Chapter 13 M & A:Companies Shopped – Now They've Dropped

Many companies whose mergers and acquisitions lit up the 1990s are taking on water.

During the go-go 1990s, WorldCom's (WCOM) Bernard j. Ebbers and Tyco International's (TYC) L. Dennis Kozlowski were the heroes of a new breed of growth- driven CEOs. Unlike other chief executives who viewed mergers as a complement to their core businesses, this new generation viewed dealmaking as the cornerstone itself and the basis for maintaining heady growth rates. And while other CEOs might view a rising stock price as a nice reward for their labor, to executives like Ebbers and Kozlowski, keeping the stock price high was critical to their formula because it gave them the currency to keep their spending sprees going.

Now, of course, many of the celebrated dealmakers of the′90s have run into a brick wall. With Wall Street suddenly turning a cold eye toward the aggressive acquisitions accounting and leverage that drove much of the growth of the past decade, such acquisitive high-fliers as WorldCom, Tyco, and Conseco (CNC) have fallen out of favor with investors. According to a study by Bridgewater Associates Inc., the 20 companies with the greatest merger-and-acquisition activity over the past four years, a group that includes Cisco Systems (CSCO), AT&T (T), and even General Electric (GE), are now being punished by Wall Street. Through Feb. , their stocks were down an average 15% since the beginning of 2002, compared with a decline of 5% for the companies in the Standard & Poor's 500-stock index.

Aggressive dealmakers who also took on huge debt loads, convinced that rapid growth rates would never slow, are faring even more poorly in the harsh light of a slow-growth, post-Enron world. With accounting practices coming under close scrutiny, Wall Street has lost its appetite for overlooking those heavy debt loads at deal-driven companies. The reason: earnings and cash flow are suddenly much smaller than the go-go dealrnakers expected, leaving many companies struggling to make interest payments or pay down their debt. Bridgewater notes that of the most acquisitive companies, those who took on the heaviest debt loads to support their acquisitions were down more than 20% through Feb. 4.

Those plummeting share prices clearly reflect Wall Street's heightened fears that the earnings growth at many of the era's biggest acquirers may not in fact have been as strong as it once appeared —and it certainly can't be kept up.

Investors now focused on "quality of earnings" are raising questions about whether accounting gimmicks have allowed serial acquirers like Tyco International Ltd. to inflate their earnings. "The growth-by-acquisition game is over," says Sam Rovit, head of Bain & Co.'s merger integration practice. "Many of these companies are going through detox right now."

Indeed, after a decade of record merger activity, the abrupt collapse of high- fliers such as Tyco, WorldCom, and Enron has thrown a monkey wrench into a deal machine that was already depressed by the recession and stock market downturn. "The fallout from Enron is having a chilling effect on the urge to merge," notes Morgan Stanley Dean Witter & Co. strategist Joseph P. Quinlan. He points out that the $18 billion in announced deals in January was the lowest level since 1995. To get a deal done today, investment bankers say companies must be willing to pay more in cash, take on less debt, and avoid the aggressive accounting employed by the likes of Enron.

If the 1990s was about using mergers to fuel growth, many experts believe that the coming decade will mark a return to a more old-fashioned notion of growth. Companies will shed many of their unprofitable acquisitions and focus on generating internal growth from the businesses that they know best. "This decade is going to be about getting back to basics, with companies focusing on markets where they have a global leadership position," says Douglas L. Braunstein, head of global mergers and acquisitions at JP Morgan Chase & Co.

Already, it is happening: In late January, Merck6 & Co. (MRK) said it was spinning off its Medco pharmacy benefits unit to focus on its drug-development business. And on Feb. 11, DuPont Co. (DD) said it was planning either a sale or initial public offering of its $6.5 billion textiles and interiors business.

But for many of the go-go dealmakers, the future is more grim. They are facing, at best, slow growth and, at worst, the need to strip away at their empires to service their crushing debt loads. Even in once-hot Silicon Valley, where companies such as Cisco Systems, JDS Uniphase (JDSU), and Ariba (ARBA) used their stratospheric stock prices as a convenient currency to buy the revenues of other companies, many are finding they can no longer use mergers to fuel easy growth.

The case of Commerce One Inc. (CMRC), a business-to-business software company, is all too typical. The company used its rising stock value—which soared above $140 in early 2000—to fund five acquisitions that quickly catapulted its revenues to nearly $400 million. With its stock currently below $2 a share, Commerce One Chairman and CEO Mark B. Hoffman admits the days of acquiring growth on the cheap are over. " It's changed from what we were doing before, which was grow, grow, grow the company as quickly as you can, gain market share." Now, he sighs, "it's going to be much more like old, historical growth."

But for other companies, the pressures are more intense. Particularly vulnerable are those that spent freely when times were fat but are weighed down with stiff interest payments and heavy debt loads now that their growth has slowed. After spending a hefty $1 7 billion to acquire other pulp and paper makers in recent years, Atlanta-based Georgia-Pacific Group (GP) is struggling with $12 billion in debt in the middle of a sharp downturn in many of its core markets. Georgia-Pacific executives insist that the company is not facing a liquidity squeeze. Still, analysts think that Georgia-Pacific will likely have to sell or spin off some assets to remain in compliance with its lending covenants.

For other companies, the problems stem from acquisitions that haven't worked. Among them is Conseco Inc., the Indianapolis-based financial-services firm that, under then-Chief Executive Steven C. Hilbert, swung dozens of deals during the 1990s. But its biggest deal, the 1998 purchase of Green Tree Financial Corp. for $7.6 billion, hasn't panned out. And Conseco is struggling to service its debt. Given Conseco's deteriorating cash position, "it's going to be difficult for them" to make good on the $1.1 billion in debt payments due later in 2002, says Salomon Smith Barney analyst Cohn W. Devine.

Conseco executives clearly disagree. They insist that they have already taken aggressive action to bring down debt, and they say the company plans to raise an additional $750 million through the sale of portions of its insurance business and other assets. The company has also repurchased $266 million in bonds at a 30% discount in the secondary market. "Liquidity is not an issue," says Conseco's current chief executive, Gary C. Wendt. But having already sold $1 .6 billion in assets —and with an additional $6 billion— in debt still on the books—some investors and analysts wonder whether Wendt will ultimately run out of things to sell. "There're hardly any assets left there," notes Devine.

It's too early to tell how many other companies will fall as hard or as fast as the Tycos, WorldComs, and Consecos. Still, as the corporate heroes of the deal-crazed 1990s fade away, there's no doubt that they'll be taking with them their now–repudiated business model. No more deals for deals'sake alone. At least, not for some time to come.

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