorably over time, as businesses merge and create new firms that merge and create others, the companies growing bigger as the business pool grows smaller, until finally there is one huge conglomerate controlling everything and everyone: The Corporation.

While "The Corporation" exists only in futuristic imaginations, a look at some of the mergers--mega-mergers--of the past few years explains why the mega-company continues to be such a popular literary device. In 1998, NationsBank acquired Bank of America for $60 billion, AT&T; acquired cable giant TCI for $69.9 billion, Bell Atlantic acquired GTE for $71.3 billion, Travelers acquired Citicorp for $72.6 billion, and Exxon acquired Mobil for $86.4 billion. In 1999, Viacom acquired CBS for $37.3 billion, Qwest Communications acquired US West for $48.5 billion, and AT&T; acquired MediaOne for $63.1 billion.

Photo: Les Todd

Already this year, Glaxo Wellcome has announced plans to merge with SmithKline Beecham in a $70-billion deal, Pfizer has won a months-long battle to acquire occasional partner Warner-Lambert for around $92 billion, and in the largest merger ever announced, AOL and TimeWarner will join in a deal valued somewhere between $150 billion and $180 billion (numbers for unconsummated mergers tend to vary, because of their ties to company stock values).

Michael Bradley, a business professor at Duke's Fuqua School of Business and a law professor, specializes in mergers and acquisitions. His research shows that both the number and dollar value of merger and acquisition transactions in the United States hit an all-time high in 1998, with a particularly dramatic growth in value. In 1994, the value of all M&A; transactions was less than $300 billion; in 1998, it was more than $1 trillion.

The numbers are staggering, both in terms of companies that are coming together and in terms of prices paid. But what lies beneath those numbers? Why so many mergers, and how are the corporations and their customers affected? Is what's good for AOL TimeWarner good for America?

This fall, the magazine The Economist weighed in with an editorial opinion: "Recent big mergers in industries from banking to oil have been driven partly by an outbreak of me-tooism and a frothy and surprisingly uncritical stock market." And certainly the merger and acquisition numbers mirror the economy as a whole, sometimes tying into it, as in the case of such stock-based mergers as the AOL-TimeWarner deal.

"If you look at the macro data, we see that when merger and acquisition activity has really taken off, employment is very high and consumer prices are very low," says Bradley, correlating the figures to the general economic expansion of the 1990s. "If you look at the wave of mergers just recently here, the macro data belie the notion that mergers and acquisitions cause lower employment and higher consumer prices. Look what's happened to the Consumer Price Index, and what's happened to employment--the highest merger and acquisition activity on record, the lowest unemployment, and lowest rate of inflation on record."

But the correlation does not necessarily reassure Alex Keyssar, a Duke professor of history and public policy who focuses on labor issues. He is as concerned about the economic expansion itself as he is about the role of mergers and acquisitions within the economy. "Whatever it is that is really responsible for the great economic boom of the 1990s, and we don't know for sure what that is, two things are certain," he says. "One is that it will end, and it will probably end quite dramatically. The other thing is that there has been an extraordinary ideological accompaniment to it, which seems to be fundamental to what Clintonism has been, which is a sophisticated return to 'what is good for Wall Street is good for America.' Above all, what is important is to maintain the confidence of Wall Street and bondholders."

This idea, which Keyssar labels "a powerful orthodoxy," has contributed to the climate in which mergers flourish, he says, allowing bigger and bigger companies to be created that corner ever-increasing market shares, generally without triggering monopoly alarm bells. "The notion is that significant anti-trust enforcement, or new approaches to any kind of regulation, would hurt the confidence of the business community and jeopardize the prosperity," he says. "And at the moment, that is such a hegemonic view that I don't see it being overcome until the economy crashes."

