Market upheavals and euro intensify the urge to merge in 1999

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THE GLOBAL mega-merger wave that has swept the developed world this year is likely to last well into 1999, with slower economic growth and the advent of the euro compounding pressure on corporate management to do deals, according to research by JP Morgan, the American investment bank.

"Over the last two weeks 24 deals worth over $1bn have been done and the year is not over yet," Klaus Diederichs, JP Morgan's co-head of global advisory, said yesterday.

The financial markets turmoil in August and September, far from killing off the mergers and acquisitions (M&A) market, has actually galvanised managements into action.

Most of the deals, says Mr Diederichs, are being driven by the realities of the market place rather than by the kind of financial engineering that drove the M&A boom of the 1980s. "The companies we are seeing are talking about industrial logic and cost savings, not financing."

Investors, he says, have become used to double-digit returns. But in a low growth, low inflation market, achieving earnings growth of more than 3 per cent a year is going to be virtually impossible. "The only way to achieve this is to try something and go and create value."

The pressure is intensifying. "A lot of companies have been shocked over the last six months at their lack of pricing power," says Mr Diederichs. He quotes Antoine Riboud, the former chairman and chief executive of Danone, the French foods giant: "If you are number one you make a profit, if you are number two you just hang on. If you are number three you break even. The rest forget it."

Gary Duggan, JP Morgan's chief European equity strategist, adds: "The largest firms have not just the largest market share but are also able to do the largest M&A deals."

The sectors where deals are most likely to come next year are financial and retailing, which have traditionally been regarded in terms of distinct national markets. That is about to change.

"The operating environment is getting tougher and tougher, and it is harder to achieve the growth the stock market expects," says Mr Duggan. The advent of the euro also means that fund managers will be focusing on the top 50 European stocks to the detriment of the middle-ranking firms which are big in national markets but lack the size to make it on a continental or global stage.

More than two-thirds of "mergers of equals" - an all-share merger between two companies of roughly equal size - have added shareholder value, as measured by outperformance of the shares against the relevant stock market indices. That compares with a figure of 56 per cent for all deals, including straightforward takeovers.

The research runs counter to the large body of academic research frequently trotted out showing that most deals are value-destroying.

However Paul Gibbs, head of analytical policy for JP Morgan's European mergers and acquisitions team, says the main reason why deals fail to deliver is because the acquirer pays too much in the first place. This partly explains why no-premium mergers have come from almost nowhere three years ago to dominate global merger and acquisition activity.

JP Morgan's research also suggests that crossborder deals within Europe are the ones least likely to deliver value to shareholders, because of the political difficulties in integrating businesses and achieving economies of scale. Deals within the same national markets offer most scope for cost savings, and transatlantic deals have performed well.

Mr Diederichs adds that deals are also more likely to succeed if they are backed up by a clear strategy. He cites the example of the BP merger with Amoco. "The deal had a fantastic reception. It was well thought out. John Browne [the BP chief executive] had a strong track record of getting his house in order. That is not the case with other deals."

This contrasts with the Rhone-Poulenc and Hoechst deal last week, where for political reasons the precise management structure and the extent or nature of cost savings have had to be fudged.

Mr Gibbs also questions whether the ScottishPower/ PacifiCorp deal will deliver. "It is hard to see where the cost reductions are going to be achieved," he says.

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