Deal-makers implode

[Louis Proyect <lnp3@xxxxxxxxx>]

WSJ, June 6, 2002

Firms That Lived by the Deal
Are Now Sinking by the Dozens

By ROBERT FRANK and ROBIN SIDEL
Staff Reporters of THE WALL STREET JOURNAL

They shopped 'til they dropped.

>From Tyco International Ltd. and WorldCom Inc. to Vivendi Universal SA of
France and AT&T Corp., some of the most celebrated serial acquirers of the
1990s are stumbling. These and other corporate buyers led the biggest deal
parade in history, dazzling investors for years with giant mergers and
record growth rates. Today the acquirers are struggling to pay their debts,
sell off assets and defend aggressive accounting practices.

The latest casualty is Tyco, which grew from a sleepy industrial company
into one of the world's most aggressive deal machines. Former CEO Dennis
Kozlowski -- who resigned this week amid his indictment for tax evasion and
intensified turmoil at the sprawling conglomerate -- sought to create the
next General Electric Co. He deployed teams of lightning-fast negotiators
who could swoop in, buy companies and start cutting costs in a matter of days.

Tyco acquired 700 companies in the past three years alone at prices ranging
from several hundred thousand dollars to $9.5 billion. The frenetic deal
making made Tyco one of the hottest stocks on Wall Street, with 20% annual
growth rates, despite a prosaic portfolio of businesses that included adult
diapers, clothes hangers and water hoses. When Tyco's shares started
collapsing this year because of accounting worries -- taking away its
prized deal currency -- the merger machine ground to a halt. Tyco's stock
has fallen more than 60% over the past three months. Rather than buying
businesses, management is racing to sell off its CIT financial-services unit.

WorldCom founder Bernard Ebbers also is paying the price for a buying
binge. After building the company with more than 70 acquisitions, he is now
jobless and WorldCom's shares have plummeted more than 95% since 2000. The
company announced Wednesday that it plans to sell parts of its wireless
network.

The Securities and Exchange Commission is investigating WorldCom, in part
for its deal-related accounting. And WorldCom isn't unique in receiving
this kind of scrutiny. According to people familiar with the situation, the
SEC and Financial Accounting Standards Board, which sets rules for
corporate accounting, are looking at the ways many acquirers in the late
1990s used write-offs and "special charges" to mask the true cost of deals
and improve their results.

Plenty of companies that didn't do a lot of deals are also suffering from
accounting troubles and the weak economy. But the serial acquirers have
taken a bigger fall. A study done for The Wall Street Journal by Thomson
Financial found that the stocks of the top 50 acquirers of the late 1990s
have fallen three times as much as the Dow Jones Industrial Average. While
research studies have long shown that most mergers fail to benefit
shareholders, the recent string of blowups is by far the largest and most
visible ever.

AT&T is selling off the huge collection of cable companies it had bought
for more than $90 billion in the 1990s. Vivendi is under pressure to
deliver on its $100 billion shopping spree in the media business. The stock
of Cisco Systems Inc., one of the leading acquirers in the tech world, has
fallen 80% over the past two years. The company made more than 70
acquisitions in the 1990s, but many of the top talents at the acquired
companies have since left.

First Union Corp., which bought more than 90 banks over the past decade and
is now known as Wachovia Corp., is only now starting to recover from its
fumbling purchases of CoreStates Financial and the Money Store. Investors
remain wary of the company's recent purchase of Wachovia Corp.

The performance of advertising giant WPP Group PLC of Britain has been
hindered by its perceived troubles integrating its many acquisitions. Even
General Electric Co., a longtime king of serial acquirers whose $18 billion
in takeovers made it the biggest corporate buyer last year, is under
scrutiny for its deal making, as investors demand more growth from existing
businesses rather than deals.

"Investors want to see plain, simple, pure, organic growth," Tyco's Mr.
Kozlowski said in an interview shortly before his resignation. "Investors
won't pay up for acquisitions."

The about-face marks a stark change from the recent deal frenzy, which
peaked at $1.8 trillion in 2000, more than triple the level in the
mid-1990s. The troubles of the serial acquirers raise new questions about
the growth-by-acquisition strategy that enthralled so many companies and
investors during the bull market. Merger activity this year has fallen to
its lowest level in eight years, partly because of the recent string of
blowups. The deal mania of the late 1990s isn't expected to return for
years, if ever.

One reason is the approach that many serial acquirers followed and promoted
to investors. The idea sounded simple: Companies would apply their
expertise in acquisitions to generate outsized returns in otherwise
low-growth industries. By using high-priced stock instead of cash as
currency, the companies could pay rich premiums for deals that immediately
added to earnings growth. The higher earnings growth generated higher stock
prices, which only generated more deals.

