Remind Hershey: Merging is often a dumb idea

August 28, 2002|By JAY HANCOCK

HERSHEY FOODS Corp. boss Richard H. Lenny cried last month when he told employees the chocolate company was for sale, but his grief should be assuaged by the $20 million or so (my calculation) he would collect in post-deal severance payments.

Lenny, who joined Hershey last year from Kraft Foods, genuinely doesn't want to sell. The chocolatier's biggest shareholder, however, has said it wants to cash out to Nestle or somebody else, and $20 million collected for two years' work might eventually convince Lenny that it's a good idea.

Such jackpots are one reason so many dumb mergers happened last decade. Even when a deal didn't make good business sense, the instant cascade of riches triggered by "change of control" severance clauses in executive contracts at the target company were an intoxicating incentive to get it done anyway.

And there were plenty of deals that didn't make sense. A large library of research suggests that most corporate mergers bomb or fizzle, which surprises me and raises interesting questions about the source of U.S. economic growth in the 1990s.

"Historically, there have been a lot of bad reasons for a lot of deals," says Mark Herndon, a merger specialist with Watson Wyatt Worldwide, a human resources consultant, and co-author of The Complete Guide to Mergers and Acquisitions. "People involved in this will tell you there are only two kinds of acquirers: those that have really messed up a deal and those that soon will."

According to Watson Wyatt, 75 percent of mergers fail outright or don't produce expected benefits. On average, 47 percent of an acquired company's executives leave within a year of the deal, a brain drain that cripples many business combinations. Three-fourths are gone after three years.

McKinsey & Co., another business consultant, found that only 12 percent of the mid-1990s mergers it studied produced significant revenue growth for the combined company.

"Most sloths remained sloths, while most solid performers slowed down" after the merger, McKinsey's report said.

A study last year of international mergers by academics at the University of Arkansas and Brigham Young University indicated that the combined companies' stocks trailed those of competitors by an average of 23 percent over five years.

So if mergers have such a terrible record, why do executives keep doing them?

One factor may be "change-of-control" golden parachutes that basically penalize a boss if he tries to build a company for the long term instead of flipping it.

Herndon points to others: Bighead managers expanding their turf. The lemming factor and the fear of being left out of the party. The tendency for mergers to be decided by lawyers and financial officers and not operations people who know how things really work.

Investment bankers whispering sweet nothings have also caused more than a few disastrous deals while earning millions in merger advisory fees.

Merger swashbuckling also is more interesting to executives than running a company. Through serial acquisitions they can show shareholders they're "doing something" and at the same time disguise weakness in their core operations.

Having said this, however, I have a hard time believing that the U.S. merger and acquisition binge, which began with the leveraged buyout craze in the 1980s, has been a total flop.

The pessimistic merger studies by McKinsey and others are contradicted by the amazing performance of the U.S. economy in that same span. If mergers are so counterproductive, how come the gross domestic product has grown so fast and steadily since they became a major part of the business scene?

The macroeconomic hallmark of the 1990s boom - the rise in labor productivity, or making more things with fewer people - is precisely what one would expect from a spate of corporate deals that cut costs by consolidating duplicate operations.

Maybe the studies showing post-merger problems ended before efficiencies kicked in. Maybe the economic harvest of mergers was real but was reaped by somebody other than shareholders - parachuting executives, perhaps? Or maybe mergers really were a drag but were counteracted by productivity gains from computers.

In any case, there is no disputing that the 1990s saw bad mergers for bad reasons. MCI and Worldcom. AOL and Time Warner. Daimler and Chrysler. First Union (now Wachovia Corp.) and almost anybody. The economy might have performed even better than it did without those weddings.

Watson Wyatt's Herndon believes lessons have been learned and executives will think harder now before tying the knot. Yesterday, The New York Times seemed to prove him right by reporting that potential bidders for Hershey Foods have expressed reservations about the deal.

The price might be too high, they think. Earnings might be diluted. Their money might be better spent somewhere else. Even Hershey boss Lenny doesn't want to sell out, despite the $20 million.

Have sanity and prudence come to the merger trade? Not likely.

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