The M&A Imperative In the Age of Turbulence

S peed counts for companies that want to survive the myriad challenges of the 21st Century. Proliferating technological achievements, rapid expansion of competition to global scale, pressures to gain optimal size, and investor demands for premium stock values can overwhelm the slow of foot. It’s an environment, say m&a professionals active in the field for the last two decades, that casts m&a as the developmental mode of choice for businesses around the world. M&A: In the early ’80s, m&a seemed to come out of nowhere after a pretty fallow period in the ’70s. Why did activity take off the way it did? Ritch: One of the reasons was just where the market was. In the early ’80s the Dow was at roughly 1,000 and companies were trading at five times after-tax earnings. It didn’t take a rocket scientist to find a lot of value in that kind of an era, and that has a lot to do with it. We also had the end of hyperinflation, the Reagan economic boom, the accompanying bull market, deregulation trends in the U.S. and eventually in other countries, and the development of the junk bond market. There were just a whole bunch of different forces that led to the m&a action that we all saw. Warren: The inflation rate as measured by the CPI in 1979 was 13.3% and the prime interest rate on Jan. 1, 1980 was 15-1/4%. A recession started in 1980. The economy was at a low point where things were going to get better and activity was going to take off. Focusing on the middle market – which I would define as transactions in the price range of $10 million to $20 million at the low end to $100 million to $200 million at the top – there were some interesting developments. It was in the 1980s that you began to see the sell-off in numbers of some very good companies that had been started by World War II veterans after the war. You also saw the beginning of the private equity markets and venture capital or buyout firms. In 1980, that smaller market was poorly organized. It evolved from bootstrapping by an individual into the leveraged buyout transaction and the private equity firm. I remember presenting seminars with pioneers like Nick Wallner and Louis Kelso on how to do LBOs. In March 1980 I was part of a group of Americans that presented the first LBO seminar in London. We were speaking mostly to lawyers and investment bankers who wanted to emulate what was happening in the U.S. and start that industry in Europe. And just as it was in the public markets, there were some real bargains in privately owned businesses because there were a lot of profitable, low-growth, middle-market companies that were available for prices below book value. Atkins: I don’t think there was exactly a move from zero to 60, or zero to 100 miles per hour, that came out of nowhere. I think some building blocks were already in place, such as so-called “bootstrap acquisitions,” which basically were LBOs in their early stage. In the mid-’70s, for example, we saw the rise of the hostile takeover and the hostile tender offer. It made the tender offer a vehicle for unsolicited bids, which changed the whole character of the m&a world. It also created a reaction that you might call the fear factor in Corporate America, which was expanded initially by the corporate players and later by the financial players in the ’80s. In response to hostile bids, and even to anticipate them, companies sort of geared up to do their own thing on the m&a front. Another factor that started in the ’70s, and certainly moved with more force in the ’80s and the ’90s, was the entire change in the shareholder base – from retail to institutional and subsequently to the much more activist institutions as time went by. And, obviously, the junk market in the ’80s was a major factor in creating financial firepower to do deals. Krieger: There also was the recognition that size counts, that size matters. Many potential buyers were propelled by the notion that it was easier to expand market share by acquisition than by building from scratch. A second factor is that an increasing source of fuel to the market today is that ample sources of currency became available to do deals. Strategic buyers had a very ebullient equity market. This provided a rich equity currency that allowed public companies to increase market share by acquisition. Meanwhile, the easing of credit coupled with the creation of enormous pools of private capital created fuel for private buyers, and private buyers also were encouraged by the ebullient equity markets. Rising stock prices convinced the private buyers that they had relatively rapid exit mechanisms which weren’t so readily available in the ’70s and early ’80s. On the strategic side, you had the equity. On the leveraged buyout side and private equity side, you had cash. The vibrant economy has induced a rise in expectations. Then add to this sense of optimism the globalization of the economy. This increased the number of eligible buyers, and potential targets, by a huge degree. Needham: Inflation played a major part. Hard-asset companies witnessed significant appreciation in their underlying assets as a result of inflation. This value was not often reflected in the stock price. Accor-dingly, these companies attracted rai-ders who tried to purchase these undervalued assets and sell them off at their appreciated value. Re-member the phrases “entrenched management” and “asset arbitrage”? The only protection against raiders was for the target company to increase its debt, and the easiest way to do that was by acquisition. Accordingly, debt was king and the junk bond market responded. In 1978 the capital gains tax was