Why Do Certain Industries Attract More Mergers Than Others
Coverage of merger and takeover activity fills a large proportion of business reporting in today's media. Mergers occur more frequently in certain industries compared with others. Mulherin & Boone (2000) outlined the variation of merger activity by industry in the 1990's; approximately half the businesses in industries such as oil and gas, banking and telecommunications were involved in merger activity compared to less than 10% in the construction, newspaper or shoe industry. This essay discusses the factors which control the differences in frequency of mergers across industries and relates general findings to the banking industry which has experienced much merger activity over the last 40 years. Mergers are distinct from takeovers in that mergers involve two or more companies combining to form a new business entity whereas a takeover or acquisition involves one business buying another business (Gaughan 2015). To avoid unnecessary complication, all mergers and takeovers in this essay are referred to as mergers and the findings are derived from US and European industries.
Mergers come in waves
An established observation by empirical researchers is the presence of defined periods of general increased merger activity known as waves (Mitchell & Mulherin, 1996). Researchers highlight 6 distinct waves traced from the beginning of the 20th century to present day (Gaughan, 2015). The 3rd, 4th and 5th waves occurred during the 1970s, 1980s and 1990s respectively. Mitchell & Mulherin (1996) observed that mergers in these distinct waves cluster by industry. Merger activity in a particular industry will tend to be more active a narrow range of time such as a 5 year to 10 year span. There is limited overlap in the types of industry where mergers are most common when comparing mergers in each wave. For instance, in the 3rd wave mergers were most common in the mining, real estate and oil & gas industry, whereas in the 4th wave mergers were most prevalent in the oil & gas industry, textiles and manufacturing. In the 5th wave the highest frequency of mergers occurred in the mining, media & telecom and banking sectors. As an indicator of typical merger growth during a wave, at the height of the 4th wave there were 3336 registered mergers in the US in 1986 compared with 1889 in 1980 (Gaughan, 2015). The sixth wave of mergers occurred between 2003 and 2007 with quite similar frequency distributions across industry types compared to the 5th wave with the healthcare being a new prominent sector of increased activity (Alexandridis, Mavrovitis & Travlos, 2012). In 2014 the industry with the highest global value for mergers was media & telecommunications, followed by healthcare and energy (Statista 2015).
Industry clustering in mergers is linked to a variety of reasons referred to as 'shocks' by researchers (Andrade, Mitchell & Stafford, 2001). Shocks are sudden external changes that cause merger waves that affect whole industries such as variations in economic activity, technological change or government deregulation policy (Kaplan, 2000). Scholars refer to the neoclassical hypothesis that states once a shock occurs to an industry's environment, the assets in that industry are reallocated through mergers and partial-firm acquisitions. Managers in certain businesses simultaneously react and complete for the best assets available (Harford, 2005). Economic recessions can cause shocks across many industries as some firms that are less competitive either invite merger or are subject to hostile takeover. Conversely the 6th wave was characterised by businesses having an abundance of liquid cash through a strong global growth cycle that funded increased takeover activity (Gaughan, 2015).
Deregulation is the prominent example of a shock type affecting many industries as governments change legislation to opens up markets and allows mergers activity to be more accessible. Often industries that were previously dominated by public sector control are made available to the private sector such as the telecommunications industry in the US in 1984 with the break-up of AT&T (Harford, 2005). Acts are passed which lead to subsequent merger activity in the immediate following years (Mitchell & Mulherin, 1996). Examples would be the Telecommunications Act in 1996 and the Airline Deregulation Act of 1978. Investment banks provide process, legal and financial support to businesses to complete mergers and often encourage such activity (Gaughan, 2015). Often deregulation leads to geographical mergers where businesses from other countries or regions have the opportunity to take over existing firms, for example utility companies in the UK. More than any other factor, the relative presence of merger activity in different industries at any one time is reflection of the prevalent shock and subsequent clustering phenomenon (Harford, 2005).
