In the late '90s, M&A was surging, and there seemed no rational reason it would slow any time soon. It's easy to forget those spring-like years of the second Bill Clinton presidential term, so different from the start of the second Barack Obama term, with its fiscal fears and deep unease. The late '90s certainly experienced economic shocks, but M&A dealmaking still seemed as inevitable as faster chips, higher markets and American-led globalization. The wild '80s, with its raiders, greenmail and junk-bond-fed circuses, had been tamed with new legal guidelines out of Delaware and a broader acceptance of some of its more aggressive innovations, such as high-yield bonds and hostile deals. Private equity had matured into an accepted part of the deal economy. Raw memories lingered - "Barbarians at the Gate" and Oliver Stone's "Wall Street" remained popular touchstones - but the arguments for an expansionary M&A regime were potent: efficiency, competitiveness, free and open markets and the preeminence of shareholder value.
In short, few people questioned M&A growth, if not necessarily year in and year out, then like a steadily rising tide, not unlike the equity markets themselves. Nearly everyone in 1997 thought there would be more M&A volume - more strategic transactions, more global deals, more private equity, more initial public offerings, more bankers and lawyers - in five years, and more yet in ten. It was difficult to imagine, short of a global meltdown, what would break its momentum. M&A was a key part of a larger expansion of finance taking place. And, despite the Asia crisis and Russian default, global meltdowns weren't in anyone's calculations.
What has that 15 years wrought? In many ways, the promise of that growth has been met. M&A levels have risen generally, with the big exception of the last four years since the 2008 crisis. (2012 is likely to be down from 2011). U.S.-style M&A has spread around the world, not only to Europe but to emerging economies as well. Private equity, despite the controversies, has become globally accepted, albeit in different varieties. Sophisticated M&A now occurs deep into the middle market - and M&A is a vehicle for integrating those companies globally. Hostile forays, not to say junk bonds, rarely raise an eyebrow. Innovations have continued to occur, but few are really disruptive or even potentially transformative. The rules of the game are widely understood. And most important of all, the notion of shareholders as owners - the bedrock governance concept that supports modern M&A - has, despite a series of tremors, remained intact, now an accepted part of corporate law and professional practice.
But it hasn't been easy. That intervening 15 years has seen two serious market breaks - one that flattened the tech industry and wreaked long-term damage to the IPO business, the other that threatened nearly everything else. M&A has been involved in these market breaks only indirectly; the euphoria that preceded these bubbles bursting drove deal values to unsustainable and, in retrospect, absurd heights, but M&A was hardly causative. M&A, both strategic and private equity-driven, survived, and believers in M&A continue to argue that it is a solution to our larger woes. But critics have re-emerged. M&A, they argue, has not produced prosperity. In some quarters, M&A is blamed for the loss of America's industrial might or for stagnation, technological or economic. Over these 15 years, investment banking clearly lost power at major Wall Street firms to traders, part of a longer evolution from traditional clients to market-centric relationships. Meanwhile, the fallout from 2008 has tied M&A ever-closer to the larger critique - exemplified by the attacks on Mitt Romney's Bain Capital from both Newt Gingrich and President Obama - of what's come to be called the "financialization" of the economy.
This is a complex argument, which has been present, in one form or the other, since the early days of the modern M&A regime, that is, the early '70s. In the last decade or so, it has erupted periodically in Europe, particularly Germany, under the banner of resisting the incursions of so-called "Anglo-Saxon capitalism." In 2005, the Germans debated the characterization of private equity as a kind of invasion of locusts. This wasn't all that different from the broader critique that goes back to the '80s in the U.S. and that resurfaced after 2008. Where does reality lie? The truth is various efforts to "prove" that robust M&A (including private equity) increases employment and growth quickly becomes an almost Talmudic argument, much of which is beside the point. In the end, it's impossible to quantify what never happened. Even if jobs rise after a buyout, how can we say that the company wouldn't have done even better without that change of ownership? (It works the other way around as well.) In the end, the argument is less financial than it is political. Besides, technical studies rarely convince the man on the street.
