View from New York: Shares guarantee dowry but not marital bliss

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The Independent Online
It may be pure coincidence. But last week, with Wall Street in the grip of merger mania for the first time since the late 1980s, it was more than a little ironic that Michael Milken, the man most associated with the excesses of the last decade, should emerge from hiding.

On the cover of the New York Times this weekend, among stories about multi-media mergers and America's interactive future, is the headline 'An Unfettered Milken Has Lesson to Teach'.

Having repaid his debt to society - which is more than can be said for some of the junk-backed buyouts he financed during the last takeover boom - the former Drexel Burnham bond salesman turned up last Friday at a business school in Los Angeles to give a guest lecture on 'securitised business loans'.

'I think that sounds better than 'junk bond',' Mr Milken coyly told his class of MBA students, apparently quite unrepentant about his role in the borrowing binge from which corporate America is only now recovering.

This time, as telecommunications companies scramble to find multi-media partners, Wall Street is doing things differently. For one thing, the current mating dance among telephone companies, cable operators and Hollywood studios is a mutual one - not a 'predators' ball', where corporate raiders pursue unwilling partners, have their way with them, then chop them up into little pieces for disposal.

Those debt-driven assaults of the 1980s left their victims saddled with interest payments on hundreds of billions of dollars worth of high-yielding bonds. But under the new form of courtship, the suitor uses his own shares to pay the tab for the nuptials. Bell Atlantic, Viacom and AT&T will instead create hundreds of millions of new shares to welcome their new partners into the family.

To absorb the current shareholders of Tele-Communications Inc and its subsidiary, Liberty Media, into the ranks of Bell Atlantic owners, for example, dollars 20bn worth of new shares will be issued, almost doubling the telephone utility's market value before the announcement. Despite this immediate dilution of the companies' earning potential, each of the deals has won approval. Bell Atlantic's share price, for example, leapt dollars 6 the day its takeover of TCI was announced, and opens this morning at dollars 67, a 52-week high.

There are obvious advantages to using equity over debt. The deals are far less likely to end up in bankruptcy than some of Mr Milken's over-leveraged buyouts, which were overwhelmed by their repayment schedules. They also enjoy tax and accounting benefits. All-share purchasers, for example, are not required to account for 'goodwill' - the price they pay in excess of their new partner's book value. And the fact they are debt-free preserves cash flow and borrowing capacity.

All of these factors are clear virtues for share-for-share mergers, which have accounted for more than half the dollars 225bn worth of announced deals this year. But as sceptics on Wall Street point out, common shares have their current purchasing power only because of the three-year bull market in US equities.

The surging Dow-Jones average has transformed shares in blue chip US firms into a form of currency. Even a conservative 'value investor' such as Warren Buffett, long opposed to such equity acquisitions, is using shares of his Berkshire Hathaway Inc at dollars 17,500 a piece - he also opposes stock splits - to buy the Dexter Shoe Company.

Seen in this light the current merger boom is much more reminiscent of the 'go-go' years of the 1960s and 1970s in the US, when entrepreneurs used richly priced shares to finance diversification and conglomeration drives. What was then known as 'super-currency' - shares priced at towering price-to-earnings multiples - helped create many of the management corporate behemoths that Mr Milken's raiders spent much of the 1980s dismantling.

The current crop of telecoms mergers is almost certainly more sound strategically, being driven by technological and regulatory change rather than financial or managerial engineering. Instead of serving to insulate corporations from realities of market cycles, as diversification did, or line the pockets of financiers, as deconglomeration did, consolidation in the 'information industry' holds the promise of new growth from products that have yet to be invented.

But even apparently reassuring aspects of the 1960s analogy are misleading, says David Shulman, chief equity strategist with Salomon Brothers in New York - the investment bank that, ironically, has grabbed the lion's share of the telecoms deals. The 1960s may have been a time of prosperity, but share prices grew slower than most bullish investors care to remember, and far slower than the Dow-Jones average has since 1990.

He also notes that the 1960s were marked by three big market 'corrections', which stripped shares of an average of at least 15 per cent of their value. 'The lack of volatility is giving rise to a false sense of security about the potential for the stock market to retreat,' Mr Shulman warns.

The equity-financed merger frenzy, therefore, may not prove much more secure than the one financed by junk bonds. Those who invested in a debt-backed deal in the 1980s were perhaps more vulnerable to a downturn in that company's particular business. Indeed, the current merger boom, and the big stock market run-up that has preceded it, have occurred totally independently of the recession in the greater US economy.

But Wall Street sceptics argue that anyone whose wealth is tied up in the 1990s version of 'super-currency' could easily lose a large part of the investment by a simple correction in the stock market, let alone a full-fledged market crash, which some believe is long overdue.

The 1960s bull market was fuelled by stunning growth in output, earnings, productivity and employment - and not simply, as it is today, by declining interest rates. Corporate profits are rising very slowly, warns Salomon's Mr Shulman. 'Market participants are simply discounting earnings that will not be there later in the decade,' he says.

The mergers boom that began in the 1960s peaked in 1972 with the frenzy of the 'Nifty Fifty' bull stock market - named after the seemingly unstoppable corporate giants of the day. When the period of real industrial growth ended in 1973, in part a result of the oil shock, the equity-financed takeover era came to a crashing halt.

The other unhappy lesson to be drawn from the analogy with the 'go-go years' is that the run-up in share prices, and the rash of deals that were financed on their strength, turned out to be reliable indicators that 'asset inflation' had taken hold of the US economy.

Despite all the discounting and downsizing that plague America's largest companies, the US could well be bracing itself for another bout of stagflation, says James Grant, editor of the Interest Rate Observer, a financial newsletter.

'The proof that asset-price inflation is not a figment of the imagination is that Warren Buffett is, in effect, printing shares the way the US Federal Reserve prints money,' he writes.

Inflation is probably the furthest thing from Mr Milken's mind these days, although all the activity on Wall Street clearly is not. It seems that the convicted financier, though offering his advice free of charge, is not motivated either by altruism or, apparently, even a desire to rehabilitate his reputation.

Banned for life from the securities industry, Mr Milken too plans to profit from the multi-media revolution. His lectures are being filmed by five cameras from the educational television network he recently founded, his every move recorded for later editing and graphics enhancement.

There are 600 graduate business schools in the US alone, he says, all potential markets for the power of modern electronic media.

'If there's no risk,' Mr Milken notes, 'there's no future.'