Vodafone is key to future of the stock market bubble
Times of London
Leading technology companies
Whatever its outcome, the takeover battle between Vodafone and Mannesmann is bound to go down in history as an epic event in the development of global capitalism. It is (amazingly) the first big hostile bid in the history of post-war Germany. It is the most expensive contested takeover ever attempted anywhere. And it is the biggest proposed combination in telecommunications, one of the world's fastest growing and financially most exciting industries.
The German Government and the Frankfurt financial establishment will be closely watched by investors, businessmen and politicians the world over for signs that they are backing away from the commitment to free competition and open markets that Germany has apparently embraced in the past few years.
Traditional social market ideas about preserving jobs, consulting workers, regulating foreign ownership or trying to keep corporate headquarters in particular cities or countries are still deeply embedded in the German Social Democrats' political culture, but they are anathema not only to the cosmopolitan investors, arbitrageurs and merchant bankers who will decide their fates of these two companies. They also conflict with the most basic principles of the European single market. How this takeover battle is fought will go a long way to demonstrate whether the Single Market turns out to be, as Margaret Thatcher intended, a mechanism for bringing Anglo-Saxon economic liberalism to Europe or whether its main effect will be to impose more Franco-German style regulation on the UK.
My hunch is that the Germans will play quite carefully by the rules of the global capitalist game (despite Mannesman's embarrassing false start in London's High Court last week) and the outcome will be settled largely by financial arguments, rather than by political interference. Indeed, the Mannesmann board's formal response to the offer was a world away from the very traditionalist "social market" comments over the weekend from Gerhardt Schr”der, the German Chancellor. The board's only real objection to the Vodafone bid appeared to be a matter of the price: "Any offer will be measured against the value potential for Mannesmann shareholders.Today's offer does not match this value potential." To many traditional Germans this defence must have recalled a comment made by Carl Icahn, the American corporate raider, at the height of the last US takeover frenzy, in the late 1980s: "There's a price for everything except your children, and maybe your wife."
But even if this battle is played out by the rules of global free-market capitalism, it does not necessarily follow that Vodafone will succeed. This is because, amid all the financial superlatives and political excitement, two economically very important issues at the heart of this battle are in danger of being ignored.
The first is the question of business strategy. Which of these managements actually has a better strategy for creating and running a global telephone business? I cannot claim to be an expert on this issue, but several of the claims made by Mannesmann's defenders do ring true. Vodafone seems to have been rather naive in relying on minority arrangements with unreliable partners, including Mannesmann itself, to extend its reach across Europe. And Vodafone may soon be facing a squeeze on its profits in the key British market, as the inflated prices for mobile telephony here come under serious competitive pressure. In short, Vodafone badly needs to consummate this takeover in order to keep growing at the annual rate of 30 per cent plus, which its shareholders now take for granted. Of course, the same compulsion to expand by acquisition almost certainly applies to Mannesmann, which is why it was willing to jeopardise its longstanding friendly relationship with Vodafone by launching the takeover for Orange that sparked off this entire bidding war.
But why is there such a compulsion to keep merging, not only for Vodafone and Mannesmann, but for so many other companies in the telecommunications and high-tech industries? This question raises a second, and more troubling, issue. Is either Vodafone or Mannesmann really worth remotely the kind of money that is now being bandied about by both companies' directors?
It is notable that the proposed takeover of Mannesmann is to be paid entirely in newly issued shares of Vodafone stock; it does not contain any cash. This is entirely normal for takeovers in the high- tech sector. High-tech companies are now so highly valued that they generally use shares, rather than cash for all corporate transactions (and in many cases for paying large parts of their wage bills as well). This is financially perfectly rational, because high-tech shares represent an almost free currency that the management of these companies can issue at will with almost no cost to their existing shareholders. And issuing new shares to keep buying up new businesses (or sometimes to attract new customers through loss-making promotions) can become almost obligatory, because high-tech companies must keep up their rapid growth records at all costs.
Everyone knows that high tech companies are very expensive in relation to their reported profits (as shown in the second row of the chart). The justification for these high values is twofold. Firstly, the high valuations are explained by the very rapid growth in profits and revenues achieved by most high-tech companies. Secondly, it is often argued that the "first mover" - the company that succeeds in dominating a new high-tech business or market before any others - will automatically establish a position of hugely profitable monopoly power. Thus, almost any price is deemed to be worth paying to acquire a potentially dominant stake in a promising new technology or market.
So far the strategy of rapid expansion, regardless of profits or the prices paid for acquisitions has worked brilliantly for the leading high-tech companies and their investors. But both history and arithmetic demonstrate that, sooner or later, the record of relentless expansion will be interrupted. And when rapidly growing companies stop expanding or even slow down, their shares almost invariably collapse.
Specifically, two big threats to high-tech share prices now seem to be looming over the horizon. The first is the anti-trust action against Microsoft. This is drawing attention to the fact that Microsoft's extraordinary profitability and market dominance have been due largely to the abuse of monopoly power and not to "first move advantages" or other magic ingredients that are potentially available to other high-tech companies. If Microsoft's corporate strategies are now curbed by the anti-trust action, it is questionable whether its shares will be able to maintain their extraordinarily high valuation relative to its total sales revenues (see bottom chart). If Microsoft proves unable to sustain its present valuations, then the many other companies that are aspiring to become the Microsofts of the future will have to re-examine their corporate strategies - and shareholders will have to question the valuations they have built on the hopes that they have bought into the next Microsoft.
The second threat to the high-tech boom lies in the possibility of failure for one of the expansionary sharefinanced takeovers that have been helping to fuel the sector's very rapid growth. This brings us back to Vodafone. If the takeover of Mannesmann were to be rebuffed, whether by shareholders or by regulators in Europe, the shock to the high-tech sector might extend far beyond Vodafone and the European markets.
The stock market only values technology shares so highly as long as they maintain their records of uninterrupted growth and extremely aggressive expansion. If growth ceases or slows down, the share price falls and it becomes impossible to issue new shares to finance further acquisitions. Such virtuous and vicious circles are familiar components of all previous speculative bubbles in financial markets, the most famous recent examples being the conglomerate boom of the early 1970s, which ended with Saul Steinberg's failed bid for Chemical Bank and the leveraged buyout frenzy of the late 1980s, which culminated in Britain with the unsuccessful bid by the Saatchi brothers for Midland Bank. If Vodafone fails in its bid for Mannesmann, this takeover battle could mark a similar climax. It is not just the credibility of the European single market, but the future of the stock market bubble that now depends on this bid.
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