But as happened to ITT, Gulf & Western and other deal-happy conglomerates
of the 1960s, the serial acquirers of the 1990s eventually ran out of
deals. When the stock market began to falter in early 2000, companies lost
the advantage of using their shares as ever-more-valuable acquisition
currency. That reduced the number of deals, which eventually lowered growth
rates. The cycle reversed.


"When you do lots of deals, you can promise great things -- and without
ever having to prove it," says Scott B. Schermerhorn, a portfolio manager
with Liberty Funds. "It all works fine until the deals stop."

Some serial-acquirers are succeeding, so far. Clear Channel Communications
Inc., which became a broadcasting giant by buying hundreds of radio and
television stations, continues to report solid growth. Oil giant BP PLC of
Britain and Dutch grocery-store owner Royal Ahold NV have proven that
well-timed, disciplined deals can help a company dominate an industry.

Still, a look at some of the most takeover-minded companies of the 1990s
suggests that many suffer from a special set of common ills.

TOO BIG TO GROW

Serial acquirers tend to attempt increasingly large -- and risky -- deals
to maintain their growth rates. Consider WorldCom. In its early years in
the early 1990s, the company racked up growth rates of more than 20% by
buying little-known local phone carriers.

Each deal allowed WorldCom to grow impressively as it absorbed the earnings
of its acquisitions. In 1998, it bought long-distance giant MCI
Communications for about $37 billion. Investors rewarded the company by
bidding up the stock price. The more-valuable stock fueled more deals.

As WorldCom ballooned, however, it required larger and larger acquisitions
to show impressive percentage gains in earnings. In 1999, Mr. Ebbers
reached an agreement to purchase Sprint Corp. for $115 billion in hopes of
sustaining his deal momentum. But federal regulators blocked the deal on
antitrust grounds. WorldCom's growth rate began to slow, and investors
responded by pushing down its stock price.

"WorldCom had to do Sprint to feed the beast," says Scott Cleland, chief
executive of Precursor Group, a telecommunication-consulting firm in
Washington. "When they hit the antitrust wall, the momentum stopped, and
everything started to crash."

WorldCom spokesman Brad Burns says, "The company didn't rely solely on
acquisitions for growth." It also generated growth by means of its own
operations, he says. "A broader shift in the marketplace" created huge
pressures on the company that explain its difficulties after 1999, he adds.

BID HIGH, BUY HIGHER

Caution became a dirty word for serial buyers in the late 1990s, as chief
executives and their investment bankers scoured the landscape for splashy
deals. The result: eye-popping bids that in retrospect look excessive. The
average acquisition price rose 70% from 1995 to 2000, to $470 million,
according to Dealogic CommScan, a financial-data provider.

Aggressive acquirers are now facing the fallout from their binges. In
April, AOL Time Warner Inc. took one of the largest write-offs in corporate
history: $54 billion. The write-off reflected a reduction in value of
"goodwill," or the premium between the price that AOL paid for Time Warner
and the actual value of Time Warner assets. In other words, AOL admitted
that its acquisition wasn't worth the purchase price by a long shot.

Similarly, Vivendi in April took a multibillion-dollar writedown reflecting
its purchases of Seagram Co. and French pay-TV company Canal Plus SA.
Cordiant Communications Group, Boeing Co. and Vodafone Group PLC also have
taken big write-downs recently.

After more than 100 acquisitions in the late 1980s and early 1990s,
Columbus, Ohio-based Banc One Corp. vowed to take a breather in 1996.
"We're not going to overpay, and we're not going to do dumb deals," vowed
Chief Executive John B. McCoy.

Consolidation continued to sweep the banking world, and prices kept going
up. By January 1997, Banc One rejoined the acquisition game, buying First
USA Inc. for about $7 billion. That price was 20 times First USA's
estimated 1997 earnings. By comparison, the total value of Banc One's own
outstanding stock was only about 14 times its earnings. Price-to-earnings
ratios are often used to gauge the relative wisdom of acquisitions.

Mr. McCoy defended the comparatively high purchase price by citing First
USA's growth potential. "You're going to pay more" for a target likely to
grow swiftly, he said in 1997.

Later that year, Banc One bought First Commerce Corp. for $2.97 billion, or
24 times First Commerce's annual earnings. Less than a year later, Banc One
combined with First Chicago NBD Corp. in a $30 billion deal and became Bank
One Corp. Since then, the bank has struggled to cut costs and integrate its
acquisitions.

"We did a good job of buying attractive franchises," says Bank One
spokesman Thomas Kelly. "We did a poor job of integrating them
effectively." As for overpaying, he says, "It is so hard to know whether
the prices were right."

