Market Values: If It’s A Merger, 2nd Thoughts Should Follow

THE term “merger mania” may be more than a snappy description of the recent pace of corporate deal-making. It could be an astute diagnosis of a malady spreading through boardrooms and financial markets.

Research shows that mergers are often poorly timed, with the volume of deals reaching a crest just ahead of peaks in the stock market. And there is little evidence that they improve the fortunes of shareholders — except those of the investment banks that instigate the transactions.

The value of global mergers and acquisitions totaled $1.2 trillion in the first quarter, according to the research firm Dealogic. That is the highest amount ever and 23 percent more than the comparable figure for the 2006 quarter.

American deals accounted for $442 billion, down a bit from the fourth quarter and a shade below the record set in the first quarter of 2000, when the technology boom began to go spectacularly bust.

The feverish activity could help the stock market — for a while. Because cycles in mergers and acquisitions tend to lead the market averages, every transaction may be buying a bit more time for the bulls, said Tobias Levkovich, chief United States equity strategist for Citigroup Investment Research.

But what’s in it for merger participants themselves? The fact that the pace of corporate coupling increases after asset prices have soared might make you wonder.

So might the de-merger mania that is occurring alongside the wave of takeovers; some companies created through mega-mergers are effectively undoing those transactions or thinking seriously about it. Altria recently cut loose Kraft, which it acquired in the 1980s in the largest corporate combination until then, and DaimlerChrysler is thought to be eager to dispose of its American half, even if it means accepting far less than the $36 billion it paid for Chrysler in 1998.

The present run of mergers is fueled by very low yields on junk debt, which can make the numbers work out when they otherwise would not. As long as the financing cost is less than the anticipated cash flow from the combined corporate entity, a merger may seem reasonable. How the businesses will fit together and make their way in the marketplace is almost beside the point.

Mergers often fail to produce expected benefits because the assumptions used to justify the transactions are too optimistic and the sale prices prove too high, said Alan Brown, head of investment at Schroder Investment Management in London. “All the evidence points to most deals not being good for the investor in the acquiring company, at least in the short to medium term,” Mr. Brown said.

Data compiled by Thomson Financial confirms Mr. Brown’s observation. Share prices of 14 of the 20 companies executing the largest mergers last year fell in the 90 days after the transactions were announced. Of the 15 deals that had a 180-day history since announcement, stocks of 8 of the acquirers had declined.

When deciding whether to invest in a company involved in a big deal, the critical factors are the reasons for undertaking the transaction and the price, Mr. Brown said.

“One has to look for a really compelling logic for the deal and then that the price is reasonable,” he advised. “Too many deals founder not on the logic but on the price that the seller has managed to extract.”

Mergers that work best often involve two similar businesses that are joined to try to achieve economies of scale and added commercial clout, like Exxon and Mobil, Nationsbank and Bank of America, and Procter & Gamble and Gillette.

ANOTHER common rationale is to create more profit opportunities by merging companies that seem to be two sides of a coin, usually a business that sells one type of content and a second that distributes it. Time Warner and AOL, and Travelers and Citibank, are examples. These deals often reap fewer gains, perhaps because participants overestimate the potential for cross-selling.

For Mr. Levkovich, the value of a merger depends on the deal makers more than the deal. If a company’s executives do a good job adding value for shareholders generally, chances are the transactions they arrange will do the same. And if the people in charge are weak, a big merger is unlikely to make up for their deficiencies.

“Good management trumps what may seem to be questionable deals,” he said. “In contrast, seemingly obvious deals could collapse into bankruptcies with bad management.”

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