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Want Growth? Just Acquire It

Through the 1990s, large companies were apt to grow through acquisition rather than through organic means. This is clearly illustrated in Table 3.1, which shows the rise and subsequent fall of IPOs, M&A transactions, New York Stock Exchange (NYSE) value, NASDAQ value, and Dow Jones Industrial Average (DJIA) value. Several explanations may be offered. First, the cost of debt financing was very low, coinciding with relatively strong institutional investor demand.8 Thus, firms could acquire other firms with relatively cheap debt funding. Also, the public equity markets were very strong, creating an opportunity to issue new equity for acquisition financing. IPOs were very popular during this time period. Finally, and perhaps most important, the rising stock market inflated company values, thus enabling acquiring firms to buy more companies by employing a stock for stock swap.9 As the stock markets continued to rise, acquiring companies were inclined to make even more acquisitions while the timing was right. The rationale among some managers was that they wanted to use their company's inflated stock price to buy up assets while the opportunity was available (i.e., before the stock price dropped and the opportunity would be lost).10 However, one of the pitfalls of an overheated stock market includes unjustified bidding wars among potential buyers leading to the "winners curse." Those who won the bidding ultimately may have been "cursed" by paying too much. At the extreme, buyers paid billions of dollars in company stock for organizations that had no profits and in some cases no revenues.11 During the mid-to-late 1990s, Lucent, Cisco, Nortel, and other telecom companies were among the most eager participants in the acquisition game.12 In the years subsequent to their acquisitions they were also among the companies that experienced the largest loss in shareholder value.

Table 3.1. Market Values in Millions

 

1996

1997

1998

1999

2000

2001

Number of IPOs*

771

519

337

508

351

110

Number of M&As[*]

13,068

13,907

16,002

13,766

12,885

8,853

NYSE market value

$7,300

$9,413

$10,865

$12,296

$12,372

$11,714

NASDAQ market value

$1,512

$1,835

$2,589

$5,205

$3,597

$2,900

DJIA market value

$6,800

$7,800

$9,300

$11,700

$10,500

$9,870

At first, the stock markets didn't react very strongly to the acquisitions, but over time it became clear that many of the acquisitions were not working. Analysts usually need a couple of quarters before deciding whether or not an acquisition will lead to the hoped-for economies of scale or revenue expansion. During this time period, companies need to sort out management changes and infrastructure adjustments. At best, a large acquisition requires six months to one year before benefits can be noticed, and many of these high-rolling acquirers were completing multiple acquisitions per quarter. Thus, sorting out the final year-to-year performance numbers was a difficult challenge. A November 1999 study by the accounting firm KPMG found that 83% of the 700 "most expensive deals" completed during the period 1996–1998 either broke even or lost money (53% lost money and 30% were considered break even). By contrast, 82% of the surveyed 107 executives from these participating firms believed that these deals were "successful." A study conducted by Booz, Allen, and Hamilton (2001) found similar results in the success and failure rate for companies that merged during the time period 1997–1998.13 Many other academic studies also show that many mergers did not provide the intended cost savings or strategic benefit. Yet, even as evidence emerged indicating that many deals were not working as planned, individuals still pushed acquired growth initiatives forward. Why?

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