reduced significantly. This gave birth to the venture capital boom, which then migrated to the LBO boom. The owners of privately owned companies could now sell and realize a larger portion of the proceeds. The Reagan tax cuts also spurred new investment. Then you had the wild rush by the S&L industry and other financial institutions seeking higher and higher yields. These S&Ls became one of the major sources of money for the LBO industry and provided the junk bond industry with its seed capita, and these junk bonds became the currency of the raiders and LBO industry. Cotter: I think there was a new sense of stability that really captured the mind-set of Corporate America and, in many ways, Wall Street. That was because there was an economic stability that the country was beginning to see for the first time in a long time, created by the decline in inflation and the administration’s effort to deregulate and privatize the economy, among other things. It was being captured not only in the United States but also throughout Europe. There weren’t any big wars taking place around the globe, which was quite remarkable, and people talked a great deal about the peace dividend. When you find stability captivating the marketplace and captivating the mind-set of the boardroom, you find people willing to move in a direction that they hadn’t moved in the past and to adopt a sense of external growth as opposed to pure and simple internal growth. The sense also was captured by the capital markets, and a free flow of capital began to rise. The junk bond market and what was taking place in the private equity market were offshoots. Remember when we started in this business and we used to talk about break-even trading days for the Street? In the late ’70s, we estimated that to break even on back-office expenses, we needed 20-million-shares days or something like that. Today we are we are at one billion shares plus on the New York Stock Exchange, on top of Nasdaq, which for all intents and purposes didn’t exist during the mid-’80s. All of this grew out of the sense of confidence in the marketplace in the 1980s and people’s ability to realize value in whatever sense – the public market, the private market, the debt markets, or the equity markets. Lederman: During 1975 and 1976, the Dow Jones Industrial Average was about 600. Oppenheimer & Co. was doing what we called “Oppenheimer transactions.” They would buy the assets of company at under book value and give a premium over the market to the stockholders plus a refund from the government for selling the assets at a loss. They used the proceeds remaining in the company to set up a municipal bond fund. That type of transaction gives you a sense of the marketplace at the time. Today, people cannot believe that anything will sell for under book. These were companies with hard assets. Around the same time, people became comfortable with leverage and combined that with the search for value. So, in 1977-1978, Kohlberg, Kravis, Roberts acquired Houdaille Industries and a year later Forstmann, Little bought Union Ice. There seemed to be an infinite amount of leverage. On Houdaille, the price was $350 million. Kohlberg put in $25 million – part of which was its fee. I was teaching corporate finance at NYU Law School then and I am looking at cases in which we are determining whether a debt-to-equity ratio of 1-to-1 is good or bad at interest rates of 3.5%. By the early 1980s I was doing leveraged buyouts with interest rates of 22% to 25%. This grew from a very, very depressed equity market and allowed KKR, Oppenheimer, and Forstmann, Little to work on deconglomerating America. So, it didn’t all start at once. There were several driving factors: a very depleted equity market, enormous amounts of liquidity, and the need to redo Corporate America. Lewkow: There were ups and downs during this period. When the high-yield market basically came to an end and financial hostile bids disappeared, there also was a sharp reduction in the strategic deals that people were doing often to avoid a possible hostile financial bid. So, we went through a relatively fallow period, but m&a activity picked up again with the improvements in the public and private equity markets. There were a lot of opportunities during a period of relatively low antitrust enforcement. People saw that strategic deals worked and that big was good. You could accomplish things by growing bigger. Synergies were being realized, at least some of the time. With a well-timed acquisition you could acquire strategic assets and prevent your competitors from acquiring them. Targets also were more receptive to the concept of a merger of equals as a way to avoid having to make some tough decisions. Mergers of equals are hard to do but they can create value for shareholders and keep executives happy as well. Stern: Inflation was mentioned, and I believe that it was a factor. As inflation abated, growth for a number of companies slowed substantially. Mergers and acquisitions became the vehicles to provide growth. In August 1982, the Dow Jones Industrial Average bottomed in the 600s. Moreover, the private equity market was just beginning to flourish. Private equity sources were essentially providers of liquidity. The first LBO sponsors were buyers of businesses whose owners had no other option. Larry mentioned the Oppenheimer transactions, which were designed to provide an exit for owners who had taken their businesses public during the late ’60s and were still frozen in their ownership positions 10 years later. M&A: Even when m&a activity was starting to increase, it was, as you have described, one of several development