JDSU--Megamerger mania
July 14, 2000
These days, it seems like the only companies not doing mega-macho mergers with ambitions to take over the world are those that are being prevented from doing so by the regulatory agencies. (See "Worldcom and Sprint put on brave faces").
Poor Bernie Ebbers of Worldcom (WCOM) is being prevented from expanding his critical wireless services through a Sprint (FON) acquisition, even though he is probably one of the few executives in the world who has half a chance of making something like this work.
The irony is that if government agencies really want to increase competition, they ought to allow mergers to go through. The simple reason is that most big mergers fizzle rather than sizzle. Let them merge into failure, and you'll see a ton of executive defections and spinoffs carving up the market for themselves.
Ebbers, of course, is one of the two possible exceptions to this rule. The other is Cisco (CSCO) CEO John Chambers. These guys have made a specialty of managing growth through mergers, and proved that it is indeed a rare talent.
Grab and grow
Company after company has set itself onto a path toward oblivion by trying to quickly grab market share and heft through giant mergers. Cisco competitor Ascend Communications tried to keep up with its neighbor by buying Cascade, and that's exactly what it got -- a cascading stock price. Computer Associates (CA) tried to become the world's biggest software company through acquisitions, and ended up losing out to companies that grow themselves internally, Microsoft (MSFT) and Oracle (ORCL). CA has a market cap of $16.5 billion, compared to $412 billion for Microsoft and $215 billion for Oracle. Close race, huh?
Sure, CA is in the wrong markets -- too much emphasis on mainframes. But have no doubt about its merger motives. It used to brag that it was the second largest software company after Microsoft, after a wave of mergers built its growth. Indigestion came later.
Look at the results of some of the other recent mega-merger announcements. America Online (AOL) announced its intent to acquire Time Warner (TWX) in January of this year. It still hasn't happened. The FCC is getting ready to hold hearings on the merger. In the meantime, executives have been bailing out of Time Warner amid other signs of culture clash. (link TK).
Here's an interesting comparison. AOL's P/E ratio is at about 137, Time Warner's is at 62. Investors are clearly betting on the New Economy company, AOL. But Yahoo (YHOO), which is not as big as AOL even before the merger, is trading at a P/E of about 278. I would bet on the company that likes growing without acquisitions, too.
Let them merge
Now, of course, the news is about JDS Uniphase's (JDSU) proposed buyout of SDL (SDLI). (See "JDS and SDL in $41B marriage"."). While SDL's stock rose on the news, it did not match the offering price from JDS, whose stock dropped on the news. Again, antitrust concerns seem to be at the forefront.
I would worry more, however, about managing to digest such a big meal. Let them merge. There will probably be more defections and spinoffs, and increased competition.
The funny thing about all this is that while half the world seems to be merging, the other half seems to be divesting. Look what Hewlett-Packard's (HWP) divestiture of Agilent (A) did for both companies. Their stocks are on the rise. Remember AT&T's (T) divestiture of Lucent (LU)? Network Associates (NETA) did a pseudo-spinoff of McAfee Associates (MCAF), (it still owns 95 percent of McAfee's voting shares), made a lot of money and helped boost the McAfee brand name.
McAfee's stock has dropped since then, but not because of its divestiture. In general, a company's stock rarely drops when it does a spinoff, but often drops when it announces a merger, or when it runs into trouble trying to merge management, product lines and technology.
Small companies agile
I vote for the spinoff strategy. This is a time for entrepreneurs, despite the recent dotcom stock declines. The market will come back. Small companies are more agile in turbulent times. They are more focused, and gain stronger brand recognition (one of the reasons for the McAfee spinoff). As the market for small tech stocks return, a spinoff is a way to keep from losing great executives to outside startups.
Large corporations are recognizing the value of aggressive startups by investing in them. Intel (INTC) and Microsoft, rather than doing tons of mergers, have set up VC groups that simply help great startups create products for the big companies' platforms. Industry consultant and founder of Hurwitz Group, Judith Hurwitz, describes this practice as "outsourcing R&D to startups."
Now that is a great trend. In fact, a large company investment in a small one is an admission that there are shortcomings to the large company approach to innovation. "In some ways, it's a failure (on behalf of the large company) to execute," says Hurwitz. And that is fine. Some things are better done by large companies, some by small.
The price of failure
Neither approach is perfect. Most startups fail, and most big mergers inflict a lot of pain on everyone except competitors. But if a startup fails, you go on to the next one. If a megacorporation fails, shareholders are devastated, major industries are disrupted and the shakeup reverberates through huge markets. Microsoft's competitors in applications software tried to compete through mergers to gain clout, and instead ended up handing the entire industry to Microsoft.
With the exceptions of Worldcom and Cisco, companies rarely acquire their way to leadership positions. Sure, I understand the need for market share and the promise of taking an early lead in a young growth business. But betting on that strategy strikes me as being very similar to the former dotcom strategy of sacrificing profits, strategic planning and product quality for the hungry acquisition of market share. It's short-sighted and shallow.
My advice to Bill Gates: Do some corporate splitting yourself, instead of waiting for the Feds to force it upon you. To Ebbers: Tough break, but you'll do fine. To JDS Uniphase: Be careful what you wish for. And to Ray Lane, who just left Oracle, the company that made him a billionaire: If you want to join a startup, give me a call.
(Senior contributing editor Richard Brandt is working on his own startup, a company called eFounders.)
Richard L. Brandt is senior contributing editor at UPSIDE. |