Nevertheless, it is the view that dominates. Very few mergers have been set aside, and those that have have occasioned scathing analysis of the regulators. In the case of a proposed $33-billion petroleum merger between BP-Amoco and Arco, the Federal Trade Commission ruled that because the new company would have a monopoly on oil from the Alaska North Slope and thus could set prices on the West Coast, the merger could not proceed. The companies are fighting the decision, and financial columnists have chalked the ruling up either to bad timing, following the $86-billion merger of Exxon and Mobil, or to an arbitrary determination of markets. All of this made it into the non-financial news, largely because, as Keyssar says, "anti-trust law has been enforced erratically throughout much of the twentieth century, but certainly in the late twentieth century, enforcement seems to be the exception. The presumption now is that almost anything will get approved."

"There was a famous Supreme Court justice in the 1930s and 1940s, Judge Learned Hand," says Bradley, "and he said, 'Seventy-five percent is a monopoly; seventy-four percent is not.' The one thing you get out of that is the arbitrariness of what the cutoff is." Bradley says he and his colleagues have testified before the FTC and the Department of Justice in several merger cases, and in each case what was being determined was not the size of the company being formed but the size of the market it would control. Microsoft, for instance, is the target of anti-trust investigations because of its market share and practices. When the Glaxo SmithKline merger is finalized, however, despite forming the world's largest pharmaceutical firm, the new company will still control only 7 to 8 percent of the global market.

Pharmaceutical companies have seen a great deal of merger activity in the past few years: Glaxo and Burroughs Wellcome in 1995, Ciba-Geigy and Sandoz forming Novartis, Pharmacia & Upjohn joining and then recently acquiring Monsanto, AstraZeneca. While none of these companies controls a majority of their market, Keyssar expresses concerns about what happens when a small number of companies control more and more of an industry. "The fundamental tenet of anti-trust law was that if you have a very large amount of market share concentrated in a very small number of firms, it reduces competition, which will produce a rise in consumer prices and will also harm potential new entrants into the industry, as well as other kinds of small participants, whether retail drugstores or shippers."

Bradley says the decade of growth in mergers and acquisitions does not automatically translate into a shrinking business pool. His research, some conducted with fellow Fuqua professor S. "Vish" Viswanathan, shows that just as some mergers result in larger, more solid companies, other mergers end up with companies being spun off, or "de-merged." "A significant feature of the restructuring transactions of the 1980s and 1990s has been the reversal of conglomerate diversification," he tells his "Corporate Restructuring" class. "While conglomerate mergers were extremely popular in the 1960s and 1970s, the 1980s brought about the so-called 'bust-up' takeover, where large conglomerates were purchased and 'busted up' into their constituent parts and sold off piecemeal."

De-merging can occur for several reasons. Bradley points to the case of Eastman Kodak, which, in a fit of diversification in the 1980s, bought Sterling Drug--a company that bore no relation to Kodak's traditional strengths. The merger drained Kodak, which later decided to refocus on photography and sold Sterling to SmithKline Beecham. But then there is Lucent Technologies, once a division of AT&T.; As Bradley tells it, Lucent became successful but, as a part of AT&T;, wasn't living up to its potential; competitors like Sprint, which might use Lucent's hardware, were suspicious of entering into any kind of a technology deal with an AT&T; division. Finally, AT&T; realized that it would benefit more from spinning Lucent off entirely, and now independent Lucent is the world's largest telecommunications equipment maker.

While some individual cases throw off the curve, Bradley says the trend of his research shows that horizontal mergers, or "mergers of equals," in which the companies have complementary goals and efficiencies, have the greatest rate of success because they can create market power, economies of scale, and economies of scope. One example he uses in his course is the 1998 Travelers-Citicorp merger, which created the world's largest financial services company, allowed each firm to cross-promote the other's offerings, and provided one-stop financial shopping.