or investment choices. Why have we reached the point where today, m&a is likely to be the preferred choice? Atkins: Speed and scale. Today, the pace of change is enormous and the size of the change and expansion necessary to compete in today’s world often is at such a large scale that if you spend the money and build, you just don’t get there in time and you don’t get there in size. So, the solution is m&a in its broadest definition. But there is a change in the definition of m&a as well. It is not just “buy a business” today. M&A now also includes establishing a joint venture, creating an alliance, carving out something that creates value, or a combination of all those things. Krieger: The current vitality of m&a activity is in large part stock market-driven. Plus, it is widely accepted in many industries that there is a faster payback if you buy rather than build. Acquisitions are thought to provide quick synergistic savings or growth in market share, and thus provide a fairly quick and dramatic payback in the early years, at least theoretically. Cotter: Historically, people used to treat acquisitions as simplistically as capital budgeting. They learned over time that they involved far more than simple capital budgeting decisions. During the ’80s, in fact, when we went through that enormous period of restructuring, people learned to take costs out of the business. It was during that period that synergies really became something of a buzzword. They learned how to create tremendous value by taking costs out of the business. That was important in letting people reach decisions in terms of what they were prepared to pay for an asset. Before they understood what restructuring really did, they couldn’t pay as much as they did later. On top of that, we saw the phenomenon of the development of the global marketplace. You can’t afford to wait in creating the critical mass that you need to build value in the future. Today, people are attuned to realizing that critical mass and economies of scale to compete just in a U.S. market or North American market are inadequate, because now we are competing in a much broader and more global sense. Needham: Plus you have the currency. High P/E stocks make it easier to do deals and larger capitalization stocks provide the liquidity that makes it attractive to sell to them. I agree that speed of building a worldwide company is paramount and acquisition is the way to do it. As industries consolidate and grow, smaller companies have to track that growth. Acquisition is the route that they are taking. I find it interesting that it is often easier to put companies together now with the advancements and commonality of operating software. Sort of “plug and play.” Stern: That’s true. Targets that at one point looked expensive when trading at six times cash flow subsequently looked attractive at a nine or 10 times multiple because the acquirer had the currency to make a nondilutive acquisition. Let me add one point regarding size. Scale is needed not only to compete but also to service your customer. If your customer keeps getting bigger, the little guy must bulk up in order to remain a key supplier. In some cases, acquisitions are made as a means of staying competitive with key customers. Lederman: In this marketplace, people cannot innovate fast enough. There is an enormous need for other people’s innovations. We used to think that in Corporate America the great corporations like IBM could perpetually create their own innovations. That is all gone by the wayside. IBM almost wound up as a shell and it had to reinvent itself. It had to bring people in from the outside to be able to do it. It had to start to acquire and do all kinds of transactions. The fact is that there is an enormous amount of innovation out there. An enormous amount of need for cross-fertilization on one level – given the rise of the “new economy” – is really driving it. In addition, people have built brands – which are really intellectual property in some respects – and have put a lot of money into gaining market position and market share but haven’t achieved the best results. With all of Philip Morris’ marketing ability, it was not able to make out of Kraft what Nabisco was and it lusted after Nabisco. Now it is a perfect acquirer for Nabisco. So, all of those forces come together. Overall, this is a marketplace where people have to bring things together. Needham: The stock market is rewarding growth more than anything else. In the ’60s, ’70s, ’80s and ’90s market share was the mantra. Today it’s growth. Market share in the old economy is still attractive to me, and that is where opportunities may still exist. If you can combine both market share and high growth, you have the mantra of the new economy. Warren: Market share is not an end in itself. You have to have growth and new products or services. If you dominate the market in the old economy, which is threatened by e-commerce or other technological changes, you are not getting rewarded. Ritch: Right. If you have growth today, you have a virtuous cycle, too. It used to be that in making m&a moves, decisionmakers were after a combination of consolidation and the first mover advantages. Now, companies like Cisco want that and more. They make acquisitions in the high-growth areas in which they have expertise and aggressively go after synergies. Each successive deal seems to throw more gasoline on the P/E fire. It is like the ’60s in a certain sense because the high P/E guys keep buying the low P/E guys. Each time you do one, the market gives you more credit. M&A: How big is big? Or how big is optimal? First Union has announced a restructuring