The Great Takeover Debate

By John Greenwald.

As takeover mania continues to sweep through corporate America, a heated and growing debate has begun to rage along with it. On one side are those who declare that giant mergers and fights for the control of companies have been a boon to the U.S. economy. On the other are critics who contend that the takeover wars have enriched a handful of speculators while crippling target firms and wounding entire industries.

It is not a debate of the meek or mild, and in recent weeks the opposing voices have grown increasingly strident. "I think corporate raids are an outrage and a bloody scandal," says Lane Kirkland, president of the AFL-CIO. "The object is for somebody to make a killing, pure and simple, and I see no virtue in it at all." Counters Minneapolis Investor Irwin Jacobs, who has made runs at targets as varied as ITT and Disney Productions: "We're really not a bunch of big, bad wolves. Mergers and acquisitions have created a great deal of value."

New takeover skirmishes last week added fresh fuel to the controversy. In Texas, T. Boone Pickens, chairman of Mesa Petroleum, announced an $8.1 billion offer for Unocal, the twelfth largest U.S. oil producer. Pickens and his partners, who announced in February that they were investing in the California company, now hold more than a 13% interest and are seeking majority control.

Acquisitors Carl Icahn and Sir James Goldsmith were also on the prowl last week. Goldsmith, who controls Grand Union supermarkets and France's L'Express magazine, formally offered more than $800 million for up to 70% of Crown Zellerbach, a forest products company that has been fighting off the interloper since December. The day after the Goldsmith proposal, Icahn said he would pay $305 million for 51% of Uni-royal, a tire and chemical manufacturer, which immediately spurned the deal. The moves were only the latest in an increasingly frenzied round of takeover brawls and mergers. Last month Capital Cities Communications agreed to pay $3.5 billion for the American Broadcasting Cos. in what was then the largest U.S. merger outside the oil industry. That record was topped two weeks later when Hospital Corp. of America and American Hospital Supply agreed to a $6.6 billion marriage. Meanwhile, companies ranging from National Distillers to CBS have become rumored takeover targets. Says Felix Rohatyn, a senior partner in the investment banking firm of Lazard Freres: "The takeover game as it is practiced today is really a little like the arms race. You have to stop it before it gets out of control."

The latest merger wave has been the largest in U.S. history when measured in dollars. Inflation-adjusted figures in the Council of Economic Advisers' current annual report put the value of corporate combinations at $133 billion in 1984, vs. $112 billion in 1968, the previous peak year. While there were nearly twice as many mergers in 1968, the sizes of the transactions were much smaller.

The surge of megadeals has drawn Congress into the debate. Two committees held hearings earlier this month on the merger epidemic. So far, more than half a dozen bills have been submitted to regulate takeovers. Says Senator William Proxmire, a Wisconsin Democrat: "The rising tide of hostile takeovers threatens the very foundations of our American business system. They undermine productivity, wreak havoc on entire communities and saddle well-managed companies with billions of dollars in excessive debt."

Corporate raiders naturally view their highly profitable activities in a far more positive light. Says Jacobs: "Mergers occur in situations where a company is undervalued. There hasn't been a single so-called raid that didn't create significantly increased stock values." Takeover artists like Jacobs and Pickens delight in pointing to the jumps in the share prices of companies they go after. The value of Gulf Oil, which Pickens began stalking in October 1983, nearly doubled, from 41 per share at the time to 80 after Chevron agreed to acquire it in March 1984. Mesa and its partners made $760 million on that deal. The stock of Unocal has climbed from the low 30s, when Pickens first began buying it in late January, to 48 5/8 last Friday.

Economists agree that takeover fights benefit investors. "The empirical evidence is clear," says Eugene Fama, a professor of finance at the University of Chicago. "In mergers, tender offers and proxy fights, stockholders of the attacked company almost always profit." Concurs Theodore Keeler, an economics professor at the University of California, Berkeley: "In general, takeovers are a good thing. If there is no problem with competition, very few economists are going to say there is anything wrong with the merger."

But takeovers frequently have a dark side. While shareowners of target companies can reap big gains, investors in the acquiring firms may see their stock values fall. After Du Pont paid $7.8 billion for Conoco in 1981, the mountain of debt that Du Pont incurred to make the purchase helped depress the ! chemical giant's stock by 40% during the following year. Shares of Chevron dipped from 40 to 31 after the Gulf acquisition, and have recently been trading at about 35.

Such price drops are a symptom of what Unocal Chairman Fred Hartley sees as an unsustainable speculative boom. Said he in congressional testimony: "This bubble, like all bubbles, will eventually collapse, leaving the wreckage of ruined companies, lost jobs, reduced U.S. oil production, failed banks and savings and loans, and Government bailouts."

Experts on Wall Street and in Washington are particularly worried by the huge IOUs that corporate takeovers are creating. The tens of billions of dollars that companies have borrowed to make acquisitions or defend themselves from raiders will erode future profits and could prove a crippling burden in a business downturn. Warns John Shad, chairman of the Securities and Exchange Commission: "The more leveraged takeovers and buyouts today, the more bankruptcies tomorrow."

The willingness of banks to finance corporate raiding can strain long- standing business relations. Unocal last month sued Security Pacific, with which the company has dealt for 40 years, for providing credit to Pickens to buy Unocal stock. Among major banks, Chase Manhattan is the only one that refuses to extend credit for takeover fights.

