Dangerous Merge

By Daniel Kadlec

A long-running trend in corporate mergers that has worked miracles for the economy is at an inflection point, stirring debate over how to distinguish true synergy from mere diversification. This isn't just semantics. Realized synergies between two companies create big cost savings and enormous shareholder value. Diversification typically steers the other way. It broadens a company's realm and adds revenue--and overhead. Synergy is the first word out of the CEO's mouth when a deal is announced. But when you look back, the record often has not been very pretty.

The past decade was different, marked by mergers designed to focus companies on a core business and drive down unit costs. Corporations unloaded subsidiaries worth $1.5 trillion in the '90s, according to J.P. Morgan. Mergers are not risk-free, as the overexpanded First Union has proved, but for the most part, banks buying banks--and utilities buying utilities and drugmakers buying drugmakers--has worked. And with so much focus on efficiency, these deals have done a lot of Alan Greenspan's job for him, reining in prices and inflation.

Any shift away from this trend is worrisome to me. Is there such a shift? I think there is, albeit a subtle one.

Consider consumer-products kingpin Procter & Gamble, which a couple of weeks ago stuck its nose into a three-way pharmaceutical fray involving Pfizer, Warner Lambert and American Home Products--hoping to come away with Warner Lambert and its cholesterol-reducing wonder drug Lipitor. P&G, maker of Cascade and Crest, knows about cleaning. But getting rid of plaque on your teeth and doing the same for your arteries are two very different businesses. Maybe that's why the P&G gambit fell apart last week. Still, this isn't the first time P&G has tried to branch out, an effort that's emblematic of companies needing to look beyond cost savings and their core business for growth.

It is not necessarily a return to the excess-ridden '80s or the dopey conglomerates of the '60s. But cross-industry takeovers hit a 10-year high last year, when 22% of companies taken over in the most acquisitive industries were not in the same business as their buyer, according to research firm Securities Data. That's up from 20.2% in 1998 and 12% in 1993.

Bankers are quick to defend the trend, noting that new- and old-economy industries are colliding as the world goes online. Disney buying Infoseek isn't cross industry, they argue. It's all media. Ditto AOL and Time Warner. O.K., but broadening the definition hasn't helped Disney execs better understand the Internet company it bought for $1.6 billion. The Mouse refocused its prize acquisition yet again last week. And while AT&T and its recent quarry, cable operator MediaOne, are both in the data-transmission business, it is a leap to believe the phone guys can manage cable assets.

Are there synergies? One hopes so. But these deals are less about the obvious benefits of economies of scale and more about positioning for a future that no one can clearly see. Maybe Disney's move is a good one. Prosperity in the new economy probably hinges on bolder strategies than cost cutting. But such deals--and the stocks behind them--are a gamble. Take the bet if you're so inclined. I'd keep at least some chips in this area. Meanwhile, there are plenty of companies still focused on keeping down costs, and those are the nearest thing we have to a sure winner in the market.

See time.com for more on merger trends. Dan appears regularly on CNNfn. His e-mail address is kadlec@time.com