NOT SO DILIGENT

One of the main shortcuts buyers took as they chased acquisitions in the
1990s was "due diligence." That is the process -- traditionally a
painstaking one -- in which buyers and their investment bankers pore over a
target's confidential financial information to see whether deals are
worthwhile.

Patriot American Hospitality Inc., a real-estate company, started out the
decade at the forefront of the acquisition boom, scooping up discounted
properties that had suffered in a real-estate downturn.

Patriot at first earned a reputation for methodical due diligence. But as
competition began to heat up in the mid-1990s, Patriot picked up its
acquisition pace, buying hotels in Miami, Chicago, Houston and Atlanta.

Instead of scouring an acquisition target's books, Patriot representatives
sometimes merely took a quick trip to the hotel, glanced at recent room
rates and scanned local zoning laws to gauge development opportunities,
according to a person familiar with some of the company's acquisitions.
Because of problems that Patriot missed, it sometimes later had to spend
more money than expected on maintenance and capital expenditures, according
to the person with knowledge of the company's acquisitions.

"When you're doing rapid-fire due diligence, you don't have time to talk to
the hotel's chief engineer, or find out what the customer complaints are or
see how big the air-conditioning unit is," the person adds.

By 1998, Patriot had acquired about 450 hotels, including Wyndham Hotel
Corp. But in 1999, Patriot faced a cash crunch and massive debt load that
brought it to the brink of insolvency, even as its hotels remained profitable.

The company, which later changed its name to Wyndham International, held
talks last year to sell itself to London-based Bass Hotels & Resorts, but a
deal didn't materialize. Wyndham is now selling some of the hotels it
bought in the 1990s.

Fred Kleisner, Wyndham's chairman and chief executive officer, says that
the fast pace of acquisitions resulted in a "compression of the
due-diligence period." The process itself wasn't flawed, he says. Mr.
Kleisner, a hotel-industry veteran, joined Wyndham in 1999.

FOREIGN GROUND

The acquirers of the 1990s vowed not to repeat the mistakes of 1960s
conglomerates that had assembled collections of unrelated businesses that
didn't mesh efficiently.

Some of the recent buyers acquired companies in the same industry. But
these aggregations turned out to yield few synergies or savings. With their
core businesses maturing, the enlarged corporations branched into different
industries they often didn't understand. Vivendi bought media, wireless and
Internet companies to move away from its original water-utility business.
Tyco bought financial-services firm CIT in 2001 for $9.5 billion to add to
its "core" businesses of security systems, health care and industrial
products.

AT&T made the most dramatic leap, vaulting from long-distance phone service
to become the nation's biggest cable company. Even though it had little
experience in cable, AT&T decided that getting into that business was the
solution to new phone competition after deregulation.

The result: After three years of poor performance and a plunging stock
price, AT&T has agreed to sell the bulk of its cable operations to Comcast
Corp. for about $37 billion.

AT&T spokeswoman Eileen Connolly says the company's foray into cable was
successful. She cites the large number of customers the company signed up
for telephone and high-speed-data service that it delivers over cable
lines. AT&T decided to sell its cable business to Comcast in an effort to
respond to investor demands for more streamlined businesses, she says.

ACCOUNTING QUESTIONS

Most of the current accounting scandals involve off-balance-sheet
arrangements and practices for recognizing revenue. But now, the SEC and
FASB are beginning to turn their attention to the complicated accounting of
deal making. "Deals give companies more ways to play with their
accounting," says Robert Willens, an accounting expert and managing
director at Lehman Brothers.

The general problem, investors say, is that deals can obscure a company's
true growth rate and earnings. While Tyco's earnings grew more than 20% a
year throughout much of the 1990s, much of that can be attributed to its
acquisitions, says Albert Meyer of David Tice & Associates, a
money-management firm. Tyco last year cleared an SEC investigation into its
accounting practices.

Tyco spent about $8 billion on more than 700 acquisitions over the past
three years that were never individually announced to the public. The
company has said that it has clearly stated the "net" amount of cash paid
for all acquisitions. The numerous small deals weren't "material," given
Tyco's huge size and therefore didn't warrant public disclosure, the
company has said.

Separately, executives at Raychem Corp., a large electronics company
acquired by Tyco in 1999, accelerated certain payments to its suppliers, at
Tyco's request, according to internal e-mails of the acquired company. This
action had the effect of boosting Tyco's cash flow and making the deal
appear more attractive. Tyco has said the Raychem actions weren't aimed at
boosting Tyco's results and that the issue was investigated and cleared by
the SEC.

Company spokesman J. Brad McGee says its acquisition strategies have
"resulted in us having world-premier-franchise leaders and low-cost
producers in all our businesses." All of Tyco's accounting practices are
consistent with generally accepted accounting principles, he says.


Louis Proyect
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