Motives for mergers in industry
The presence of stronger incentives for merger in certain industries has also been recognised. The motives for mergers have been analysed and classified into a series of themes that can be related to various industries (Gaughan, 2015). Broadly speaking scholars recognise mergers achieve synergies where the combination of the two or more merged businesses leads to advantages that continued separation wouldn't have achieved (Bradley, Desai & Man, 1988). Such advantages ultimately allow an increased market value and profitability in the firm even after any expenses incurred during the merger process are met. Reductions in unit costs can often be achieved immediately after a merger as duplication of operation can be removed. During horizontal integration when two firms merge in the same industry and the same level of production, there often can be immediate significant cost savings as some expertise and resources can now be shared. Merger can lead to the removal of one set of central offices, unnecessary plant and machinery, and/or layers of higher management (Gaughan, 2005). Businesses in some industries can easily find initial savings such as the airline industry where the two airlines that merged can use the same offices, flight bays, machinery and personal at airports after the merger has occurred (Kim & Singal, 1993).
A series of economies of scale are possible where average unit costs are reduced after a merger which lead to competitive advantage (Gaughan, 2015). Typically these could be purchasing economies of scale where the merged company in the manufacturing sector could negotiate lower unit cost with suppliers. Marketing economies of scale occur when the newly merged firm does not have to increase the marketing budget by the same proportional rate as new there were two separate companies so as to reduce marketing unit cost. The cruise ship industry is an example where marketing costs were cut during significant mergers in the 1990s as TV advertising and travel agency fees per unit could be reduced significantly (Gaughan 2005). Financial economies of scale are possible as the larger merged company can reduce borrowing costs per unit as banks will lend at lower interest rates to larger loans or when more collateral is available. Mergers can occur in those industries which have the opportunities that allow a range of economies of scale to be achieved by the implied increase in size of operation. A slightly different concept that is related but distinct from economies of scale is economies of scope where the new merger uses a wider range of inputs to offer more goods or services to customers which leads to unit cost reductions (Cummins et al, 2010). Economies of scope can often be observed with mergers in financial institutions where each firm brings some unique inputs which are targeted to the whole new customer base. The fixed cost of developing the inputs has not changed as it is spread across the new merged firm and there are central operational costs such as management remuneration and administration costs that can be spread across the whole product portfolio.
Another common theory of motives for mergers is that they allow for the new firm to obtain market power by having enough market share to set and keep prices above competitive levels. Gaughan (2015) suggests that horizontal integration may only allow market power with the presence of strong product differentiation and barriers to entry. If it takes much resources and time to enter a market such as the airline industry then the benefits of market power may be realised. Eckbo (1983) found little evidence for market power being a conscious motive for executives pursuing mergers. However, Kim & Singal (1993) did conclude it existed in the airline industry. Other motives for merger include reduction of risk through diversification and a means of geographic expansion. Executives in corporations pursue a variety of motives which relate the industry within which they operate.
Mergers in the Banking Industry
Throughout all the last 3 merger waves and to the present day, mergers are very prominent in the banking industry. Mulherin & Boone (2000) reported that 57% of all banks in the US were part of merger activity during the 1990's. Deregulation such as the Financial Services Modernization Act 1999 is the main shock factor that has led to continued consolidation in the banking sector in US and Europe (Madura, 2003). Also during testing economic situations, less profitable or liquid banks need the support of an acquiring bank that sees the potential for growth at a reasonable cost (Bottiglia, Gualandri & Mazzocco, 2010). Banks mergers can often bring immediate unit cost saving especially with horizontal mergers in the same region. Economies of Scope are common where each merging bank brings inputs that can be spread across all customers such as a computer system for deposits or an economic research unit (Gaughan, 2005). Mergers have allowed banks to expand to new markets to take advantage of economies of scale as happened across Europe in the past decade.
Reviewing the performance of bank mergers in the US during the 1990's, Calomoris & Kareeski (2000) concluded that many mergers created value by cost-saving and taking advantage of economies of scope through cross-selling and up-selling to boost growth. However some banks didn't perform well after the initial merger period due to a variety of poor business practice often related to staff performance. Mulherin & Boone (1997) reported medium-sized banks generally had the lowest average costs and so large mergers as a means of guaranteeing economies of scale are questionable. Anderson & Joeveer (2012) found in a later study that bank mergers had created economies of scale and scope benefits to shareholders and executives in larger banks in the US during the 1990s and early 2000s. Bank mergers have failed in the sense of not providing long-term shareholder value for similar reasons to takeovers in other industries (Gaughan, 2005).The buying bank can pay too much for the bank it acquires as the executives get too ambitious for short-term gains and then find it difficult to generate revenues to realise their investment. Also mergers fail when the buyer funds the takeover through a leverage buyout where money is borrowed to finance the purchase against the assets of the existing business. Many times the debt accrued during leverage buyouts proves difficult to repay. Clearly there are challenges measuring the success of mergers in the bank sector and variations in conclusions by researchers. Banks can meet post-merger objectives but after the merger there still needs to be good business practice.