The Glaxo SmithKline merger is being billed by both companies as another example of such synergy. "Both Glaxo and SmithKline are strong, world-class companies with complementary technologies and scientific expertise," says Mary Anne Rhyne, a spokesperson at Glaxo's Research Triangle Park facility. Bringing the two companies together, both with a strength in genetics-related research, yields a combined development pipeline that includes thirty new chemical entities and nineteen potential new vaccines, and includes Duke Medical Center studies being conducted on such diseases as osteoarthritis and asthma. The research and development budget for Glaxo SmithKline would be $4 billion, which Rhyne says would enable the company to compete more effectively. "It takes us twelve to fifteen years and about $500 million to take a drug from the lab to the pharmacy shelves --one in only every 5,000 to 10,000 compounds screened becomes a drug."

That one drug, however, can provide a handsome payoff. One of the very latest mergers, between Pfizer and Warner-Lambert, brings the cholesterol-inhibiting drug Lipitor wholly into the Pfizer fold. (It had been a shared project between the two companies.) In the short time since its introduction, Lipitor has racked up $5 billion in worldwide sales. When combined with Pfizer's other highly profitable pharmaceuticals (the depression drug Zoloft, the high-powered antibiotic Zithromax, and Viagra), the $1.8 billion being paid to American Home Products to abandon its bid for Warner-Lambert and allow Pfizer to complete its takeover could end up looking like relatively small change.

Less certain to succeed are mergers of diverse interests, like Bradley's Kodak-Sterling Drug example. It can be much more difficult to overcome any inefficiencies that might be hindering one of the companies involved, because streamlining by combining workforces or infrastructure is not an option. And it can cost more to merge to begin with. For instance, Kodak outbid another company by $9 per share to ensure it would obtain Sterling.

All of the financial calculations involved in a merger can seem overwhelming, but dollars and shares are not the only costs. Labor historian Keyssar says history shows that even the best mergers can have a downside. "The overriding historical lesson is that this does result in increased prices, it does result in harms for various potential competitors and intermediaries--and people do lose their jobs, which is an important human cost.

"Now, it's also reasonable for proponents of mergers and such to say that there are questions of efficiencies and economies of change. To my mind, that's not an unreasonable point of view. But the issue becomes, what are the provisions for these people [who are displaced by mergers]? You're not going to guarantee lifetime employment. Then what provisions are there? The fact is that private provisions tend to be very inadequate, and in the United States there are no social provisions, so we are talking about very significant human costs."

It's one of the paradoxes of economics, akin to a company's stock prices rising when it announces layoffs. Bradley says it is a case of "the specific versus the general. In a specific instance, the government could intervene and save some of those jobs. But then there are several questions: Is this firm being part of a merger because they're being inefficiently run and labor is being inefficiently employed? And if that's the case, do you want to step in and maintain that inefficiency?"

"So in a particular merger--say, Glaxo-- there will be a reduction, perhaps, in employment," he says. "But the larger picture is that those people are going to come out and get another job and enhance the economy." (Glaxo officials have not released specific numbers of job cuts in its Research Triangle Park facility or elsewhere, but have said employment losses will not be significant.)

"That may happen for some of them," Keyssar says of the notion that employees who lose their jobs to efficiencies will simply get new jobs. "Some may even end up in better jobs. But a lot of them are going to go through a period where they're going to have to move, they're going to have to change industries, depending on what their job is and what their skills are. And this is going to vary by firm and it's going to vary by industry, but often blue-collar workers do end up getting very badly hurt," in terms of job seniority, benefits, working conditions, and working hours.

"If you said to a prominent executive, look, you can have a similar kind of job, the pay's only slightly lower, but it means working from midnight to seven a.m. and on weekends, they might say, 'I don't want to do that.' But it's all right for these other people."

