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July 11, 2000 - A few months ago, it seemed as though there was an announcement about an initial public offering every day; but recently, it's news of mergers and acquisitions (often called M&As) that has dominated the headlines. Every time two companies combine forces, the market reacts in some fashion, and employees of both companies take stock of their situation.

Online grocery service Webvan announced June 26 that it would buy out its competitor, HomeGrocer, in a deal valued at $1.2 billion in stock. Over the next few days, both companies' stock tumbled, losing $280 million in combined valuation, as investors reacted negatively toward this news.

The market reacted in similar fashion when Media Metrix and Jupiter Communications announced their union on June 25. Stock prices for both companies hit all-time lows, with Media Metrix down 23 percent and Jupiter down 15 percent.

Less-than-optimistic market investors and decreasing share prices have not dampened the mergers and acquisitions wave. Rather, it's one blockbuster after another. In 1998, there were more than 12,500 mergers and acquisitions deals totaling an astounding $1.7 trillion. On average, that's 240 mergers and acquisitions per week.

The M&A deals in the first five months of this year are valued at $486.5 billion, up 61 percent from the same period last year. America Online and Time Warner rang in the new year with their announced $165 billion merger - the largest corporate merger in American history. Other planned megamergers include Vodafone AirTouch and Mannesmann; United Airlines and US Airways; Terra Networks and Lycos; and the most recent Vivendi and Seagram. Wall Street analysts predict more to follow in the second half of 2000.

Companies merge to grow
Mergers and acquisitions are one of the most significant ways for companies to grow. The United States has seen waves of takeovers during the last century - at the turn of the 20th century, in the 1920s, in the 1960s, and in the 1980s. A company can grow by increasing its operations or through combining forces with other companies. Online retailer Amazon.com, for example, built a digital empire by purchasing stakes in smaller and specialized companies. Internet hardware giant Cisco also grew rapidly through mergers. Since it can be difficult to grow fast enough by expanding operations, and sometimes industries can reach capacity, consolidation of industries often follows. Companies also buy other companies to eliminate competition, or to prevent competitors from acquiring the same company.

Strong market favors M&A activity
A strong stock market is a major contributing factor to the recent wave of mergers and acquisitions. Companies that have enjoyed a run on their share prices can finance M&A growth with stock. According to J.P. Morgan, stock accounted for nearly 67 percent of the value of M&A deals in 1998. Companies being acquired are also attracted because they are typically paid 30 to 40 percent over the value of their stock.

Some of those companies are acquired before they ever go public, and others within a year of their IPO, sometimes when their stock is below its IPO price. Yet even a long-standing market leader can become an acquisition target if the price is right for both buyer and seller.

"The stock market correction of March 2000 has left some companies with good products and a low stock price," said Bill Coleman, vice president of compensation at Salary.com. "Strong-performing companies can and will take advantage of those bargains."

AOL, for example, can buy out Time Warner because of AOL's terrific run in the stock market in recent years, despite its smaller workforce and lower revenues. AOL is paying a 71 percent premium over Time Warner's market value to secure the deal.

"In the wave of mergers in the 1980s, the CEO of a company that was acquired was often perceived as a failure," Coleman said. "Today that executive is more likely to be seen as a hero. Savvy CEOs and boards of directors now recognize that being bought at a premium is a way to create tremendous value for shareholders and employees. The market is responding much more favorably to these CEOs than the last time around."

Another factor is dramatic technological change, especially in the telecommunications and Internet services industries. Businesses now have to reposition themselves strategically through partnerships to get the newest technologies. So, WorldCom and MCI merged in 1997; Bell Atlantic and GTE in 1998; and Disney and Infoseek in 1999. It's almost an eat-or-be-eaten mentality.

As U.S. businesses scramble to become internationally competitive, mergers with international counterparts enable companies to gain market share and access to customers. Companies based in countries outside the United States, such as Vodafone, are now acquiring U.S. companies in increasing numbers in order to enter the U.S. market. In January 1999, the UK telephone company acquired AirTouch, which gave Vodafone shares in the competitive cellular market. In April of this year, the combined company announced it would purchase Germany's Mannesmann for $173 billion, surpassing the AOL-Time Warner deal as the largest takeover in history.

Accounting rules also favor mergers and acquisitions. The primary issue is pooling of interests, a form of accounting for a merger which is scheduled to go away next year. Analysts will be watching to see whether that change has an effect on the number of acquisitions and mergers.

Recent mergers and acquisitions

*This merger has been canceled due to federal antitrust concerns.
Source: Salary.com, based on published information.

Megamergers
The growing Web audience helped make wireless and high-speed Internet access two of the hottest commodities. In the landmark AOL-Time Warner deal, AOL benefits from gaining access to the much-desired broadband technology, and the 28 million subscriptions to Time Warner's products. The deal would provide Time Warner with access to 22 million AOL subscribers.

The two companies promise to generate $1 billion in cash in their first year as a combined company. This means competitors would be forced to expand in order to compete. AOL is scheduled to roll out its AOL TV, which will compete head-to-head against Microsoft's WebTV.

Investors know that implementing this multibillion-dollar merger will be no easy task. Days following the announcement, AOL shares slid heavily, losing 19 percent of market value. Six months later, AOL shares are trading in the $50 range - 34 percent lower than the year-to-date high of $83 per share. Although Time Warner's shareholders have enjoyed a substantial increase in market value, the stock is now trading in the $80 range, down from its high of $105 on March 27.

Analysts have expressed their concern over how an old economy company with 82,000 employees will fit with a new economy company that is only 15 years old. The possibility of top executives leaving either company as a result of the announced merger is a significant risk as well.

There are good reasons why analysts are skeptical of the deal. For one, the U.S. Justice Department recently gave its approval to AT&T's acquisition of MediaOne group on the condition that AT&T spins off MediaOne's high-speed Internet provider. The Justice Department prevented a monopoly from forming since AT&T already owns the nation's biggest high-speed Internet access provider Excite@Home.

Given the similarity of the two deals, all eyes will be on the government to see how it proceeds with the proposed AOL-Time Warner merger. A successful combination will largely depend on the actions of the management teams.

Executives leave smiling after companies merge
Top executives often leave the merged entity, since companies normally don't need two CEOs, two CFOs, two COOs, etc. But getting rid of duplicate executives can cost the company significant amounts. Often the top managers who leave receive a "golden parachute" worth multiples of their annual cash income. Sometimes the total cost of these rewards is worth 5 to 10 percent of the purchase price.

"There's a good reason for golden parachutes," said Coleman. "The CEOs and other executives who are responsible for facilitating mergers are in theory creating significant value for both companies. They need a strong incentive to create the new company in which they will most likely have no job."

The significance of the numbers
Millions, billions, even trillions of dollars changes hands during mergers and acquisitions. It's tough to get a sense for the size of these deals, let alone the significance of the numbers.

The main reason analysts track the value of a merger is to determine whether the buyer or the seller - or both - got a good deal. These financial analysts specialize in valuation, or the process of putting a price on a company. The stock price often fluctuates after a merger announcement if analysts believe the price paid for the company was either too high or too low.

To the individual employee in a company being acquired, the value of the deal is significant if the employee holds shares and their value increases or decreases. And if the market reacts adversely, the combined company could be worth less than the sum of the parts.