Identifying the real reasons behind a failed merger is like searching for a black box in the wreckage of a passenger jet deep in the jungle. Theories abound until the real truth comes out, and there are countless questions from the backers of this maiden flight: will such a hybrid ever leave the runway again? Did the regulators send out heat-seeking missiles? And why were the co-pilots squabbling in the cockpit at 40,000 feet and cruising?
Suffice to say, it can be difficult enough for observers to fully understand what went wrong, let alone for a company to reassure the investment community that despite the failure, it remains healthy with good prospects for growth – whether they be the jilted lover or the suitor who walked away at the eleventh hour. However, when faced with the unpalatable prospect of explaining why marriage to an ideal partner breaks up, recent examples suggest that few corporations stray far from the text book in terms of damage limitation and attempts to regain shareholder confidence.
Fatal attraction
In the case of Smithkline Beecham and Glaxo Wellcome, it was clearly a case of the bride realizing that, despite the obvious physical attractions of the prospective groom, Smithkline had too dominant a personality and would not make an attractive bedfellow.
The way each handled the fall-out contrasted sharply. Smithkline appears to have scored early brownie points with its detailed February 23 statement to the markets and media that, ‘despite considerable effort on the part of Smithkline Beecham. Glaxo Wellcome has been unwilling to proceed in accordance with the agreed arrangements.’
The comprehensive statement, referring to ‘insurmountable differences’, clearly soaked up some of the potential fire, but it was also flattered by the terse one-liner sent out by Glaxo announcing an end to the merger discussions. One analyst privately refers to his job in the face of Glaxo’s communications coyness at this time as being like ‘pulling teeth’. That contrasts sharply with Glaxo’s claims to have been closely in contact with the investment community during the fall-out period.
Despite this, Martin Sutton, corporate communications manager at Glaxo Wellcome, concedes that it may have been frustrating for some analysts. ‘It was a pretty difficult situation from an IR point of view. If you have put together something perceived to create millions in shareholder value, it’s hard to then explain the reasons for not proceeding. But we’ve publicly stated how important it is to get the management issues right. Without that, the future of the business can be fundamentally affected. Better for us to have acted then, than afterwards when it would have been too late.’
Of course, both parties in this particular break-up believe their differing approaches were correct. And they stress that they subsequently made their case to investors behind closed doors and would now rather like to forget the whole episode.
All very well, but not very instructional or helpful if the desire is to develop a more flexible response next time. And, given the increasing pressure on pharmaceuticals companies to seek appropriate merger partners, there may well be a next time.
But are Glaxo and Smithkline likely to kiss and make up? Some members of the congregation believe the church door remains open and that the physical attractions of creating the largest pharmaceutical organization in the world may still lure the disaffected couple back to the altar.
Peter Knapton, managing director of securities at Legal and General, is one of that number. ‘It’s difficult for us to ascertain from a fly-on-the wall perspective what conversations actually went on between the parties, but we have seen both management teams and each has come up with a perfectly reasoned case for why this did not work,’ he says. ‘However, they have made a big statement by their actions and I’m not sure this story has completely run its course. There are some big issues at stake here and we must give the boards time to sit down and give them sensible consideration.’
Analysts were as smitten as investors by such promises of increases in shareholder value – and also somewhat blinkered to the likelihood of a personality clash between Smithkline’s Jan Leschly and Glaxo’s Richard Sykes.
Paul Diggle, pharmaceuticals analyst at S&G Securities, says everyone was initially astonished by the deal because it involved two of the most determined individual personalities in the industry. Indeed, it had seemed highly unlikely that they would be able to work together. ‘When we originally learned they had thrashed out a deal we were very positive. We believed it could work out because the deal itself made a lot of sense. Analysts and investors supported it because most of us are convinced that larger pharmaceuticals are the way of the future.’
So what story can each player best adopt in the near future? Diggle believes Glaxo may have an easier time of it – in the very short term at least. ‘In terms of IR programs, both have gone down the route of reinforcing messages about their ability to carry on independently. I think Glaxo Wellcome has an easier job to do as it appears capable of high levels of growth on its own and seems like a company that still has its options open.’
With size all important in the pharmaceuticals industry, it may not be too long before either – or both – find other partners, or even settle their own differences. In the meantime, both appear content to stay ‘on message’ about the viability of their own independence. Certainly, at the end of April, Jan Leschly was having none of it when questioned on the possibility of negotiating a new deal with his erstwhile bedfellows at Glaxo: that deal is not going to happen, he stressed. ‘As an independent company we have the opportunity to grow very strongly on what we have.’