In addition to concerns about market efficiencies or employment costs, some mergers bring yet another set of concerns to bear. Susan Tifft '73, Eugene Patterson Professor at the Sanford Institute of Public Policy, is teaching a seminar called "Who Owns the Press: News in an Age of Media Consolidation." She says the AOL-TimeWarner merger should sound public alarm bells about news content. "One of the things I'm concerned about, and that I think consumers should be concerned about, is that the standards for journalistic content are different in these two different companies. You look on the Time magazine website or the Fortune magazine website now, it's pretty clear where the ads are. They're banner ads, usually, at the top. If you look on the AOL site, they pop up all over the place, sometimes they go scooting across the screen.

"I think there's going to be a lot of cross-promotion, where AOL is going to be promoting TimeWarner's products and TimeWarner magazines and CNN and so on are going to be promoting AOL products. So one of the concerns is to be a very, very canny and skeptical consumer of the news that you're getting, and actually to be quite aware of what's advertising and what's news, because there's a real danger that it's going to be blended."

Another concern of media mergers, which also include 1995's Disney-Capital Cities/ABC merger and the 1999 CBS-Viacom deal, is self-censorship on the part of the news half of the organization. Tifft says there is a "danger that because you're covering yourself--and it's hard to avoid covering yourself--that you're going to pull your punches." There are financial pressures inherent in any company, questions of debt or profit, and "it's hard to stand apart from those pressures."

Tifft, who was working at Time when Time Inc. and Warner Bros. merged in 1989, says credibility is an enormous asset for a news organization, and merger-day remarks by Time Warner's Gerald Levin and AOL's Steve Case have shown the new company values that credibility. In the first issue of Time after the merger was announced, a letter to the readers promised to continue "the separation of church and state," as the divide between news and advertising is known in journalism, and to continue to practice high-quality, independent journalism.

"They had all the buzzwords in there," says Tifft. "So now I think the thing for consumers to do is say, 'We're going to hold you to that. You made this pledge in public, you put it in writing, and we're tacking it up on our bulletin boards and we're going to see whether or not that's the case.'"

In fact, in the following weeks, both CNN and Time provided in-depth coverage of an $8-billion class-action lawsuit filed against AOL by computer users alleging that its new version 5.0 causes serious problems with computer hard drives. And Tifft says there is an argument to be made that a larger company will help a news organization, making it possible to "take some risks, insulate our news operations, and let them do the best journalism they possibly can. And if they don't make a profit in any one year, so be it, because a news operation is different from a widget factory. You're serving a very different purpose. You're serving the public, and you can't always be thinking about what's profitable or you won't do good journalism."

The question of profit and the public interest is one Tifft has posed to her class, quoting the First Amendment and its guarantee of free speech, and quoting an author saying that a capitalist press can never be truly free. "I said, how do you reconcile these two? On the one hand, you're guaranteed freedom of speech. On the other hand, there is no free speech, because of the profit motive. And that, to me, is the critical tension."

It is a tension that exists in terms of the free market and its regulations as well, making the questions of what to do about mega-mergers --if anything--more difficult to answer. "Anti-trust has always been an ideologically contradictory stance," says Alex Keyssar. "You're saying the government has to regulate in the interest of having a free and competitive economy, and that's got built-in contradictions. On the other side, we've got free competition. I emerge as the winner of that competition--so I'm Microsoft, and I'm the big boy on the block, and now you say I'm uncompetitive because I have an 80-percent market share, but I say I won it in free competition. During the early twentieth century, people spent a lot of time trying to distinguish between 'good' and 'bad' trusts."

Bradley reiterates the notion of specific versus general, seeing a greater good in the economic cycle even as he admits certain shortcomings. In the airlines, for instance, he says, "it's pretty apparent. You don't have to be a Ph.D. in economics to know that when two airlines combine and there's only one provision [of services], then prices go up. On a case-by-case basis, you could maybe argue that employment is being compromised and prices are being raised."

But on the whole, Bradley says the bigger picture is positive. "If you were the social dictator in the sky, if you were the one who was saying how the game should be played and your goal was to maximize the value of the country, then you would say, yes, let's keep mergers and acquisitions. They do very well in reallocating resources."