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The Urge to Merge Reemerges

Animal spirits rampant on a field of cheap money. For some analysts, that describes the red-hot deal-making that is going on here. According to Dealogic, the 4,373 deals consummated so far this year have a total value of $821 billion, a 20-year high. So it’s good news: newly confident CEOs, backed by their boards, are bravely borrowing to finance restructurings in several industries. Unless, of course, observers with somewhat different takes on all this activity prove right. As they see it, the deals spurt is a reflection of a weakness in the U.S. economy – the failure of the “top lines” of many companies to grow. Many CEOs are convinced they cannot rely on what is called “organic growth” to keep shareholders happy and, not incidentally, shareholder activists from calling for managements’ scalps.

Much of the recent growth in corporate profits has come from cost-cutting, rather than sales growth. But there comes a time, as one airline executive famously said, that you can cut so much cheese off the pizza that no one will eat it. After years of slimming down, many corporations have cut so much fat that further cost cuts will come at the expense of bone. So, organic growth unlikely, grow by acquisition. Besides, executive salaries are not unaffected by the size of the enterprise atop which the CEO sits, and prestige at the country club is said to grow when gross sales increase.

There is no doubt that cheap money is one driver of these deals. June will be the fifth consecutive month in which corporations have tapped bond markets for more than $100 billion, as companies re-leverage to borrow at very low rates, with interest payments deductible from income taxes due, an added advantage for buyers. Until recently, many companies have shored up their share prices by buying back shares, shrinking the number over which earnings must be spread. But with share prices high, buybacks are expensive, especially when compared with the current low cost of borrowing to finance growth-enhancing acquisitions.

Nor is there any doubt that in some cases deals reflect optimism, and in others nervousness about organic growth prospects. But there is more to this merger wave than low interest rates, the varying appraisals of the economic outlook, and corprocrat self-interest. There is the fact that many industries are in upheaval because technology, or changing consumer tastes, or both, has made existing structures obsolete. Enter John Malone, apparently determined to maintain his reputation as a cable-industry genius capable of putting together deals that are actually in his shareholders’ interests, including a sale of one of his companies to AT&T for $59 billion. Using one of the firms in his stable, Malone has bought both Time Warner Cable (TWC) and Bright House, and now controls a colossus worth well over $100 billion with over 75 million subscribers worldwide. Previous suitors of TWC either refused to pay what they thought was an exorbitant price (Rupert Murdoch, 21st Century Fox), or were shot down by regulators (Brian Roberts’ Comcast). Malone knows that the cable industry is changing:

* cable-cutters are switching to streamed (cable-free) content,

* consumers are increasingly resisting paying for “bundled” channels they are forced to take in order to watch the few they do like, but

* customers are increasingly looking to cable providers for other services (telephone, internet), and

* content providers, already claiming 40 percent of cable companies’ costs, are consolidating to increase their bargaining power vis-à-vis distributors such as cable companies.

Malone, knowing that the first two of these trends threatens the value of his existing cable assets, is counting on constructing entities capable of meeting all the communication needs of his customers, and bargaining effectively with content providers. It may be the largest gamble he has ever taken, but betting against him is not a sure way to riches.

Then there is the health care-industry here, which accounts for about 17 percent of the U.S. economy. It is being roiled by Obamacare and a technological revolution that has made the sure hands of a surgeon in Switzerland available to a patient on the operating table in the deepest western U.S., no travel required. Throw in new requirements for capital-intensive record-keeping, and hospital reimbursements based on patient outcomes rather than costs incurred in treatment, and you have a wave of hospital mergers and consolidations that PwC partner and industry expert Dan Farrell predicts will continue in response to the need to “repurpose the healthcare system and change the clinical pathway.”

No surprise that some companies are unenthused about the possibility of being acquired. Sergio Marchionne, chief executive of Fiat Chrysler, is convinced that consolidation of the auto industry is required if it is not to compete away its profits. So he made an unwanted advance to CEO Mary Barra’s GM, suggesting they merge their companies. Ms. Barra and her board rejected Marchionne’s suit -- “We are committed to our own plan.”

The attempt by Monsanto to force a shot-gun wedding with Syngenta has also been met with cold indifference by the intended bride. The bid ($45 billion, a 43 percent premium over the pre-merger-talk price of Syngenta shares) is, the pursued company says, “grossly inadequate” and, anyhow, when the time comes for anyone objecting to speak his piece, many voices will be heard. Antitrust regulators here and abroad will certainly want time to review the effects on competition. And because this would be structured as a tax inversion deal, the combined company to re-domicile in London to avoid U.S. taxes, leading senators are already objecting, with the Treasury Department certain to join in efforts to derail any such deal.

There are two often-unnoticed consequences of all of this deal-making. When 1+1=1, a single surviving company, it needs only one chief financial officer (CFO). And that is usually the CFO of the acquiring company, leaving his or her counterpart out in the cold, warmed only by a generous severance package.

Regulators, on the other hand, find themselves busier than ever. The large number of deals requiring regulatory review by U.S. authorities is so great that the decision whether to intervene or wave a deal through now takes ten months, compared with seven in past years. That delay can cause potential merger partners to abandon hope, and cancel their plans, Somehow, every economic trend has one by-product government grows.