Raiders often need little help from banks to launch their attacks. By issuing so-called junk bonds, which are not rated by investment services and typically pay up to 3% more interest than less risky securities, a takeover artist can tap a virtually limitless source of cash. "It says something about where we are in our financial system," notes Lazard Freres' Rohatyn, "when impeccable institutions buy something that calls itself 'junk' up front." Drexel Burnham Lambert, the Wall Street firm that was the first to use the securities in the financing of takeovers, estimates that some $7.2 billion of the $60 billion worth of junk bonds outstanding have been sold for that purpose. The rest were issued by new ventures and small- and medium-size companies that have found the bonds to be a convenient, if costly, method of raising money.

By far the biggest winners in the takeover wars have been the raiders and the advisers who arrange their deals. "We are talking about probably the most immense accumulation of wealth in history," says Andrew Sigler, chairman of Champion International, which paid $1.8 billion to acquire the St. Regis paper & company last year. "The robber barons look like corner muggers in comparison to the amounts that are now being made." One example: Michael Milken, the Drexel Burnham senior vice president who masterminded the use of junk bonds in takeovers, this year is expected to earn about $20 million for his creative financing. The investment bankers who worked on the Chevron-Gulf merger, at $13.2 billion the largest corporate consolidation ever, charged $65 million in fees. Last month directors of Mesa Petroleum awarded Pickens an $18.6 million bonus for his role in the Gulf battle.

Who pays for the vast windfalls that the raiders and their helpers make? To finance its acquisition of Gulf, Chevron raised nearly $11 billion through banks and other lenders. The $80 a share that Chevron paid then went into the pockets of Gulf shareholders, including Pickens and his partners. Pickens' gains thus came from the money Chevron borrowed. The California company was willing to go deeply into debt to pay more for Gulf stock than it had been trading for because Gulf was rich in oil reserves, tankers, refineries and other assets. Chevron believed that the various parts of Gulf were worth far more than the value that the stock market had placed on the company as a whole. Chevron thereby gambled that it would be able to manage Gulf's assets efficiently enough to make the merger pay. The company has already set about selling some Gulf operations to help retire its borrowings. Firms commonly use that tactic, called "asset stripping," after completing a takeover.

The raiders' astonishing profits not only seem scandalous to the general public but are particularly galling to labor leaders. Reason: many takeovers and mergers result in the closing down of suddenly superfluous plants and the dismissal of many employees who are no longer needed. "Employees are traded and bartered as chattel in the corporate wars for control and fast profits," declared a policy statement by the executive council of the AFL-CIO. "Workers' wages, working conditions, pensions and even their jobs are threatened by divestitures and takeovers."

The damage is hardly limited to employees. Says Bruce Smart, who recently retired as chairman of the Continental Group, a diversified packaging maker, after Investors Peter Kiewit and David Murdock acquired the Connecticut firm: "There are other stakeholders in a company beside the shareholders, and they all lose." Customers and suppliers can suffer as time-honored - relationships are severed. Communities may lose employers, residents and sources of taxes. In Pittsburgh, the former headquarters of Gulf, officials estimate that the shutdown of the company's facilities will deprive the area of $75 million in income and other revenues.

Buyouts can also shatter a company's culture, the vital web of traditions and methods of doing things that firms develop over the years. "There is what we call organization-specific knowledge that can be destroyed," says Michael Jensen, a professor at the University of Rochester Graduate School of Management. Though he strongly favors mergers for economic reasons, Jensen acknowledges that "the memory and culture of a company are very difficult and delicate matters."

Some experts assert that the takeover binge will soon burn out. "Like every mania, this one will correct itself," says Robert Pirie, president of Rothschild Inc., a Wall Street investment firm. Pirie argues that a colossus like IBM, the world's largest computer maker, is already off limits to raiders. "If someone took it over and split it up and then spent the cash elsewhere, he'd be destroying a national asset."

Opponents of takeovers are demanding congressional action. Among the measures being sought are tax revisions that would bar the deduction of interest on loans used to finance raids. Opponents also want an end to greenmail, the practice by which a raider launches a fight for corporate control and then agrees to be bought out for a premium.

Steps to regulate takeovers generally receive little support from the Reagan Administration. The Council of Economic Advisers declares that "there is no economic basis for regulations that would further restrict the merger and acquisition process." And while Commerce Secretary Malcolm Baldrige strongly objects to takeover ploys like greenmail, he asserts, "I am sure that a stringent surge of rules would be worse than the abuses that you have now, so I would just like to see greenmail taken care of." Baldrige believes that lawmakers will continue to condemn takeovers but are unlikely to agree on specific measures to combat them. While merger mania may perish of its own excesses, it is unlikely to be legislated away.

QUOTE: "I think corporate raids are an outrage and a bloody scandal."

--Lane Kirkland,

President, AFL-CIO

QUOTE: "We're really not a bunch of big, bad wolves. Mergers and acquisitions have

created a great deal

of value."

( --Irwin Jacobs, Investor

QUOTE: "The robber barons look like corner muggers in comparison to the amounts that are now being made."

--Andrew Sigler, Chairman,

Champion International

QUOTE: "In mergers, tender

offers and proxy fights, stockholders of the

attacked company almost always profit."

--Eugene Fama,

University of Chicago

Economist

QUOTE: "The takeover game as it is practiced today is really a little like the arms race. You have to stop it before it gets out of control."

--Felix Rohatyn,

Investment Banker

With reporting by Dan Goodgame/Los Angeles and Frederick Ungeheuer/New York, with other bureaus