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Mergers a rite of passage in life of U.S. companies
Dan Fost
Chronicle Staff Writer
December 19, 2004
The San Francisco Chronicle
FINAL
A.1

Three huge mergers convulsed the business world last week, making 2004 one of the most active periods of corporate consolidation in decades.

The multibillion-dollar deals are but the latest of tectonic shifts that sporadically reshape America's business landscape, affecting tens of thousands of employees, changing the fortunes of millions of shareholders and, ultimately, touching the wallets of millions more consumers in often unforeseen ways.

The ink was barely dry on Oracle Corp.'s triumphant $10.3 billion acquisition of rival PeopleSoft Inc. on Monday when Chief Executive Larry Ellison declared he was seeking new targets to acquire.

Hot on Ellison's heels, Sprint Corp. and Nextel Communications Inc. announced their proposed $35 billion union. Veritas Software Corp. and Symantec Corp. capped the week's frenzy on Thursday, announcing a $13.5 billion merger.

Software and cell phones are 21st century technologies, but they are now entering a phase common to all commercial endeavors since the dawn of the Industrial Revolution: consolidation.

"That's an old story in American business," said Richard Sylla, a financial historian at New York University's Stern School of Business. "New industries come along, and then they get a shakeout."

Silicon Valley's hallmark, however, is speed. And that's the twist that tech is bringing in this new wave of consolidation.

"The same advances in technology that have led the pace of innovation to increase, have also supercharged the pace of industry consolidation," Bruce Judson, a faculty fellow at the Yale School of Management, said in an e-mail.

"In the scheme of things, the search engine industry is really very young, but it's already down to three major players -- Yahoo, Google and MSN. It took the automobile industry decades for the same level of consolidation to occur."

According to Mergerstat, a company that tracks global mergers and acquisitions, 2004 saw the second greatest amount of merger activity -- after 2000 -- of any year since it started keeping records in 1962. Computer software, supplies and services led the way with 1,563 mergers, although the total value of those deals, $36 billion, was dwarfed by the value of mergers deals in banking ($139 billion), communications ($119 billion) and leisure and entertainment ($96.5 billion).

High failure rate

Many forces, both from within an industry and a company, can prompt a decision to merge. Whether they work, and who they benefit, are subjects of hot debate.

Some studies show that 50 to 70 percent of mergers fail, in that they don't live up to their financial promise. And for every merger advocate who claims that the resulting "synergy" will lead to lower costs passed on to customers, there's a merger critic who argues that the loss of competition leads inevitably to higher prices and less innovation.

Several factors contribute to industrial consolidation, said Barbara Hampton, a vice president with CoreNet Global who lectures on mergers (after a lengthy career working with merger-happy telephone companies).

Some acquiring companies are trying to shore up their weaknesses, while others are simply trying to get bigger to achieve economies of scale. Some may seek to eliminate competitors, while others are trying to reinvent themselves. Often deregulation spurs a wave of mergers, and the stock market also leads the cheers for corporate combinations. "It's hard to gain the large increases in revenue and profit that Wall Street insists on without merger and acquisition," Hampton said.

Once a few companies in a given industry merge, that creates pressure on other companies to wed, in order to compete with the new behemoths.

"If you're in an industry that's consolidating, you almost have to jump on the bandwagon," said Peter Rosenberg, who heads the San Francisco office of investment bank Barrington Associates, a merger specialist. "You have to grow yourself, or sell yourself. If you don't, your competitors will."

AT&T, Cingular combine

Earlier this year, the union of AT&T Wireless Services and Cingular, the cell phone company owned by SBC Communications Inc. and BellSouth Corp., created the largest mobile phone company in the country, with 46 million customers, and set the stage for the merger of Sprint and Nextel.

"In communications businesses, you have tendencies to consolidation," said Sylla, the New York University professor. "There must be great economies of scale. The networks are costly to build, and firms tend to be big."

The telephone industry started as what Sylla called a patent monopoly, from 1876 to 1893, but when the patent expired, it opened up "a decade of fierce competition."