and other companies involved in megamergers are considering cutbacks. Is there a threat that some of these businesses will become too unwieldy to manage? Lewkow: I don’t think First Union is an example of size. First Union is an example of what you buy. No one will say that acquisitions per se are good. You have to know what you are buying and it has to fit in with your strategic plan. With wonderful 20/20 hindsight, we might criticize some acquisitions, and certainly a lot of people had questions about First Union’s deals, even at the time they were made. But they did not involve great examples of size. There are a lot bigger deals out there, including many in the financial services industry. Krieger: How big a battleship do you need to win the next battle? It depends on the kind of war you want to fight. Cotter: I don’t think that you can say that there is one size that fits all. Ritch: Especially with the dismantling of supposedly strategic acquisitions. Lederman: The ego of the ’60s was that the managers could manage a cement company and a brassiere company and a rocket company all at the same time. The idea was that the top financial guys were so good and so adept that they could basically manage the resources of a conglomerate enterprise. We found out in the ’70s and ’80s that they didn’t know what was going on below. They just didn’t know. They were never integrated. We are going to see the same thing now. Just because you carry cable doesn’t mean that you can make movies. Just because you can market cigarettes doesn’t mean you can market something else. If you are a bank, it doesn’t mean that you can be a merchant bank or whatever. Needham: You need to keep up with the rapid pace of change today. I believe that most product and technology innovation is done at small companies. But, these small companies often do not have the resources to market their innovations. Ergo, there is a compelling need to sell to larger companies that can provide the distribution and capital necessary to capitalize on the innovation of the small companies. At the same time, these larger companies will be selling off the tired business units to smaller groups and have them rejuvenated. Sounds like an m&a ecosystem cycle. Lederman: At one point, people used to say that the whole is worth more than the sum of the parts. And then the parts were worth more than the whole. When the market starts to look at these companies and it says that the pieces are worth more than the company as a whole, you are going to start to see breakups Ritch: Actually it is complicated. The market will afford high multiples to certain companies like GE, Tyco, or Danaher because the market has confidence in these management teams. Further, analysts who follow these companies know that on a division-by-division basis, they are comprised of market-leading businesses, frequently with high-margin and noncyclical attributes. Warren: I am sure we will get around to talking about why mergers don’t always work. It often comes down to leadership and people. The question is whether the management is capable of running the merged company at a particular size. Cotter: There has to be a theoretical limit in terms of what size business any group of individuals can in fact effectively manage. But I would argue that the value-creation opportunities in creating size even now are so enormous that they can’t be neglected. Let’s say there is a $36 billion deal with a price of almost 15 times EBIT-DA and opportunities for cutting costs by a billion dollars. If, in fact, the companies are right and they can create over a billion dollars of synergies, they are also creating at least $15 billion of value creation in that transaction. M&A: There have been several studies, mostly based on stock prices, that conclude that most mergers are unsuccessful. After years of dealmaking experience, why do we still have such a high failure rate? Stern: This is failure postacquisition. You just mentioned First Union. The company wrote off a very large investment in the Money Store. I guess it was Warren Buffet who said you can take the world’s greatest manager and put him or her into a business with bad economics and the business economics will win every time. There is no way around buying a bad business. Sometimes businesses get bought for supposedly strategic reasons. Sometimes the definition of strategic is tied exclusively to the fact that the transaction is not dilutive to earnings. In my experience, I have never seen an acquisition that at the end of the day succeeded or failed solely because the price was right or the price was wrong. Lewkow: If you go through the statistics, you can find all sorts of things. If you look at the specifics and you compare acquiring companies with peer groups, you will find that there are significant numbers of companies that underperformed. Yet, the economy and the stock market as the whole have been very successful and m&a has been a major part of everything that is going on. Substantial values have been created for shareholders in an environment where there is not just one or two m&a transactions but thousands of m&a deals. M&a couldn’t have been an abysmal failure or we wouldn’t have the stock market prices that we have today. Atkins: It certainly is true that one of the measures of failure is whether the stock price of the acquirer or combined company has gone down from one moment in time to another after the transaction. I think there are actually a fair number of companies that have succeeded in doing what they planned postacquisition, but they got caught in the downdraft of the old economy versus the new economy