M&A has also suffered from self-inflicted problems. The '80s debate focused on the widespread perception that M&A was a destructive force of unleashed private interests, that is, greed. Particularly after the tech bubble burst, another critique surfaced: that M&A rarely succeeded even on terms set by its primary players, corporate executives. The poster child for this was the AOL Inc. (NYSE: AOL) merger with Time Warner Inc. (NYSE: TWX) in January 2000. In retrospect, this deal flashed many danger signs. It was famously (then notoriously) a transformative transaction: AOL was taking over traditional media conglomerate Time Warner. It was a deal that unfolded in an overheating market, particularly for tech; it was cheered in the media, in the markets and among the soon-to-be-pilloried Wall Street research community. It was enormous at $164 billion - and its integration was fantastically complex, with huge cultural differences, particularly between the startup mentality of AOL and the fiefdoms of Time Warner, with its publishing, film, TV and cable assets. It was a giant bet on so-called "convergence," driven by a belief in the transformational possibilities of the Internet. It was, as became apparent quickly, a massive disaster. Integration stalled; convergence failed; and, after the bubble burst, it became obvious that AOL, like so many dot coms, had a customer base that was not only difficult to monetize but also quick to flee.
AOL Time Warner eventually won the door prize as the worst M&A deal ever. (Was it? Everything is relative. Would it have looked so bad if the dot com bubble hadn't burst so soon after? Maybe. But timing is everything.) There were other stinkers in the last few years of the bull market, notably in hot sectors like telecom and media. But again, how do you judge? Companies, markets and M&A are far more complex phenomena than the raft of consulting and academic studies on M&A suggest. AOL Time Warner was ugly, but it's a very tiny sample.
Clearly, many deals do succeed, though how success or failure is measured and judged gets extremely technical. Dealmaking, like markets and the economy, is a dynamic process. The company that acquires today won't be the same company a year or two into the future, not to say in a decade. And like metrics about buyouts and jobs, or discussions of economic equilibrium, when you try to measure the effectiveness of M&A, you continually run into the "compared-to-what" problem. The yardstick of potential value is elusive.
Pfizer Inc. (NYSE: PFE), for instance, executed a whole series of major pharma deals throughout the '90s and the new millennium: Pharmacia Corp., Warner-Lambert and Wyeth, among many others. With research productivity lagging and major products going off patent, a now-gargantuan Pfizer eventually saw its growth stall and its profitability shrink, and it began to restructure. Was this a failure? For a very long time, shareholders didn't believe that. Moreover, how do we know how Pfizer would have fared without those deals? Could organic growth suffice to generate capital gains?
You can ask the same question in a larger context. Yes, M&A deals fail for a hundred different reasons, from executive grandiosity, to too high a price, to lousy due diligence and post-merger integration, to sheer bad luck. Uncertainty rules.
Every M&A deal is a bundle of risks. It's an art not a science. And, for all the disciplines and checklists, it always will be that way.
M&A can pad the shrewd CEO's already ample pay. But imagine a modern economy in a globally competitive world without M&A. Envision an economy only limited to organic growth. How much of GDP growth stems from M&A? No one really knows. But what we can say is that a corporate economy without M&A is slower growing and tilted to the very largest companies - not unlike the predominately industrial economy that existed up until the '70s. This kind of corporate establishment fits uneasily into a post-industrial, global and competitive arena.
What we can also know, in a more nuanced way, is that companies tend to do better M&A deals when shareholders impose discipline. That brings us to the role shareholders play in M&A. What would it require for the modern M&A regime to end? The answer, I believe, is that the current governance paradigm, which attained hegemonic status roughly around the time modern M&A emerged, would have to be displaced. M&A without the exclusive goal of share enhancement is a shadow of itself. Shareholder governance has taken some serious blows since 2008, despite efforts of the governance community to pretend that it was executives (and their proverbially Svengali-like Wall Street advisers) who simply ran amok. In fact, sophisticated observers understand how complicit shareholders were not only in the vast consolidation of finance over previous decades - the mega-firm, financial supermarket or universal bank model was, for many years, popular among investors, as Sandy Weill knew - but for the increasing appetite for risk and leverage, not to say escalating executive pay. Institutions have proven not only to be passive shareholders but ones that, if they are active, often favor taking on risk in diversified portfolios. And to make matters worse, the rise of indexing and speculative, algorithmic trading has made markets less sensitive to value creation. There is a snake in the garden of M&A, and it's called the shareholder.
