The New Mergerphilia

By Michael Peltz

Glossary of Terms

Financial Accounting Standards Board: FASB is a self-regulatory organization set up in 1973 to establish and interpret generally accepted accounting principles.

Goodwill: The premium paid for a company over and above the value of its tangible assets (or book value). In acquisitions, goodwill is generally understood to represent the value of a company's business name, product brands, customer loyalty, and intellectual property, and it is subtracted (or charged) against future earnings.

Pooling of Interests: A tax-free method of merger accounting whereby the two companies simply add their separate assets and liabilities together on one balance sheet. Pooling of interests can be used only when an acquisition is paid for with common stock. It has been popular in recent years because it enables the acquiring company to avoid writing off a charge against profits for goodwill.

Purchase accounting: Used in purchases that involve cash, this accounting method requires the company making the acquisition to write off goodwill charges over a period not to exceed 40 years. Proposed changes in FASB rules would require all companies to use purchase accounting, regardless of method of payment, and would reduce the write-off period to no more than 20 years.

Tender offer: The offer to buy shares of a company, usually at a premium above their market price, with the intent of taking control of that company. Tender offers are often associated with hostile takeover bids but may also be used by companies to acquire shares during friendly negotiations.



On March 25, one day after Newell completed its $5.8 billion acquisition of Rubbermaid, the little-known consumer-products maker spent several hundred thousand dollars more to run a splashy ad on consecutive right-hand pages in the front sections of The New York Times and The Wall Street Journal. The first page of the ad posed the question "What would you call a company that offers financial performance, innovative thinking, cost management, new product expertise, customer service, and forty brand names?" Readers could then turn to the next page to discover the answer: "Newell Rubbermaid, you know us by the companies we keep." Decorating the border of that page were logos from the entire family of Newell brands, which include such household names as Levolor, Rolodex, Little Tikes, Calphalon, Sharpie, and, yes, Rubbermaid.

The ad's bold claim that the merger "also brings together strategic management disciplines which we believe will increase shareholder value" caught our attention. And the market's.

Newell (NYSE: NWL) soared 5.1 percent on March 25, closing at more than $49 a share, its highest level since the Rubbermaid acquisition was announced the previous October. Not that the intervening weakness in Newell's shares was all that unusual, because the stock of the acquirer often goes down initially on news of a merger. In this case, Newell had tumbled 11.5 percent, sparked by legitimate fears that earnings per share would be temporarily diluted when the company issued new shares to pay for Rubbermaid in the all-stock transaction.

The rebound this spring, however, was short-lived. Newell shares dropped back into the mid-$40 range, well off their pre-merger high of $55. "The market is reacting to the short-term challenge of the merger and the resulting downgrading of earnings expectations for this year," explains Elliott Schlang, managing director of LJR Great Lakes Review. He nonetheless thinks Newell Rubbermaid is "an extremely attractive merger on a fundamental basis" and sees the recent weakness in its stock as a good buying opportunity.

Try telling that to investors. They seem to have forgotten that Newell has one of the best track records in corporate America when it comes to integrating acquisitions. In this decade, Newell's shares have gone up 312 percent, as the company (based in Freeport, Illinois) has made 20 major acquisitions, which should account for more than $5 billion of its projected $6.4 billion in annual sales this year. That's a lot of Burnes picture frames, Goody hairbrushes, Kirsch window treatments, and Sanford pens. "Our basic strategy is to deliver superior brands and customer service to mass merchants like Wal-Mart and Target, and Rubbermaid really was an important acquisition for us strategically," explains CEO John McDonough, who along with several other senior managers runs Newell from a white converted farmhouse in Beloit, Wisconsin, about a 45-minute drive from the Freeport offices.

Newell's difficulty in convincing investors of the long-term merits of its most recent merger illustrates the angst that typically surrounds corporate marriages. For every deal that works out well, there seems to be another that struggles. In a recently published paper that looked at 3,500 U.S. mergers and acquisitions from 1980 through 1991, Purdue University professor Raghavendra Rau found that the stocks of acquiring companies underperformed their peers by 4 percent, on average, during the three years after a merger was completed. "I'd tend to avoid mergers, because overall they do poorly," says Rau.

Dodging deals is difficult. Since 1995, there have been more than 110,000 announced mergers and acquisitions worldwide, representing a total value of about $7.4 trillion, according to Securities Data. Nor is the buying frenzy likely to slow, as companies have little choice but to grow bigger faster to compete effectively in today's global economy. In addition, a proposed U.S. accounting change, which would eliminate favorable "pooling of interests" treatment for all-stock acquisitions like Newell's purchase of Rubbermaid, may actually boost M&A activity during the next 16 months, as companies rush to complete deals before the rule's expected adoption by the Financial Accounting Standards Board in January 2001 (see glossary).