valuations. I have a bunch of clients who are just killing themselves because they are doing fine after they have made acquisitions. But nobody is giving them credit for that. So, I believe that decline in stock price is not necessarily a judgment of success or failure. On the other hand, two notable measures of failure to me are, first, when a buyer didn’t know what it was buying, which is a due diligence function to a large extent, and, second, when postacquisition integration efforts are ignored or poorly conceived and/or executed. These failures often are causes of poor stock price performance. There is a large variation in the quality of due diligence in m&a today. Some people are very good at it, some people are very bad at it, and some people don’t care about it at all. There also are people who are very good about focusing on getting an integration plan in place and understanding what to do with it. And there are people who have no real understanding that once you get two companies together you actually have to do something with them. Realization of acquisition benefits won’t just happen if you don’t have a team that understands that you have to bring culture together and bring operations together and make them work, and spend real time on the plan after the closing. It doesn’t start at the closing; it starts before the closing, so there is a plan that is ready to go. Lots of companies that can do that have had good successes. But amid the hype of doing a deal, that stuff can get lost in the aftermath of the signing. Later, people say, “Gee, why didn’t it work?” Well, it didn’t work because nobody designed it so that it would work. Warren: The key to it is integration – sweeping up after the big parade. Too many acquirers focus on the financial dimension and ignore the operations dimension. At today’s pricing, an acquirer can’t ignore squeezing out the last drop of synergy. When the CEO moves on to the next acquisition, there have to be people there who are really going to make changes in combined business according to a well laid-out plan. In the manufacturing and distribution sectors, where our firm does a lot of work, our most successful acquirers bring key operating people into their acquisition teams to plan and execute the integration between the two businesses right up front. Speed counts. If you delay the key changes, bad things happen. People leave, and you never get the chance to make up the opportunities that you let slip by. If you are going to achieve cost savings, you should move as quickly as possible. Krieger: How much of the problem is due to the optimistic announcements made early on about the anticipated synergistic savings that would be achieved and the time frame in which they are expected to be achieved? I think we are seeing some skepticism about this in the stock market today. Often, that is why the acquirer’s stock gets whacked when the parties come out with the deal announcement. There seems to be some healthy skepticism about the feasibility of achieving the synergies in the time frame projected. Without the synergies, many deals that are promoted as attractively accretive tend to look less promising the morning after. We all know that the stock market is a short-tempered lover. Atkins: The market isn’t stupid. There was a period of time when every equity combination was treated well, but that has changed. The acquirer would tell its story on day one, and the next thing you know it is not enough. Six months or a year go by, and people realize that what has been promised isn’t being delivered. Now the market is much more likely to say, “Okay, show me.” The whole psychology is changing. Lederman: Well, I think there is more to it. I think that the market is, in fact, very mercurial. If you don’t deliver in the marketplace, the market punishes beyond belief. The fact is that if you are off by 5%, you may get punished by 25%. Stern: The way the market reacts to m&a transactions is really a subset of the overall market tone. When the overall market is strong, transactions tend to be viewed bullishly, and acquirer stocks react positively on an announcement. Most of the time, however, the market looks at proposed transactions with a big question mark. If you think about it, the outcome of m&a transactions can be described the same way Woody Hayes discussed the prospective outcome of a forward pass: three things can happen and two of them are bad. In bull markets, investors often bet on one-in-three odds. In more normalized markets, such as we have at the moment when the market psychology is not decidedly bullish, investors look askance at m&a transactions. Needham: I think that something has happened in the market that is significantly different than it has been in the last 15 or 20 years and that is the rate of change today both in products and distribution. This creates a problem for due diligence because you can’t do due diligence on your customers when these customers do not know how their own market is changing. Take the telecommunications market. You have a limited number of end customers, which mean that market share comes and goes in large chunks overnight. This is going to force a change in deal structuring: more equity to provide for the increased risks associated with rapidly changing industries and customer concentration. For the LBO community, this will probably force quicker exits to accommodate their IRR requirements. M&A: What m&a implications do you see from the supposed classification of the old economy versus the new economy? Are we in a situation where regardless of how well an old economy company performs, it’s still not going to be