Market Basics: Merger Waves
In the market basics of this week we will analyse the different merger waves and their underlying reasons. In the last section of this article we will further discuss if such a wave is currently approaching and which industries are affected most.
A merger wave can be defined as a period of time in which more merger bids materialise than usual. As can be seen in the visual below, there have been six of these waves since 1895. The most recent wave occurred around 2004. The three most common drivers of merger waves are positive stock market conditions, technological change and overcapacity.
The following will carefully study and outline the individual waves:
The clustering that occurred between 1897 and 1904 is frequently labelled the monopoly wave and predominantly impacted the manufacturing industry. It mostly saw competitors or firms that operate in a similar industry merge to create economies of scale. Hence, trust formed a crucial pillar during this era. The factors that led to this period of intense horizontal integration declining were a stock market crash, banking panic and arising regulations against monopoly.
The second wave known as the oligopoly wave and occurred between 1919 and 1929. Rather than the horizontal mergers of the first wave, this wave saw vertical mergers prevailing. The key difference is that vertical mergers are typically aimed at efficiency enhancements (for example a hardware firm merging with a software firm), while horizontal mergers are mainly targeted to increase market share. The main drivers were favourable stock market prices and arising regulations against horizontal integrations. Consequentially, companies were forced to favour vertical acquisitions. A further driver behind this merger wave was the end of WW1. Organisations were looking to grow through productivity enhancements, hence sparking the need for vertical mergers. The main industries impacted were chemicals, banking and public utilities. The turning point of this wave was the stock market crash of 1929.
The conglomerate wave which occurred between 1965 and 1969 mainly centred around the oil industry. Benefiting from the post-war growth opportunities, these mergers were focused on achieving expansion and diversification. With horizontal and vertical mergers not providing adequate solutions, companies largely turned to conglomerate mergers. In short, conglomerate mergers involve companies from unrelated sectors and are aimed at achieving diversification, an increased consumer base and enhanced efficiency. The recession of 1971 marked the end of this wave. Its end was mainly caused by intensified antitrust enforcement.
The refocusing wave (1984-1989) was driven by falling interest rates, capital market innovations and deregulations. Leveraged buyouts and private equity started to rise in popularity, while more intensive use of debt and investment banking started to materialise. Deals were mostly hostile and involved both large and small firms. This wave was very broad-based and touched almost all sectors. A further development was the introduction of new financial markets, such as the “junk bond” market. The end was caused by the S&L crisis and the 1990 recession.
Between 1994 and 2001 falling interest rates and greed for economies of scale led to the famous strategic wave. During the 1990s western economies entered the longest post-war expansion and companies reacted to the increasing demand by pursuing M&A activity. This was characterised by industry-specific shocks like demographic changes and technological changes. The organisations mostly involved in this wave were venture capitalists. Many large mega-mergers materialised, with deals often exceeding valuations of a billion. In fact, most of the biggest M&A deals in history occurred during the strategic wave. The end of this wave came rather abruptly with the burst of the internet bubble in 2000 and saw many established firms, such as Worldcom and Enron file for bankruptcy.
Relaxed antitrust rules and innovation in credit derivatives triggered the sixth wave. It took place between 2004 and 2007 and was largely shaped by globalisation and shareholder demands. Similar to the fourth wave, the businesses involved were mostly private equity firms. The wave was further heavily supported by the financial markets and led to a clustering in the financial industry. The 2007 economic crisis signalled its end.
Why do mergers occur in waves?
A very common reason is the overvaluation of shares. When a company’s shares are priced above their fair value, the managers can capitalise on this by going through an acquisition in which they buy targets with overvalued shares.
Another frequently cited reason by academic articles are economic and demographic shocks. Firms do not have the time to adapt quickly and thus, increase their adaptation speed by acquiring one capable target.
Are we currently in a merger wave?
Similar to 2007, stock markets are booming and merger activity is reaching its peak. According to Bloomberg, the peak in merger activity signals an upcoming recession. Should we be worried? One should note that in the early stages of a merger wave, firms largely pursue mergers in order to adapt to the external environment. Once the wave rises, merging becomes a trend for managers and a signal of power. This is exactly when irrationality comes in and danger appears. We are currently still witnessing the aftereffects of the 6th wave. While there is still some activity left for investment banks and private equity boutiques to capitalise on, we can be sure that the currently favourable conditions will not last another 6 years.