Will there be a paradigm shift, like the one in the '70s that replaced stakeholder governance with shareholder democracy and that powered M&A over the next four decades? That's difficult to foresee today. Modern M&A is, by now, deeply rooted, not only in corporate law, but in regulation and policy. Yes, there is a deep flaw buried in the structure of modern M&A (and one, by the way, that is less relevant to private equity, which has other vulnerabilities, particularly on fees and taxes). The flaw is that shareholders have demonstrated that they're absentee corporate owners. But for all the ideological jousting of the recent campaign, neither political party seems eager to mess with the underlying basis of the current M&A regime. (Both support shareholder governance, usually for different reasons.) The changes that may be coming in a second Obama term will operate on the margins, tightening antitrust and bumping up the tax on carried interest. But given a still-divided government, it's a stretch to see something as central as the tax deductibility of debt, the linchpin of many deals, eliminated.
It is hard to dispute that M&A has matured, just as swaths of Silicon Valley have matured. But, even with a less rigorous antitrust policy, or reduced taxes, or greater economic certainty, it's difficult to envision the kind of M&A growth over the next 15 years that we saw in the past, particularly in the U.S. M&A practices have spread. But increasingly those overseas markets, such as China, Brazil, Turkey and India, are developing indigenous financial and legal advisers, private equity investors, markets and banks. Investment banking has already been displaced politically at the big banks, and M&A advisory services has been absorbed into a larger set of product offerings led by financing desks. Fees, like nearly everything else, will be squeezed.
The highest level of adviser who can reach CEOs will continue to command a high price. But generally, the business has grown routinized with corporations taking on more of the work, from analysis to execution, themselves. There are subtle distinctions, however, to keep in mind. Particularly in the middle market, with its larger number of private owners, private equity players and local advisers, governance problems may not loom as large, and smart advisers can make a huge difference. Big cap M&A turns on share prices; much of the middle market is driven by ample and reasonably-priced financing. Besides, given its size, the middle market, particularly at the lower depths, is simply less mature than the big cap universe. It's a huge and often opaque arena with a lot of companies and considerable growth potential.
Middle market aside, maturity doesn't mean the game is over. Not by a long shot. Merger booms and busts will continue, and high-profile deals will still occur and, if the economy and the stock market cooperate, the M&A numbers may do just fine. Until the day comes when companies no longer feel compelled by shareholders to exceed the reach of their organic growth, then this M&A regime will continue. And for all the problems, that day is not here yet.
The first big break: Failure of the United Airlines LBO in the fall of 1989 marks the start of recession and a major setback for M&A. Drexel Burnham Lambert collapses, Mike Milken goes to jail, and junk seems dead. It's not, and M&A roars back.
High tide: Clinton second term sees new highs in M&A volumes. Glass-Steagall dies, the dot com bubble inflates, and 9/11 looms. When the smoke clears, M&A crashes with the economy.
The golden age: Private equity drives M&A volumes, setting new highs in 2006. Unfortunately, dead ahead is a subprime crisis, a credit crunch and Lehman Brothers.
The age of uncertainty: M&A ticks along sedately, after a surge in the first half of 2010. The problem: political wrangling, fiscal cliffs, Europe in crisis and a slowing China.
Robert Teitelman is the founding editor-in-chief of The Deal LLC, a New York media company focused on financial dealmaking, which began life in 1999 as a daily newspaper backed by New York private equity firm Wasserstein & Co. In 2012, TheStreet Inc. (Nasdaq: TST) bought The Deal for $5.8 million. Teitelman continues to do consulting with TheStreet, blogging at the HuffingtonPost and is working on a number of writing projects in finance.