rewarded, whether it’s on acquisitions or anything else? Needham: I see old economy deals coming in and it’s often difficult to remind yourself that they are still making money with probably less risks than the sexier, new economy companies. The public market is just not rewarding solid old economy companies because they don’t promise that lure of high growth. Over time they will migrate toward one another because at the end of the day you have to make and sell products in the most efficient way, and that requires elements of each economy. The new economy deals will require more equity to accommodate the increased risk and the funds to finance growth. Lewkow: There are a lot of so-called “old economy” companies, particularly ones with smaller market capitalizations, that are trading at low multiples but are perfectly good companies. They have steady cash flows and steady earnings but the market is just not interested, especially in the smaller companies with limited liquidity and very limited analyst coverage. The employees can’t be incentivized with options because the stock does not have significant upside potential. What you are starting to see now is that more and more of these companies are looking into going private. Management buyouts are inevitable, although the decline in the availability of credit is interfering with that process. Stern: I agree that we will see more management-led going-private transactions. Let’s not forget that there is risk in announcing a going-private deal. Management is putting a price on the company at a time when there may be no intention to sell the business to a third party. Lederman: But when the multiples go down and the market doesn’t appreciate the value of the company, people do take them private. My good friend Lewis Cullman made his fortune from the “A Week at a Glance” calendar. With all of the computers that everybody has in their pockets, why do they need a calendar? Well, the calendars still sell, and it is a cash flow business beyond belief. It just churns out money. The point is that when the market depresses the stock, we wind up taking them private. All the LBOs are originally developed on the basis of declining-asset companies whereby you could leverage them up and then you could milk them. Obviously, there is going to be a new economy. Are there going to be companies that are not going to be winners in the marketplace? Yes. What is going to happen to those companies? They are going to get reacquired. There are two levels of acquisitions going on. There are the big public marketplace acquisitions, which are in consolidating industries, and there are other kinds of acquisitions that have to do with private capital finding a niche for itself and making money. Atkins: How many times have you seen euphoria followed by a reality check? It is going to keep happening. The dot-coms were the darlings of everybody and all the institutional money had to have a piece of them. A lot of retail money also went into that sector, and it was just feeding on itself. Then somebody woke up – surprise, surprise – and said that they are only growing sales and maybe they will never make a penny. And by the way, why are we valuing these companies at some infinite number of earnings that don’t exist? It is not a bad question. For a while people were hoping that they would all be panning out in some way. There was immediate value for everybody — an awful lot of trading and getting in and out. Over the long-term, that can’t be sustained. It has never lasted over time in the past and it won’t this time around. So, we probably will wind up with something like a middle economy populated by the survivors when the field matures. Krieger: At my firm we are doing a lot of deals in which the old economy is investing in the new economy. I think the distinction between old economy and new economy is a bit artificial. Many old economy companies are morphing into new economy businesses. There is a transition that is obviously going on. And we have to remember that the new economy isn’t just the Internet. New economy things are happening all over. The new economy is also making old economy factories more efficient, providing high-tech productivity gains. E-commerce is important, but let’s not fool ourselves. That’s only a small piece of what is happening in our economy. The GEs, Exxons, and Citibanks of the world are not sitting on their hands. They are major factors and major investors in the new economy. Lederman: It is also retooling, in a certain sense. We’ve had cycles of retoolings. Mellon grew when it helped finance the retooling of the Rust Belt. All these old businesses have to retool and basically get themselves in position so that they can distribute better. I represent some pharmacy companies that have moved their distribution to the Internet, for example. Warren: But in some industries like distribution and logistics, it is a lot easier for companies that have the fulfillment capabilities or the bricks in place to obtain what they need to be a new economy company by either acquiring or allying with some kind of interface on the Internet. Needham: That’s right. I see manufacturing being separated from the guys who sell in the businesses. If you are in a fast-moving business and your customers are changing, you can’t afford to be completely integrated, because things are changing too fast. The last thing that you want is a 450,000-square foot plant that you have to keep busy. You ought to be able to farm it out to somebody else who is doing the manufacturing and has a whole different set of economics. Ritch: You’re right. Contract manufacturing seems to be