February 18, 2004
Merger Mania A Bubble Symptom

J.P. Morgan Chase & Co. recently acquired Bank One Corp. in a transaction now valued at $60 billion. According to Dealogic Cingular Wireless’s $41 billion takeover of AT&T Wireless is the largest all cash-offer in history.  Disney may have balked at Comcast’s $50 billion all-stock offer but the embattled Eisner was finally able to land the Muppets from Jim Henson Co.  North Fork Bank is purchasing GreenPoint Financial Corp for $6.3 billion in stock. Yes folks, if you have not already noticed, ‘merger mania’ is back. 

Thomson Financial says that $450 billion in mergers were completed in 2003 (compared to an astonishing $1.75 Trillion in 2000). Although $450 billion is not exactly a stunning number given the rally in the markets last year, remember that stocks started out 2003 a weak note and that many of the more notable mergers – including Bank of America’s takeover of Fleet Boston for nearly $50 billion – did not arrive until late in the year (or when the stock market rally was in full swing).  Suffice it to say, and not unlike the chicken and egg conundrum, it is difficult to know what came first: rising stock prices or an increase in merger activity. 

The ‘what came first’ riddle aside for the moment, what is clear is that in recent weeks stocks have continued to rally as merger activity has picked up.  For bears daring enough to sell stocks short this news has been down right glum.  To be sure, although studies have concluded that acquiring companies usually don’t make money for shareholders (Ulrike – Dec 2003), the fact is that mergers add an unquantifiable layer of excitement to the marketplace. With investors seemingly excited about everything these days – low interest rates are fantastic, a plummeting dollar is a blessing, and the unprecedented wave of fiscal and monetary stimulus unleashed in 2003 has created a couple of new jobs! - news of mergers arriving en masse is the last thing bears wanted to hear. 

Comcast Helps Awaken Merger Mind state

Despite vying for Disney’s untidy balance sheet (Disney’s working capital was (and is) in decline as intangibles boomed during the 1990s), Comcast seemed to make a reasonable bid for Disney’s attractive cash flows last Wednesday. However, immediately following Comcast’s hostile offer, which was made at a 9.9% premium using last Tuesday’s closing prices, Disney shares surged and Comcast’s declined.  The end result being that Comcast – which has said it would not raise its offer which gives Disney a "full and generous valuation” - has gone from bidding $54.25 billion for something worth $49.36 billion on paper to bidding $49.17 billion for something worth $55.15 billion on paper as of yesterday’s close.

This nearly $11 billion swing may not seem like a lot. After all, Comcast can issue all the shares it wants to purchase anything management wants when liquidity is running as hot as it is in the markets these days.  However, given that Comcast would need to tack on more than $11 billion to its original offer to make any serious new offer for Disney today, CEO Brian Roberts – who was reportedly displeased after Eisner said no to a friendly takeover on February 9 - may be rethinking just how badly he wants to purchase the mouse.

Suffice it to say, market reaction to Comcast’s takeover offer suggests that investor’s continue to be enamored with ‘in play’ stocks. For example, following the Comcast announcement speculation emerged that Microsoft – who has never orchestrated a deal this big – might come up to bat, and, as strange as it may sound, it was said that GE might take a run at Disney’s theme parks. Apparently any company with cash wants to own a part of Disney.  However, what no one seems to care about is that DIS shares have jumped 75% off their 52-week lows (March 2003) and that no one wanted to touch the company with a 10-foot pole less than 1-year ago.

Merger Mania Simply That

In fantasy land Microsoft issues a gazillion shares, purchases every company in America, and starts paying out 100% of free cash flow in dividends. In this fantasy land it would not take analysts long to figure out that no possible takeover targets remain.  Furthermore, it would not take individual investors – who dumped another $40.8 billion into stock funds in January – to figure out that their equity returns are ultimately hinged to the financial performance of a company, not to Greenspan’s words, Fed models, past performance, and analyst merger expectations. 

Back to reality – one merger spreads speculation of others, and ultra low interest rates compel savers to become supposedly savvy stock chasers. The mergers may well continue until something gives – until either the deficit, the dollar, and/or inflation nudge US interest rates higher.  However, when it gives a company like Disney – whether on its own or within another – will be exposed as being a company unable to generate the type of returns investors are paying for today.

In short, there is no chicken/egg conundrum to contemplate.  The mania brought about today’s merger binge.