Research shows that at any one time during the last 50 years, it is possible to outline and rationalise those industries that have most merger activity. Shock factors such as deregulation or the prevalent economic conditions trigger increased merger activity in certain industries in phases known as waves which last for 5 to 10 years. The present time is not considered to be in a wave phase but there is significant merger activity in the healthcare, telecommunications, energy and financial service industries (Langston, 2014). Various motives pursued by managers drive merger activity and some industries have tendencies to present more potential opportunities from mergers compared to others. Banking sector mergers often allows two businesses to reduce risk and promote growth through initial cost savings and economies of scope. Mergers are not always successful for managers and shareholders as businesses can be overpriced or leverage buyouts can be misconceived. Mergers activity seems set to continue in the near future as a preferential method of growth in many industries.
Alexandridis, G., Mavrovitis, C.F. & Travlos, N.G. (2012) How Have M&AS Changed? Evidence from the Sixth Merger Wave. European Journal of Finance. 18. pp.663-688.
Anderson R.W. & Joeveer K. (2012) Bankers and Bank Investors: Reconsidering the economies of scale in banking. Financial Markets Discussion Paper 712. London: The London School of Economics and Political Science.
Andrade, G., Mitchell, M. & Stafford, E. (2001) New evidence and perspectives on Mergers. Journal of Economic Perspectives. 15(2). pp.103-120.
Bottiglia, R., Gualandri, E. & Mazzocorro, N.G. (2010) Consolidation in the Financial Industry. Basingstoke: MacMillan.
Bradley, M., Desai, A. & Man, K.E. (1988) Synergistic Gains from Corporate Acquisitions and Their Division Between Shareholders and Acquiring Firms. Journal of Financial Economics. 21. pp.3 -40.
Calominiris, C.W. & Kareeski, J. (1998) Is the Bank Merger Wave of the 1990s Efficient? In: Kaplan, S. (ed). Mergers and Productivity. London: The University of Chicago Press.
Cummins, D.J. et al. (2010) Economies of scope in financial services: A DEA efficiency analysis of the US insurance industry. Journal of Banking & Finance. 34(7). pp.1525-1539.
Eckbo, B.E. Horizontal Mergers, Collusion and Stockholder Wealth. Journal of Financial Economics. 11(1). pp.241-273.
Gaughan, P.A. (2015) Mergers, Acquisitions, and Corporate Restructurings. 6th Ed. Hoboken, New Jersey: Wiley.
Gaughan, P.A. (2005) Mergers: What can go wrong and How to Prevent It. Hoboken, New Jersey: Wiley.
Harford, J. (2005) What drives merger waves? Journal of Financial Economics. 77. pp.529-560.
Kaplan, S. (2000) Mergers and Productivity. Chicago: University of Chicago Press.
Kim, E.H. & Singal, V. (1993) Mergers and Market Power: Evidence from the Airline Industry. American Economic Review. 83(3). pp.549-569.
Langston, R. (2014) M & A Deal-Makers. [Online} Available from: http://raconteur.net/finance/ma-deal-makers
Madura, J. (2003) Financial Markets and Institutions. New York: Thompson.
Mitchell, M.L. & Mulherin, J.H. (1996). The Impact of Industry Shocks on Takeover and Restructuring Activity. Journal of Financial Economics. 41. pp.191-229.
Mulherin, J.H. & Boone, A.L. (2000) Comparing acquisitions and divestitures. Journal of Corporate Finance. 6. pp.117-139.
Statista (2015). Value of global mergers and acquisitions in 2014: by industry (in billion U.S. dollars). [Online] Available from: http://www.statista.com/statistics/245949/value-of-global-m-and-a-in-h1-2012-by-industry