Look back
Certainly the sands of time help to evaluate just how effective original merger messages actually were. Consider the case of the aborted merger attempt of Staples and Office Depot which met opposition from the US Federal Trade Commission last July.
The message coming from both camps at the time was that there were complementary synergies to be had from this $4 bn deal, before either company got too involved in their respective market segments. The official view after the FTC deemed the deal anti-competitive was, once again, that each organization could continue to grow with or without the union taking effect.
However, while the impact on Staples was minimal, Office Depot’s stock plummeted 19 percent. For Staples, there was no attempt to reposition ‘the message’ after the merger failed. As vice president of IR, Sam Levenson explains that investors were being kept abreast of developments as these unfolded: ‘It was just a case of maintaining continuity throughout. We thought it was highly likely we would merge but we had to manage the situation all along the way. As the FTC required more information from us, we kept investors informed. This was mainly through conference calls but there was certainly no need for us to change our stance for crisis management.’
Jim Stoeffel, an emerging growth stocks analyst at Salomon Brothers, agrees. ‘Both companies held a number of meetings with the investment community and that worked well, but Office Depot had a harder selling job to do. Everyone knew that Staples was stronger, but with Office Depot we had a lot of concerns. We knew they were losing middle management, so there were some doubts about how they might shape up. We therefore brought their stock down to a neutral position. Over the past few months Office Depot has brought in a new management team which has done what it needed to do. The business has stabilized and the stock is now back on our buy list.’
Staples is sure it won’t want to merge with another major US competitor such as Office Depot. The FTC made it clear this would not be well-received: at one point it even suggested Staples consider a mail order company instead.
Such smoke signals from the regulators did not discourage aerospace giants Lockheed Martin and Northrop Grumman from the pursuit of a $9 bn merger. But that, too, was recently blocked by the US Justice Department and is currently being contested in the courts. Both companies have since announced that they would seek new deals if a federal judge blocks the merger. But they’re also stressing the strength of the individual companies should the deal be blocked. Confusing, eh?
Jim Hart, from the public information department at Northrop, says: ‘We’re keeping investors informed on the progress of the merger, because it’s still going ahead. But we are also still promoting the strengths of our business, in particular the electronics segment. We’ve indicated that the company was in the strongest position in its history, and still is.’
Peter Aseritis at Credit Suisse First Boston has a candid view on this posture: ‘Yes, Northrop has a strong electronics segment,’ he concedes. ‘But when you are number four in the market it’s difficult to compete against the likes of Lockheed and Raytheon. Northrop may have $4 bn to invest, say, while Lockheed has $9 bn and Raytheon $13 bn. In a mature market which is only growing at 0-2 percent, it’s difficult to see how Northrop can possibly compete.’
Apart from the obvious truths about Northrop’s lack of size, there was a significant drop in the company’s stock price from its high of $139 when the merger was first announced. The new pricing suggests the market is already assuming the deal is off.
Different strokes
In contrast, Lockheed’s share price has held up well. Ironically, one reason is that some analysts believe its earnings per share in 1998 and 1999 will be higher without the merger. For its part, the company continues to push messages about the benefits the deal would bring the customer, rather than making selective disclosures to specific investors or analysts.
Paul Nisbet at JSA Research is bemused by the different versions of events coming from each of the companies and the US government. The government, which ostensibly wants to encourage consolidation in the defense industry, says its position hasn’t changed. Nisbet is not sure who is telling the truth.
‘Over time the competitiveness of larger companies will make it difficult for Northrop to survive alone. However, I still have the shares as a buy and will do so until we know the outcome of the litigation.’
For Nisbet, at least, this particular hybrid is still in the air waiting for permission to land. However, the dip in Northrop’s share price and the similar impact on other victims of failed mergers, conveys the starkest of messages to companies who are picking through the wreckage of a failed deal or have just entered severe turbulence. In such troubled times, the investment community’s perceptions must be managed in as dynamic and proactive a way as possible in order to ensure that the company maintains credibility.
Investors are certainly becoming more aware that while a corporate captain continues to insist the plane is in good shape, some of the passengers at the back are shouting, ‘Mayday, Mayday’. If emergency instructions are not adequate there may well be investors bracing themselves for a rapid descent.
