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As a merger wave swells, companies dare the government to stop them

Michael Santoli
Michael Santoli
As a merger wave swells, companies dare the government to stop them

Days before a judge sided with the Federal Trade Commission Tuesday in blocking the merger of food distributors Sysco Corp. (SYY) and U.S. Foods Inc., Office Depot Inc. (ODP) shareholders voted to approve its sale to Staples Inc. (SPLS) - a deal that would complete the roll-up of the former Big Three of office-supply retailers into a single company.

Weeks earlier, Charter Communications Inc. (CHTR) agreed to acquire larger rival Time Warner Cable Inc. (TWC), which along with Charter’s pending purchase of privately owned Bright House Networks will create the country’s second-largest cable network. Comcast Corp. (CMCSA), of course, had just walked away from a deal to acquire Time Warner Cable in the face of Federal Communications Commission oppositions.

Meantime, AT&T Corp. (T) is awaiting approval to acquire DirecTV (DTV) and Dish Network (DISH) is keen to merge with T-Mobile US (TMUS) – which together will test regulators’ tolerance for cross-sector unions in telecom and media.

And of course the largest health insurers have embarked on a manic matchmaking exercise, in which so far Cigna Inc. (CI) has rebuffed Anthem Inc.’s (ANTM) takeover bid, Aetna Inc. (AET) has approached Humana Inc. (HUM) and UnitedHealth Group (UNH) reportedly covets Aetna.

These courtships are occurring in disparate industries at different lifecycle stages. But there’s a common thread: All of them could, or did, face significant regulatory pushback – and yet the CEOs and boards made firm decisions to challenge the government by seeking to partner up with big rivals.

As the volume of announced global mergers and acquisitions surges toward $2 trillion for the year, a higher-than-usual share of the activity appears vulnerable to antitrust challenge.

As one veteran merger-arbitrage trader puts it, the current deal slate largely reflects “the consolidation of already-consolidated industries,” with “concentrated industries looking to become more concentrated” by going from, say, five major players to four, or three to two.

While the Department of Justice under President Obama has hardly been overly hostile toward corporate combinations, antitrust authorities are girding for more deals that stretch the boundaries of standard industry concentration.

A write-up of a recent American Bar Association antitrust conference points out: “The DOJ also highlighted that enforcement activity is on the rise, in part because of an increasing number of merger transactions that raise potentially complex and problematic issues.”

The report adds that DOJ officials cited “an increasing amount of aggressive transactions. They have identified a need to ‘push back’ against what they perceive as overreaching by companies interpreting” merger guidelines under laws meant to maintain vigorous competition.

Of course, President Obama last year reportedly sought – with personal arm-twisting and public shaming - to scuttle large cross-border “tax inversion” mergers that would have a U.S. company relocate overseas for tax purposes.

Still, companies have not shied away from pursuing transactions aimed at rolling up substantial chunks of several industries.

The merger-arb trader says corporate executives are willing to take their chances with regulators and to weather potential public scorn because “if they can get the deals through, the benefits are tremendous.”

Pricing power, insulation from global competitive threats, huge cost efficiencies await CEOs and CFOs who squeeze through such “horizontal mergers.”

Of course, a coalescence of factors is now driving an urgent rush of corporate combinations, sending announced deal volume to nearly $2 trillion globally year to date.

As Deutsche Bank economist Torsten Slok has detailed, the current environment features cash-rich corporate balance sheets, tepid organic-growth trends, record asset levels in activist-investing funds and a deal-embracing investor base that, on average, has been sending the stock prices of the acquiring company in newly announced transactions higher.

None of these forces alter the fact that, over the long term, big mergers tend not to create value, according to a raft of academic studies. But from within a bull-market cycle with competitive threats and opportunities demanding attention from CEOs and directors, there’s a great appetite to act or be acted upon. Executing a merger that promises significantly more market power is that much more attractive.

In the current tussle for “transformative” combinations, Monsanto Co.’s (MON) strenuous courtship of its Swiss agricultural-chemicals counterpart Syngenta AG (SYT) is instructive. Monsanto has offered $45 billion to buy Syngenta, which represents more than a 40% premium to the Swiss company’s value before the merger talks surfaced.

Monsanto has pressed its case publicly and has lobbied Syngenta shareholders and government officials, and has gone the extraordinary step of agreeing to pay a $2 billion breakup fee if a deal is blocked by regulators. (Usually, the target company is liable for a breakup fee.) Syngenta has released a YouTube video in which its CEO sets out specific demands for agreeing to begin negotiations.

This mutually aggressive stance shows both the upside of a potential combination to Monsanto, which emboldens management to push against possible antitrust opposition that makes Syngenta hesitant to submit to friendly merger talks.

The fog of regulatory uncertainty also hangs over the pending combination of Staples and Office Depot. The terms of the deal would give Office Depot shareholders $10.75 in cash and stock, yet Office Depot shares trade at a steep discount, below $9. Office Depot shares weakened further Wednesday after the Sysco-U.S. Food decision emerged.

The Staples-Office Depot deal highlights another rationale used by executives trying to combine in already-consolidated industries: the constant threat of technological disruption to their business models.

When the two office-products retailers tried to merge in 1997, the FTC blocked the way, calling it anticompetitive. But that was the year Amazon.com (AMZN) went public, and since then it has become a huge source of competition and price deflation in this category.

The media and telecom companies, certainly, are also counting on the specter of new competitors threatening the pay-TV “bundle” to ease their contemplated combinations.

And, of course, the considerable threat of healthcare-policy shifts will be cited by any health insurers looking for approval to merge.

All these companies and their antitrust lawyers can plead their case and strike a vulnerable pose for the regulators.

But, ultimately, their ambitions are dependent on the assent of judges, regulators and an administration that might have no strong interest in allowing big companies get bigger to preserve power over customers.