"AT&T was in the catbird seat because it built the first long- distance network," he said. For companies to gain access to that network, he said, AT&T demanded it buy them, ultimately becoming a heavily regulated monopoly.

Ma Bell was broken up in a famous 1983 court ruling, but rapid technological changes led the resulting seven "Baby Bells" to start their own series of mergers. AT&T also pursued a strategy of consolidation, bringing together cable, long distance, local service and wireless service all under one corporate umbrella, but it couldn't make the combination work, and it broke itself up again.

"AT&T was one of the great American companies, and now it's limping along," Sylla said.

The large conglomerates that result from waves of consolidation risk becoming dinosaurs, so immense and dependent on a certain way of doing business that they fail to grasp the need to change.

That may be motivating IBM's exit from the business of selling personal computers. Big Blue sold its PC division this month to Lenovo Group, a Chinese firm, for $1.75 billion. The venerable technology company is betting that PCs will become even more of a commodity, and the future profit margins will be in software and services.

The constant change is part of what Barbara Hampton calls the "MAD cycle," for merger, acquisition and disposition. "There's always another side to it," she said. "There's a way to grow your business, and to clean your business."

It's a bet-the-company kind of move. But seeing how business history is littered with case studies of companies that grew large and then stood pat and fizzled, companies often have tremendous incentives to reinvent themselves.

Sylla, the business historian at NYU, can recall how the auto industry consolidated in his lifetime. "The smaller companies -- Studebaker, Nash, Hudson, Packard -- all disappeared," he said. "By the 1960s, we just had big producers."

But when the energy crisis hit the U.S. in the 1970s and gas prices rose, fuel-efficient cars from Japan and Germany began to threaten that dominance.

"Even the companies that are on top struggle at times," he said.

Pain is inescapable

Consolidation never happens without causing a lot of pain. In some cases it may be through job loss, as seen when Hewlett-Packard swallowed Compaq Computer, or as is likely when PeopleSoft is absorbed into Oracle. In other cases, it's a result of a large competitor getting larger, and beating the smaller rivals.

Sylla cites Joseph Schumpeter's classic line from 1942 that "creative destruction is the essential fact about capitalism." Old structures must be torn apart to give birth to new ones. "The oil business brought whaling to an end," Sylla said. "Horse and buggy makers were put out of business by the automobile. Think of the typewriter business. Who would buy a typewriter today when a computer and a printer do the job so much better?

"It's called progress," he said. "And for some people who are on the short end of it, there's a lot of adjustment costs."

Many U.S. workers fear for their own jobs, and rightly so, as their corporate employers consolidate or ship work overseas to cheaper labor markets.

Yet many of those workers will be able to find new entrepreneurial opportunities, said Bruce Judson, of Carmel, N.Y., the Yale lecturer and author of "Go It Alone."

"People are constantly innovating with new niches," he said.

Just because there are beverage giants like Coca-Cola and PepsiCo, he said, didn't prevent smaller companies from starting up with innovative beverage drinks. A microbrewing movement grew up under the noses of a consolidated beer industry.

"Consolidation almost always brings the elimination of jobs," Judson said. "The good news is, those same forces are going to bring opportunities and make it easier to start businesses than ever before."

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CHART: TOP 10 BUSINESS MERGERS SELLER BUYER VALUE in billions 1 Bank One Corp. JPMorgan Chase & Co. Inc. $57.6 2 AT&T Wireless Services Inc. SBC Communications Inc/BellSouth Corp. $40.9 3 Nextel Communications Inc. Sprint Corp. $35.0 4 Guidant Corp. Johnson & Johnson $24.3 5 SouthTrust Corp. Wachovia Corp. $14.5 6 Veritas Software Corp. Symantec Corp. $13.5 7 Sears, Roebuck & Co. Kmart Holding Corp. $10.4 8 People Soft Inc. Oracle Corp. $10.3 9 Charter One Financial Inc. Royal Bank of Scotland PLC $ 9.9 10 Hynix Semiconductor Inc. Citigroup, N.A. $ 8.6 . Chronicle Graphic Sources: Fact Set Mergerstat and Chronicle research

E-mail Dan Fost at dfost@sfchronicle.com.