popping up all over the place. It’s not just electronics and computers anymore but pharmaceuticals, you name it. Stern: I agree that a company with scale can be successful as an outsourcing manufacturer. I interpreted the thrust of the old economy/new economy question more cynically. Some of the largest transactions announced in the past year have been a new economy company taking advantage of a high valuation to acquire hard assets. America Online’s acquisition of Time Warner and Qwest’s acquisition of US West are two good examples. Ritch: Just because you have a wire doesn’t mean you can produce a movie. At some point when the market stops rewarding those combinations, people are going to turn around and ask, “What are the relative values of the enterprises?” Remember when the airline companies decided that they basically were not in the airline business but rather in the transportation business and the real estate business? They wound up with hotels and car fleets. Those assets became more valuable than the airlines and they had to get rid of them. M&A: Acquisitions are used to fulfill a variety of purposes. Over the next several years, what do you see as the primary purposes and goals of m&a? Do you expect more dealmaking in sectors that haven’t had many acquisitions in the past? Ritch: Globalization is one purpose. It is on the minds of many of my clients around the world. One example is the automotive sector. All the original equipment suppliers think they have to be everywhere, that they have to be in all the major markets in the world, whether it is through outright ownership of assets or joint ventures. That wasn’t true for most of the last 25 years. Many people had nationalistic blinders on. We had a number of clients in Europe who did acquisitions in the U.S. but, frankly, they were the exception to the rule. Today, everybody in the automotive industry is scrambling to be everywhere. And it is not only in automotive but in many other industries. Lederman: The utility industry has enormous growth potential and it is deregulating. That industry is about 10 years behind the rest of the economy in restructuring, but it has come along very, very rapidly. You are going to see even more massive changes, with mergers and acquisitions playing a big part. Lewkow: One development that has created interesting opportunities is the use of tracking stocks. People have used them to make acquisitions and get separate valuations for subsidiaries as independent entities even though they are not independent. There are a lot of negatives as well as positives to tracking stock. It is not for everybody. Stern: Two trends already mentioned will clearly continue in the future. The first is the rationalization of excess capacity. We have seen this in the utility, food products, and financial services industries. The other trend is globalization. It was said before: Enterprise is no longer governed by geographical boundaries. I am amazed at the sheer size of the transactions we are seeing – $20 billion, $40 billion, etc. Some recently announced acquisitions are bigger than the GDP of small countries! I believe that the need for earnings growth and overall competitive position will continue to be strategic drivers. While a small number of announced transactions have been challenged on competitive grounds, the authorities have been reasonably accommodating. This is a far cry from the ’70s and ’80s, when size alone was a major stumbling block. I used to work with Federated Department Stores, which, I believe operated under an FTC consent decree in the 1970s. The suggestion of acquiring Allied Stores (merged in the late 1980s) or Macy’s (acquired in the 1990s) would have been laughed at. In the 1970s, it would have been deemed a waste of time even to dream about such a major consolidation. Lederman: I was working on a little deal which was held up by the regulators for more than three months. The target is Carson, which makes black hair care products, and L’Oreal was making the acquisition. Major transactions were going through and we were still sitting there. So, you don’t know what the regulators are going to do but they are, in fact, enforcing. Atkins: I think that is the flip side of the themes on the continuation of m&a activity. One of the likely constraints going forward, particularly with globalization, is antitrust, particularly in Europe. The EU has taken a much more aggressive view of life, maybe even more so than in the U.S. They have a view of market power that really doesn’t relate to traditional antitrust analysis. Big can be bad. I think we are going to see more and more that the EU regulators will put their foot down on things that we wouldn’t have thought about three to five years ago. Cotter: Another theme is that CEOs are going to be continually pressured by the more sophisticated investors that really control the marketplace. There will be great pressure for value. That is really the genesis of the tracking stock. It is the ability to identify any valued assets and place them in a marketplace that will fairly and fully recognize the value that is imbedded in those assets. A large part of that is taking businesses that are fundamentally fixed-cost businesses and separating them from businesses that are variable-cost businesses in a sense. That’s a big part of restructuring. If you can separate the generating assets from the wires and separate the wires from the consumer, you can create value for the benefit of the shareholder. The same thing is going to continue throughout all the infrastructure businesses in the U.S. They are going to separate hard assets from the marketing company.