Investors can actually profit from playing the merger game. One way, of course, is to try to build a portfolio of potential acquisition targets, since most companies are bought out at a premium to their current stock price. But that's tough, even for professionals. And if a stock in your portfolio were to get taken out, you would still need to know what to do with the stock you would be likely to receive.

A better tactic is to look at companies that have already made acquisitions and apply what money manager Mary Lisanti calls the "commonsense test." "The first thing you have to do is sit down and figure out if the merger makes sense," says Lisanti, chief investment officer for equities at Northstar Investment Management. "The mergers that I've seen that are most successful basically bring products together that are truly value added. In other words, they fill out your company's product line, or by adding this product line, you can offer another service, or by adding this service, you expand your customer base." That sounds a lot like Newell's strategy, but it's also at the core of computer networking giant Cisco Systems' success (see Equity, spring 1999). "Cisco is the best without a doubt at making technology acquisitions," says Kathryn Gould, a general partner with venture-capital firm Foundation Capital.

For the most part, Cisco and Newell have acquired smaller companies and product lines, but both companies have been so skilled at integrating these acquisitions that they should have little trouble digesting larger deals, too. "It's like anything else," says Northstar's Lisanti. "You get better the more you do it." Usually, but not always. Take Cendant, the product of a December 1997 merger between franchising giant HFS and discount-shopping-club operator CUC International. Former HFS chief executive Henry Silverman, the longtime deal maker now running the combined company, failed to notice that CUC had been inflating its earnings. When the news broke in the spring of 1998, Cendant's stock tanked. Similarly, McKesson HBOC's stock plummeted this spring when the drug-distribution company had to restate prior earnings because HBO & Co., which it acquired in January, had improperly booked revenue.

So how do you separate the Cendants from the Ciscos?

Watch out for red flags. On October 19, 1998, shares of HBO & Co. fell 14 percent, as analysts questioned whether the once highflying software maker was settling for a lowball price from McKesson. "Investors should be careful when a company has been doing extremely well and its management suddenly sells out for not much of a premium," says Jennifer Silver, who manages the $560 million Neuberger Berman Manhattan Fund. "Perhaps they're not seeing as much of a future as others see for them."

Focus on the fit. Finding the strategic fit sometimes requires a little extra homework. Some investors dumped shares of Federated Department Stores after its $1.7 billion March acquisition of catalog company Fingerhut, failing to realize the value of Fingerhut's product-fulfillment technology and the 35 million people in its customer database. Those who stuck with Federated have been rewarded with a 34 percent jump in its stock, as Fingerhut's direct-mail unit has signed agreements to fill orders over the Internet for 22 retailers, including Wal-Mart and eToys.

Be wary of cross-industry mergers. Using acquisitions to get into new markets and industries can be very tricky, as shareholders of McKesson have found out all too well. "It significantly raises the level of risk," says money manager Lisanti.

Culture counts considerably. Watch out for deals that are billed as "mergers of equals," especially when the participating companies have very different cultures or when senior management of both companies have big egos. An obvious example is Citigroup, created last year by high-powered CEOs John Reed of Citicorp and Sandy Weill of Travelers, who continue to share the title of CEO.

The proof is in the process. A company should have a consistent and clearly defined formula for making acquisitions and integrating them into its existing business. At Newell, the integration process is called Newellization. "We focus the strategy, establish financial discipline, install our systems, and make sure we are not carrying products or customers that are not profitable," says chief executive McDonough.

Pay attention to price. Don't worry too much about the premium being paid by the acquirer. Instead, try to determine how much that company would have had to spend to increase the business internally, and how that compares with what the company is paying to make the acquisition. It's okay for a company to overpay a little if an acquisition is really critical to its strategy and can be easily integrated into its existing business.

Think about tomorrow. Investors today put too much importance on short-term earnings. So, inevitably, many acquisitions are guaranteed to be disappointing because they will at least initially dilute earnings per share. Short-term earnings disappointments, as Newell Rubbermaid experienced this spring, can actually provide an excellent opportunity for savvy investors to get in at a good price with companies making strategic acquisitions that should pay off two to three years down the road.

Michael Peltz is Worth's financial editor. Additional reporting by Worth associate writer Dave Califano.

Illustration by Philip Anderson


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