Big Doubts About Big Deals

By Charles Alexander

Politicians and scholars debate the merits ofmultibillion-dollar mergers

Mobil plans to bid $8 billion for Conoco. Penn Central offers $1.4 billion for Colt Industries. Heileman Brewing Co. opens talks on a possible merger with Schlitz Brewing.

The frenzy of bid-a-billion merger making again rippled through American business last week. Company presidents nervously looked for corporate marriage partners, bankers arranged billion-dollar lines of credit, and investors wildly bid up stocks that looked like potential takeover targets. But, as the madding crowds continued to get in on the deals, more and more executives, academics and politicians were becoming concerned about the merger mania. Even those who approve of mergers in principle are stunned by the sheer size and number of the new corporate couplings.

The match-ups made in the past few months link familiar names in almost every American industry: American Express and Shearson Loeb Rhoades, Prudential and Bache, Nabisco and Standard Brands, Sohio and Kennecott. If the present frenetic pace of takeovers continues, U.S. companies could spend $70 billion this year to swallow up more than 2,000 other firms.

But is this rush of corporate marriages really good for the U.S. economy? Will this help get America out of the economic stagnation of the past decade? Does bigness mean greater efficiency for business? Many were dubious about the benefits of the big deals. Said New Jersey Democrat Peter Rodino, chairman of the House Judiciary Committee, as he called for congressional hearings on antitrust policy: "This sudden seizure of merger madness could slow down our nation's economic growth." Added Wall Street's Felix Rohatyn, one of the leading merger makers: "There's too much macho involved. This has become show biz."

Others, though, insisted that the takeovers and acquisitions were both necessary and overdue. Said Robert Bork, a top antitrust expert and former Solicitor General: "We've won the war intellectually by showing the efficiencies and economies of scale that grow from consolidations. A lot of mergers that should have taken place were held back for years because of the Justice Department's antitrust division."

As the debate developed last week, bidding intensified in the most extravagant sweepstakes in corporate history--the takeover of Conoco, the ninth biggest American petroleum company. Mobil, the second largest U.S. oil firm, said it was planning to hike its cash offer for 51% of Conoco to $95 per share.

For the moment at least, that would equal the $95 per share offer by Du Pont, the biggest U.S. chemical producer, for up to 51% of Conoco stock and top a $92 per share offer from Canada's Seagram, the world's largest liquor distiller. Though Conoco's price tag is now about $8 billion. Wall Streeters expect the bidding to surge even higher. Almost completely overshadowed by the Conoco battle was the announcement last week that the Penn Central Corp., a conglomerate with holdings of everything from oil rigs to amusement parks, would acquire Colt Industries, a diversified manufacturer of firearms and engines, for $1.4 billion. Such paltry billion-dollar deals now pass almost unnoticed.

If these mergers were taking place against the backdrop of a vibrant economy, there might be little cause for concern. But Government statistics released last week showed that U.S. business remains in the doldrums. During the second quarter, the output of goods and services fell at a 1.9% annual rate, raising fears that the nation is entering its second recession in two years.

The slump has cooled inflation from its 13.5% pace of last year, but consumer prices in June were still rising at an uncomfortable 8.8% annual rate. Though economists have been predicting for months that interest rates would drop, the cost of money remains stubbornly high. Two-year Treasury notes were auctioned last week at a record price of 15.92%. The towering charges for borrowing money sent the Dow Jones stock average skidding to 924, its lowest point of the year.

Many members of Congress, including Judiciary's Rodino and Rhode Island Democrat Fernand St Germain, the chairman of the House Banking Committee, see a disturbing connection among high interest rates, sluggish growth and the merger explosion. In the bidding battle for Conoco alone, they note, the contestants lave lined up some $20 billion in standby bank credit. Though much of the financing comes from European banks, many economists and executives contend that heavy loan demands from the merger candidates help keep the U.S. money supply tight and make it more difficult for a small business to finance new machinery or for a family to borrow money for a new house or automobile. Says W. Martin Dillon, chairman of Northwestern Steel and Wire Co: "The merger trend and the competition for capital it entails are probably helping to keep interest rates up."

The main cause of the current stampede of mergers, however, is not complex. The prolonged depression in the stock market has made the shares of hundreds of American corporations irresistible bargains. The Dow Jones average now stands no higher than it did more than 16 years ago. But inflation has inexorably driven up the value of industrial plants, equipment and other assets. Says Yale Economist Paul MacAvoy: "Market values of corporate shares are drastically out of line with the replacement cost of corporate assets or the long-term market values of those shares."

As a result, many companies find it cheaper to buy factories rather than build them or to acquire mines rather than dig their own. Firms with scarce natural resources are the most tempting takeover targets because the price of their assets in the ground has increased particularly fast. For example, since the first energy crisis in 1973, the value of Conoco's plentiful oil, coal, natural gas and uranium reserves has risen from $2.6 billion to $14 billion. Experts say that Conoco's shares are worth at least $45 more than any of the bidders are now offering.

