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Merger Mania Signals Terminal Phase of Bull Market

May 13, 1998

One of the chief hallmarks of stock market bubbles (as we are presently experiencing) is the prolific rate at which publicly traded companies attempt to enhance their bottom line through mergers and acquisitions.

As the stock market roars to uncharted heights and as starry-eyed investors continue to pump liquidity into the over-valued stocks of various companies, there invariably comes a point where stock prices can travel no higher. At that point, the market becomes technically over-bought and a downward "correction" in prices becomes imminent.

When it becomes evident to the chief executives of large corporations that their company's stock stands to suffer, they seek ways of fending off the unavoidable and artificially propping up their stock's price through sundry techniques and devices. One of these devices is the merger. Corporate mergers are executed in numerous forms: a mutually agreed merging of assets between two or more companies; a joint venture or partnership between companies; or the less friendly hostile takeover. Each of these acquisition techniques have been conducted at breakneck pace in the past few years.

In his book, At the Crest of the Tidal Wave, stock market maven Robert Prechter noted that M&A is one way that companies express the extreme optimism that is characteristic of stock market bubbles. He pointed out that in the past fifteen years, the number of mergers and acquisitions has come from about 1,000 per year to nearly 7,469 in 1994. Since that time, the level of M&A has reached nearly 10,000 per year, a record. "Such activity is indicative not of minor bull market tops," wrote Prechter, " but of ones that precede prolonged and devastating bear markets."

This trend toward M&A has recently reached a crescendo, with major, multinational companies announcing mergers on a weekly basis in the past few months. This week alone, baby bell SBC Communications Inc. announced that it agreed to buy Ameritech Corp. for about $61 billion in stock, and Oilfield services company Baker Hughes Inc. announced it would buy Western Atlas Inc. in a stock deal valued at about $5.5 billion. The deals were only two of a handful announced on May 11. They follow the biggest industrial merger in history unveiled last week, between car maker Daimler-Benz AG and Chrysler Corp.

Also on May 11, Monsanto Company announced a $4.4 billion acquisition of biotech seed companies DeKalb Genetics Corp. and Delta & Pine Land Co. Upon revelation of the deal, DeKalb's stock soared to $98.00 a share, up from its previous close of $77.00. Monsanto's stock also climbed on the deals, gaining $3.06 to $56.56.

But while the owners of DeKalb and Monanto stock may have initially benefited from the announcement, an examination of the effects that mergers typically have on the stock prices of the merged companies reveals that such upward valuation is often short-lived. For example, on the day the Chrysler-Daimler deal was announced, the Dow Jones Industrials lost a total of 171 points. On May 11, the day of the big merger announcements, the Dow surged 135 points, or 1.5 percent, in early trading, fueled partly by the merger news. But by day's end, the Dow had only managed to hold on to 36 of those points.

And while the stocks of merged companies may dramatically appreciate on news of a merger, they more often than not recede back to or near their pre-merger levels within a few days.

Even more alarming is the fact that many, if not most, of these big mergers are financed through the stock of the merging company, rather than through cash or issuance of corporate bonds. This extremely risky form of leveraging leaves the merged companies solely at the mercy and vagaries of the market. Should the merged companies' stock decline for any reason, the companies would have no way of paying off the debts incurred in the transaction, or of paying dividends to their shareholders.

Even mainstream stock analysts—who generally have been remiss in their duty to inform the stock-buying public of the inherent dangers of this overvalued market—are beginning to wake up to the ill-founded nature of most mergers. A recent Reuters press wire article was entitled, "U.S. merger wave may signal Wall St rally's twilight." The article, which had a highly unnatural (for them) bearish tone, began: "A wave of mammoth corporate mergers that has given Wall Street new reason to rally could also be a sign the bull market is in its twilight phase. At a time when incipient concerns over faltering corporate profits and budding inflation appeared set to sap the market's momentum, headline-grabbing deals have pulled buyers back." The article further stated that the huge deals could just be another sign of a market near its top, with companies, using their own lofty stock prices as currency, searching to grow through mergers. When even a large news reporting agency like Reuters, which is representative of the psychology of the crowd, begins to sound bearish on the stock market, the end is probably closer than we think.

And for every (short-term) success story of merged companies, there is the horror story of a merger deal that didn't quite live up to expectations. A prominent example, of course, is the merger between Union Pacific and Southern Pacific railroads. The newly merged company is now responsible for the worst rail gridlock in U.S. history. Across the Southwest, rail traffic logjams, lost or side-tracked railcars, and train delays have become commonplace on account of this ill-conceived corporate marriage between two large and totally self-sufficient companies. The damage to the entire U.S. economy has been estimated at more than $2 billion and counting due to the UP/SP fiasco, and shippers across the country have been forced to find alternative means of shipping their goods because of it.

While the UP/SP merger may be the exception, rather than the rule, there can be no denying that in the long run mergers and acquisitions tend inevitably toward the dissolution of the merged companies and the dissatisfaction of the shareholders. And in many cases, such "marriages" end in "divorce."

In time, the folly of this current M&A craze will be manifest for all the world to see.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.


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