Chapter Two

History of
Mergers
Patrick A. Gaughan
Mergers, Acquisitions, and Corporate Restructurings
John Wiley & Sons, 6th Edition, 2015
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 Merger Waves

❑ 1st Merger Wave 1897–1904

❑ 2nd Merger Wave 1916–1929

❑ 3rd Merger Wave 1965–1969

❑ 4th Merger Wave 1981–1989

❑ 5th Merger Wave 1994–2001

❑ 6th Merger Wave 2004–2007

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 What Causes Merger Waves

• Mitchell and Mulherin, Journal of Financial Economics

(1996): three types of shocks: economic, technological,
and regulatory

• Jarrad Harford, Journal of Financial Economics (2005):

found that sufficient capital liquidity was also needed in
order to have a wave – not just these shocks

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 First Merger Wave (1897-1904)

▪ Started after the Depression of 1893

▪ Continued until 1904
▪ Peaked between 1898-1902
▪ Featured horizontal mergers - they often resulted in a near
monopolistic industry
▪ Known as monopoly merger wave
▪ Companies formed from wave: DuPont, American Tobacco,
U.S. Steel, and International Harvester
▪ Note: U.S. Steel formed from merger of 785 plants
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 First Merger Wave
(1897-1904)

Source: Ralph Nelson, Merger Movements in American Industry

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 Mergers by Types (1897-1904)

Type of
Merger Percentage

Horizontal 78.3

Vertical 12.0

Horizontal and vertical 9.7

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 Sherman Act and First Merger Wave

• Sherman Act of 1890 did not impede the monopolistic

combinations.

• Justice Department did not have resources.

It was understaffed and not interested in aggressive
antitrust enforcement.

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 Characteristics of the First Merger Wave

❑ Development of Transportation System

• Railroad
• Canals
- Following the Civil War, firms began to serve national
markets rather than regional markets
❑ Specialization of Management
• As firms grew the demands on management expertise and
time required management to specialize

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Role of Investment Bankers in the First Merger Wave

• Investment bankers played a major and aggressive role in

promoting the mergers
• Remember: No Glass-Steagall Act separating commercial
investment banking
Example: Railroads - expanding industry in the 1880s

• Leading Railroad Financiers: Jay Gould, Edward Harriman,

and William Vanderbilt

• At this time 60% of the stocks that traded on the NYSE

were railroad stocks

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Role of Investment Bankers in the First Merger Wave
(cont.)
▪ Depression of 1893-1897 - Severe
- 169 Railroad companies went bankrupt - nearly 25% industry
- J.P. Morgan: had underwrote securities of many of the
companies that went bankrupt
Many of these were sold in Europe, especially the United
Kingdom, where there was an outcry about the risk level of
these securities
- In bankruptcy process, J.P. Morgan and other investment
bankers stepped in on behalf of investors through a voting
trust
- The voting trusts helped facilitate mergers. They may have
been forced upon selling firms
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 Morgan Arranged Recapitalization

▪ Purpose was to stabilize the businesses and industry

▪ Process: Similar to LBOs
1. Estimate minimum cash flows - after necessary business changes
2. Adjust debt to level that cash flows can service
3. Stockholders and banks put up necessary additional working capital
- Voting trust oversaw the business for approximately five years
- Sounds like K.K.R.

▪ Oil Industry: J.D. Rockefeller – Used price wars to compete

and expand
- Competitors given offer to sell and get trust certificates in exchange

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 Role of J.P. Morgan

• Intense competition was weakening companies and making

the securities this company issued risky
• Morgan wanted to control the untamed competition
• He reorganized weak companies and combined them into
holding companies called trusts
• Shareholders would be offered trust certificates in
exchange for their shares and the trusts would be
controlled by J.P. Morgan & Co.
• New Jersey passed a law allowing such trusts and many of
them located there

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 Examples of Trust Morgan & Co. Founded

• International Harvester – formed in 1902 through the

merger of McCormack Harvesting Machine Tool Co. and
Deering Harvester Tool Co. by Morgan lieutenant George
Perkins
• Morgan & Co. – earned a $3 million fee for putting the
deal together
• International Harvester – had 85% share of farm tool
market

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 Second Merger Wave (1916-1929)

• Facilitated by cooperation among businesses as part of

war effort
- Government did not press antitrust enforcement
- They encouraged businesses to cooperate
• Investment bankers were aggressive in funding mergers

- Much of capital was controlled by small number of

investment bankers
• 70% of mergers were horizontal while most of the others
were vertical

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 Second Merger Wave (1916–1929) (cont.)

