Mergers and acquisitions. If, at first

Will the latest cycle of European mergers produce better results?

COMPANIES have embarked on what looks like the beginnings of a re-run of the mergers and acquisitions (M&A) wave that defined the second bubbly half of the 1990s. That period, readers might recall, was characterised by a collective splurge that saw the creation of some of the most indebted companies in history, many of which later went bankrupt or were themselves broken up. Wild bidding for telecoms, internet and media assets, not to mention the madness that was Daimler's $40 billion motoring takeover in 1998-99 of Chrysler or the Time-Warner/AOL mega-merger in 2000, helped to give mergers a thoroughly bad name. A consensus emerged that M&A was a great way for investment banks to reap rich fees, and a sure way for ambitious managers to betray investors by trashing the value of their shares.

Now M&A is back. Its return is a global phenomenon, but it is perhaps most striking in Europe, where so far this year there has been a stream of deals worth more than $600 billion in total, around 40% higher than in the same period of 2004. The latest effort came this week when France's Saint-Gobain, a building-materials firm, unveiled the details of its £3.6 billion ($6.5 billion) hostile bid for BPB, a British rival. In the first half of the year, cross-border activity was up three-fold over the same period last year. Even France Telecom, which was left almost bankrupt at the end of the last merger wave, recently bought Amena, a Spanish mobile operator.

Shareholders' approval of all these deals raises an interesting question for companies everywhere: are investors right to think that these mergers are more likely to succeed than earlier ones? There are two answers. The first is that past mergers may have been judged too harshly. The second is that the present rash of European deals does look more rational, but - and the caveat is crucial - only so far. The pattern may not hold.

M&A's poor reputation stems not only from the string of spectacular failures in the 1990s, but also from studies that showed value destruction for acquiring shareholders in 80% of deals. But more recent studies by economists have introduced a note of caution. Investors should look at the number of deals that succeed or fail (typically measured by the impact on the share price), rather than (as you might think) weighing them by size. For example, no one doubts that the Daimler-Chrysler merger destroyed value. The combined market value of the two firms is still below that of Daimler alone before the deal. This single deal accounted for half of all German M&A activity by value in 1998 and 1999, and probably dominated people's thinking about mergers to the same degree. Throw in a few other such monsters and it is no wonder that broad studies have tended to find that mergers are a bad idea. The true picture is more complicated.

Of course, it's different this time

Several factors suggest that European companies, in common with their counterparts elsewhere, are not being reckless in the latest round of deals. Importantly, some of the features of the bubble years have disappeared or become less influential. For example, managers are less loaded up with share options, which has reduced their temptation to chase deals that deliver a short-term pay-off at the cost of long-term value creation. Companies also seem more intent this time on strategic, rather than financially motivated deals - building on core strengths and buying into new geographic markets are common themes in the latest round of deals, whereas costly diversifications are little in evidence. In addition, a bigger proportion of deals are being paid for in cash, a currency which managers tend to harbour more prudently than shares and which is a less forgiving measuring rod.

And finally, as labour-market and other reforms (however modest) in Europe have slowly eased the way towards a genuine single market, firms are understandably focusing on building a stronger pan-European competitive position. Sometimes the best way to do this is through mergers.

However, there are also good reasons to be wary. The latest deals may seem more targeted and strategic, and therefore better justified, than many in the 1990s. But most merger waves begin in this sensible way before spiralling out of control. The recent growth of hedge funds and private-equity firms means that there are many more potential bidders for any target company. Private equity, in particular, is a potent competitor capable of pushing up prices for a company looking for a strategic merger. And cash, today's currency of choice, is a remarkably cheap commodity thanks to low interest rates and abundant liquidity. In other words, the ingredients for excess exist. Paying too much for a reputation-enhancing acquisition or headline-grabbing takeover remains an ever-present danger for anyone at the top of a big company.

Editorial asks whether the latest cycle of European mergers (M&A) produce better results than the last one in the second half of the 1990s.

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