Congressional critics, though, blame the Reagan Administration for creating a new atmosphere that encourages merger fever. The President appointed William Baxter, a Stanford law professor who firmly believes in the virtues of large-scale enterprises unfettered by excessive Government regulation, to be his antitrust chief in the Justice Department. Baxter's boss, Attorney General William French Smith, succinctly stated the new Adminstration's philosophy in an oft-quoted speech before the District of Columbia Bar. Said Smith: "Bigness in business is not necessarily badness. Efficient firms should not be hobbled under the guise of antitrust enforcement."

Baxter openly accepts some responsibility for the merger phenomenon. Said he last week: "The statements we've made at the Justice Department have allowed people to think about mergers that they really wouldn't have thought about in past Administrations." Mobil's bid for Conoco is a case in point. Such a merger between two of the top ten petroleum companies would never have been seriously considered during Jimmy Carter's term. Baxter insists that his trustbusters will not allow any acquisition that significantly reduces competition within the oil industry or any other. He also maintains that a Mobil-Conoco combination would be subjected to tough scrutiny in Washington.

Baxter should be wary, if only because the American public has long been apprehensive about excessive corporate power. He admits, "The strains of populist hostility toward large companies are deeply ingrained in the U.S." Government trustbusters have enjoyed broad public support as they attacked both concentration within an industry and combinations between corporate giants in unrelated businesses. Yet the burgeoning growth of corporate America has outpaced all the antitrust efforts. Since World War II, the portion of U.S. industry controlled by the 200 largest manufacturing firms has risen from 45% to 60%.

Many prominent economists, such as James McKie of the University of Texas and Lester Thurow of M.I.T., argue that large-scale mergers can enhance industrial efficiency by creating economies of scale. In the jargon of management, mergers create corporate synergism: two plus two can equal five. Combining two companies under one management can reduce administrative overhead and bring fresh leadership to a tired company. The new firm can order raw materials in large quantities or use new technologies to reduce production costs. The result: lower prices and better goods for consumers.

Some merger advocates also contend that big companies have the best chance of holding their own against increasingly aggressive foreign rivals. Larger and more efficient firms can often undersell huge overseas competitors, which frequently benefit from liberal antitrust policies. Says William Agee, chairman of Bendix Corp. "The acquisitions we're seeing at the moment will be a good thing for America in that they will make us more viable in the world market."

Other scholars challenge the notion that corporate behemoths bring greater efficiency and lower prices. They assert that big firms, like governments, are more likely to become bureaucratic and complacent. Says Willard Mueller, an economist at the University of Wisconsin: "Large companies are not innovative. Hugeness destroys initiative." Indeed, during the past decade, two-thirds of all new jobs in the U.S. were created by businesses with fewer than 100 workers. Some of the most creative and innovative firms in America today, companies such as Apple Computer, Genentech and New York Air, are small, new corporations.

The history of mergers is Uttered with both celebrated successes and famous failures. Large companies have often offered special expertise to smaller firms that they absorb. When United Technologies bought Otis Elevator for $500 million in 1976, the parent company's skilled technicians significantly improved the design and manufacture of its newly acquired products. Other mergers have been much less successful. LTV Corp. was one of the highest flying firms of the 1960s, but its forays into businesses as wide-ranging as prescription drugs and sporting goods drove it to the edge of bankruptcy. The company's turn-around to financial health began after it sold off several of its acquisitions and concentrated on the manufacture of steel and a few other basic products. Recalls Paul Thayer, who is now LTV's chairman: "We had been a conglomerate mess to say the least. We had no corporate understanding of the businesses we were in."

One of the most serious charges leveled against mergers is that they channel money away from productive capital investment. Instead of building new plants and providing new jobs by developing new or better products, so the theory goes, companies are now all too eager to buy the existing factories of other firms. Many corporate executives see the key to growth as acquisition rather than innovation. Complains Walter Adams, a professor of economics at Michigan State University: "Mergers don't create new factories or add new employment. Oil companies say they need profits to expand in gas and oil. That's persiflage. What they really want is to diversify through acquisitions and get into other industries."

If the merger momentum continues unabated, the public could demand congressional action to curb takeovers. Two years ago, Democratic Senators Howard Metzenbaum of Ohio and Edward Kennedy of Massachusetts introduced a bill in Congress that could have prohibited mergers between companies with assets of $2 billion or more. If sentiment against mergers grows, they stand ready to introduce that legislation again.

A rush to pass such an arbitrary limit on merger size could be a serious mistake. Says Justice's Baxter: "Mergers are a very important part of the functioning of capital markets, and one has to be very careful about a simplistic and sweeping reaction to merger surges."

Such action would severely limit the Government's prerogative to judge each merger on its own merits. Many mergers no doubt create highly efficient firms that deliver low-cost products to consumers, while other corporate marriages are hastily conceived and poorly executed. No merger is intrinsically good or bad. It must be considered on the basis of the two corporations involved and the industry in which those firms operate. Small is not always beautiful; big is not always bad.

American companies, like the U.S. economy, can and should grow both larger and stronger.

--By Charles Alexander.

Reported by Evan Thomas/Washington and Frederick Ungeheuer/New York, with other U.S. bureaus

With reporting by Evan Thomas/Washington, Frederick Ungeheuer/New York

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