• Many of these mergers were characterized by economics

of scale

- This made firms economically stronger

• Wave ended abruptly with Stock Market Crash of 1929
• Industries that had the most mergers:
1. Primary metals
2. Petroleum products
3. Food products
4. Chemicals
5. Transportations equipment

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 End of Second Merger Wave

• It ended like the 1st merger wave – with an economic

downturn that was started by the 1929 stock market crash
• This was followed by the depression of the 1930s
• With dramatically declining demand, companies were not
seeking to expand through mergers

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Merger & Acquisition Announcements 1969-1980

Year Announcements

1969 6,107
1970 5,152
1971 4,608
1972 4,801
1973 4,040
1974 2,861
1975 2,297
1976 2,276
1977 2,224
1978 2,106
1979 2,128
1980 1,189

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 Third Merger Wave (1965-1969)

Source: Mergerstat Review

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 Third Merger Wave: Conglomerate Era

• 1960s featured a long economic expansion

• However, companies were prevented by intense antitrust
enforcement from buying companies in similar industries
• The only alternative was to acquire companies outside the
company’s industry
• IT&T, run by Harold Geneen, was a classic conglomerate

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 P/E Game

• Assume acquiring firm is larger than target.

• Acquirer P/E = 25; annual earnings are $1 million and
it has 1 million shares outstanding. Pa = $25.
• Target P/E = 10; annual earnings are $100,000 and it has
100,000 shares outstanding. Pt = $10.
• Acquirer offers one share for two shares of the target.
• Two shares of target are worth $20.
• To finance purchase acquirer issues 50,000 shares.
• EPS after merger: $1.1 million/1.05 million shares
= 1.05 (up from 1).
• If P/E of acquirer remains the same, then: 25 (1.05) = $26.25
-- this is the acquirer’s new stock price.
• Price went up by virtue of acquisition.
Note: P/E must not decline.
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 Conglomerate P/E Ratios in the 1960s

Corporation 1960s High 1970 Value

Gulf & Western 17.2 7.6
ITT 21.6 14.4
Litton Industries 45.5 14.3
Teledyne 41.6 13.3
Tenneco 15.1 11.3
Textron 21.7 10.5

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 Number of Mergers in 1970s

Source: Mergerstat Review

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 Pathbreaking Hostile Mergers of the 1970s

❑ Inco vs. ESB (1973)

• 1st hostile takeover by a major reputable firm

• Supported by Morgan Stanley – the leading investment
bank at that time – Morgan’s person – Rob Greenhill
• Inco planned the deal when they had excess cash
• They pressured Morgan Stanley to support the deal even though
they did so reluctantly
• Morgan Stanley had recently lost some major clients due to
increased competition in the investment banking business

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 Inco – ESB Takeover (cont.)

• ESB – maker of personal and auto batteries

• Personal: Ray-O-Vac
• Auto: Exide and Willard
• Not on the forefront of technological change in this
industry
• Industry was developing a maintenance free auto battery
and ESB was working on a low maintenance auto battery
• Industry was working on extended life batteries and ESB
was behind the competition
• Inco hoped to use its cash flow to accelerate R&D

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 Inco – ESB (cont.)

• ESB used primitive “knee-jerk” antitakeover defenses:

pursue white knights and file antitrust lawsuit
• Antitrust lawsuit slowed the approval of the takeover but
eventually Inco prevailed
• Problem for Inco: when they were able to take over ESB
the nickel market was down and they no longer had the
cash flow to support ESB’s R&D
• Not a positive outcome for the takeover

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 Inco – ESB (cont.)

• Morgan Stanley – banker handling this transaction was

Robert Greenhill
• He supported hostile takeovers
• Inco’s law firm was Scadden Arps and their attorney was
Joe Flom
• Proxy solicitor: D. F. King

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 Inco – ESB (cont.)

• Inco’s offer: $28 price per share

• ESB’s stock price: $19 – below book value and even
below working capital/number of shares
• Could possibly even buy ESB at this price, sell off all fixed
assets and have money left over
• ESB wanted $34 per share
• ESB’s investment bank – Goldman Sachs
• Proxy solicitor: Georgeson & Co.

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 Inco – ESB (cont.)

• ESB’s CEO: Fred Port

• ESB sought out white knight – United Technologies –
Harry Grey and Ed Hennessy
• United offer $34 per share
• Inco countered with $36 per share

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 Inco – ESB (cont.)

• Inco was held up by an antitrust lawsuit for 39 months

before they had a free hand to operate ESB
• By then Inco’s cash was down because the nickel market
was down
• 1981: Inco sold off ESB in four parts

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 Inco in 2006

• Involved in several suitor takeover battles as the global

metals industry is consolidating
• Inco first stepped in as a white knight for fellow Canadian
Falconbridge Ltd., a leading cooper, nickel, and zinc
producer.
• Inco, however (then #2 world nickel producer), was
acquired for $17 billion in 2006 by Brazilian CVRD – the
world’s largest iron ore producer

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 United Technologies vs. Otis Elevator (1975)

• Second hostile takeover by a major reputable firm

• Takeover by Grey and Hennessy
• Was the first hostile takeover by United
• Different from Inco vs. ESB in that it was successful

Otis Elevator
• 1975 sales: $1.1 billion
• 2006: $ 3.4 billion

United still owns Otis as of 2006

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 United – Otis (cont.)

• Otis selling for $32 per share but book value $38 per share
• Otis is in the elevator business which is cyclical but one-
third of business comes from servicing elevators which is
not that cyclical
• 60% business from international sources – good
international diversification for United but U.S. company
so not as much country risk
• October 15, 1975: United offered $42 per share
• Otis rejected offer and sought white knight – Dana Corp
(auto parts manufacturer - filed Chapter 11 in 2006)

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 United – Otis (cont.)

