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Why We Keep Coming Back for Mergers Even Though They Don't Work


New merger booms always have their doubters, and the present cyclical upsurge is no exception.

The next merger boom is already here.

It's easy to think such a statement is based upon optimism following the worst post-war recession in living memory, new sovereign and municipal debt crises seemingly arising once a month, and the still-unknown consequences of quantitative easing.

But it's not the case entirely.

New merger booms always have their doubters, and the present cyclical upsurge is no exception. For every few articles such as The Economist's "Shall We" anticipating a rise in overall merger activity and volume, there seems to be at least one other media piece bemoaning stagnant deal total transaction numbers when assessed on a year-to-year basis.

But understand the factors behind those apparently flat numbers through February through March, and the result is a decidedly more buoyant forward perspective, merger-wise.

Tech sector deal volume has risen fairly consistently since the second half of 2011, particularly in social networking. Bank financing - required fuel for merger-cycle growth once the initial cheap, cash-only opportunities are depleted - has been a question mark for several quarters, as bank capital adequacy levels are debated in New York and Brussels. But merger financing is historically a profit-leader, and the siren-song allure of increased profits is music to embattled bankers' ears.

The Economist piece points to an additional explanation for the relatively subdued levels of deal volume in this decade's signature M&A cycle through about February of this year: hesitancy on the part of would-be operating company acquirers to blindly chase those sexy-but-doomed deals, which were reminiscent of merger bubbles past.

No longer are dud deals rubber-stamped by the board just on the say of the acquiring company chief executive.

Those mistakes included "transformational" deals designed to puff up the acquiring firm CEO's ego and temporary market stature while changing a utility into an entertainment conglomerate (Vivendi SA (EPA:VIV) /Universal) or a fading dial-up net service provider into a multimodal print-and-virtual media juggernaut (AOL, Inc. (NYSE:AOL) / Time Warner Inc (NYSE:TWX) ). Both deals - and transactions resembling them - are today correctly viewed as being merger train wrecks. These errors shortened chief executives' careers while stalling the acquiring company's momentum and competitiveness.

The Newest Merger Boom

As spring 2013 officially heats up and becomes summer, the corner in the M&A deal marketplace finally appears to have been turned, with tech leading the way. It all started with Facebook's shock acquisition of Instagram shortly before its May 2012 Initial Public Offering at DOUBLE the price set a week earlier.

At one point in time, Facebook Inc (NASDAQ:FB) / Instagram appeared to be a one-off. But social networking competitors, and those trying to make up for lost time, have picked up the momentum, exemplified by Google Inc's (NASDAQ:GOOG) acquisition of Waze and Yahoo! Inc.'s (NASDAQ:YHOO) acquisition of Tumblr (the latter snatched away from Facebook at the eleventh hour). International telecoms, local news media, natural resource companies, utilities and pharma are all now picking up their consolidation pace. Announcements of the creation of acquisition war chests come once-per-week, signaling acquirers on the hunt.

Thus, the customary factors that have driven each of the past three post-merger booms are now all falling into place (Fig. 1). Plus one more: record high share prices coincide with new expansion optimism.

In a phrase, mergers are once again beginning to appear safe to do. The result is that the present merger boom appears to be in second phase of a predictable pattern (Fig. 2). With returns from internal investments now often disappointing to outright career-threatening, it is at this point in time in recoveries past that chief executives begin looking outside the firm: to strategic alliances, new commercial licenses and contracts, and most conspicuously, acquisitions of other companies.

As in any marketplace, the intensity of buying mania matters in M&A. The number and range of quality merger targets for external investment quickly disappear as the merger cycle ages and a "buyers' panic" takes hold. In the late phases of recent merger cycles past (1982-1990, 1996-2000, 2002-2008) all that's left to acquire in the final, frantic months of the merger cycle - just before the bubble pops - are poorer quality target companies at prices so high that acquisition regret is almost assured.

Thus, not only do merger cycles matter, but knowledge of them are also critical to the acquiring company's CEO in order to know which part of the acquisition cycle she or he is entering, thus helping ensure the highest chances for M&A program success.

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