• United upped offer to $44 per share - $6 per share above

book value
• Deal proved to be a winner for United – Otis even better
than what United thought
• Second hostile takeover by major reputable firm but first
that was a good deal

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 Colt Industries vs. Garlock (1975)

▪ Another hostile takeover by a major reputable firm

▪ Brought hostility to an all time high
▪ Colt Industries – highly successful industrial
conglomerate > $1 billion in sales
▪ (2006: $3.63 billion in sales)
▪ Best known division – Colt Firearms
▪ Maker of the M16 assault rifle
▪ Largest division – Crucible Stainless Steel Co.

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 Colt (cont.)

• Used to be known as the Fairbanks Whitney Co.

• Was a diversified conglomerate in the 1960s
• 1964 changed name to Colt
• New CEO Margolis came to power and decided to sell off
divisions and then use capital to acquire new businesses
• Garlock – made packing and sealing products
• Stock sold for $20 per share with EPS at $2.70 but
forecasted to be $3.30 for 1975
• Garlock book value $21 per share

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 Colt (cont.)

• November 1975: Colt offered $32 per share

• Garlock opposed bid
• Alleged antitrust conflict as they said both companies sold
products to some of the same customers – weak antitrust
argument
• Garlock hired Richard Cheney of Hill & Knowlton

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 Colt (cont.)

• Colt pursued aggressive PR campaign to appeal to

shareholders
• Took out ads in The Wall Street Journal and The New
York Times – said “Why The Rush?”
• “Why the Need for Saturday Night Special Takeover Bid?”
• “Why Did They Not Contact Garlock Management Before
Bid?”

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 Colt (cont.)

• Garlock pursued AMF as a white knight

• Colt raised bid to $35 per share
• AMF dropped out and Colt won
• Third largest hostile takeover by major reputable firm – but
that took the level of hostility to an all-time high

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 Fourth Merger Wave (1981-1989)

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Fourth Merger Wave (1981-1989)

Source: Thomson Financial Securities Data

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 Characteristics of Fourth Merger Wave

• Number of hostile mergers up

• Size of targets larger
• Industry trends – more mergers within certain industries,
for example, oil and natural gas
• Deregulation – banking, for example, airlines
• Role of the raider:
• Carl Icahn
• Paul Bilzarian
• Belzbergs

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 Fourth Wave (cont.)

• Development of antitakeover strategies and tactics

• Role of investment bankers and attorneys
• Development of laws: federal and state
• Development of the junk bond market
• Michael Milken and Drexel, Burnham Lambert
• High number of leveraged buyouts and going private
transactions
• Relaxed antitrust enforcement

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 Fifth Merger Wave (1994-2001)

❑ Roll-ups and consolidations of industries

- Roll-Ups: Market enthralled with consolidating deals

- Consolidations: Consolidate through larger scale
acquisitions of companies

❑ The major industries: 1. Funeral Homes

2. Office Products
3. Floral Products

❑ But, failed to deliver on promised gains, such as lower

costs and greater synergies

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 Large Roll-Ups
Company Name Industry

Metal USA Metal service centers

Office Products USA Office products

Floral USA Florists

U.S. Delivery Systems Delivery

Comfort Systems USA Air conditioning

Coach USA Bus company

Waste Management Waste removal

Republic Industries Car dealerships

Source: Economatrix Research Associates, Inc

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 Fifth Merger Wave (1994-2000)

Source: Thomson Financial Securities Data

Note: The transactions above include deals in which at least one party is a U.S. company.
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 Fifth Merger Wave (1994-2000)

Source: Thomson Financial Securities Data

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 0
1000
2000
3000
4000
5000
6000
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98

Source: finance.yahoo.com
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
NASDAQ

Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15 500

0
1000
1500
2000
2500

Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Nasdaq and S&P 500

Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
S&P 500

Jan-04
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Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
 S&P 500 P/E Ratio, 1990-2009
S&P 500 PE Ratio Average
65
60
55
50
45
40
35
30
25
20
15
10
5
0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Source: Standard & Poor’s

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Yearly Aggregate Dollar Return of Acquiring-
Firm Shareholders (1980-2001)

Source: Moeller, Sara B., Frederik P. Schlingemann, and René M. Stulz. “Wealth
destruction on a massive scale? A study of acquiring-firm returns in the recent merger
wave.” Journal of Finance, vol. 60, no. 2 (April 2005).

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 Broadcasting, Communications, Banking & Finance Sectors as a
Percentage of Total U.S. Transactions
45%

40%

35%

30%

25%

20%

15%

10%

5%

0%
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Source: Mergerstat Review, 2014.

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 Average P/E Offered Relative to S&P 500

30

28

26

24

22

20

18
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Mergerstat Review, 2014.

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 Total Value of US M&A in 2013 Dollars
$2,500,000

$2,000,000
in Millions

$1,500,000

$1,000,000

$500,000

$0
1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013
Source: Mergerstat Review, 2014.
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