The EC's Merger Mania

With the junk bond market dashed and fears of higher interest rates growing, the mid-to-late eighties wave of mergers in the United States appears to have come to an end. Investors are now looking for a new outlet for financial wheeling and dealing. They may have found what they want in the turbulent European Community, whose leaders are hoping corporate consolidation and restructuring will create internationally competitive European companies.

Merger mania has already begun lapping at the European shores. While the number of European targets of large cross-border deals numbered less than one quarter of the international total in the first half of 1989, it rose to over one-third the total in the second half of the year, according to Fortune magazine. Mergers and acquisitions (M&A) have occurred at an especially high rate in England; in the first three quarters of 1988, the value of acquisitions in the United Kingdom exceeded that of any previous year. Steven Wolitizer, co-head of the M&A department at Shearson Lehman, reports that one half of the business in his division is now European, up from approximately one-quarter.

Analysts say the end of the merger run is not in sight. Randall Caudill, head of the international mergers and acquisitions office at Prudential-Bache, states that "gravity is on the side of continued transactions." Wolitzer says that European M&A "has increased dramatically in the past year" and that he "see[s] that being sustained."

The merger trend does not meet with disapproval in the European Commission's offices in Brussels. In announcing a December 1988 directive regulating takeovers, the Commission stated that it "considers that in general takeover bids can be regarded as a positive factor which provides a mechanism for the market to select the most competitive firms and could stimulate the process of reorganization of European companies." Mergers are actually one of the desired outcomes of the consolidation of the European Community, says Ella Krucoff, head of press relations for the European Community's U.S. office. Krucoff anticipates that the high level of mergers will continue and does not expect the European Commission to intervene. "No one sees stopping the heart of the 1992 process," she says. The Commissioners hope that world-class European firms will emerge out of the corporate wrangling that 1992 is generating. They call European corporate reorganization "indispensable in order to face up to international competition."

Attitudes such as this lead analysts to speculate that a relatively high level of market concentration will be permitted in Europe.

The Commission is so enthused about promoting industrial restructuring that it is considering a proposal to create pan- European companies which would have no legal national origin. Companies registered under the European Company Statute would operate under European legislation independent of national laws. A European Company would be subjected to tax policy of the country in which it has its head offices, but would be able to offset losses sustained by its permanent establishments in other EC countries against any profits. To avoid creating an advantage for European Companies, the Commission is planning to propose similar rules for other firms.

The Commission is also promoting research consortia in which competing companies engage in joint research in high-tech areas. In 1984, the European Council of Ministers approved plans for the European Strategic Program for Research and Development in Information Technologies (ESPRIT), allocating 750 million ecu (an ecu is roughly equal to one U.S. dollar) over five years. The next year it established the Research and Development in Advanced Communications Technologies in Europe (RACE) program. Both programs bring together multiple companies and universities, have widely been viewed as successful and have received additional funding from the Council of Ministers. Other collaborative efforts are also receiving encouragement from the EC. For example, Philips of the Netherlands, Thomson of France and Bosch of West Germany are working together to develop high-definition television.

While the Commission has signalled its approval of joint research ventures, the vigor with which it intends to enforce other anti-trust provisions remains unclear. In January 1990, Air France, a state-owned airline which is the largest carrier in France, purchased the private company L'union des Transports Aeriens (UTA),the country's second largest carrier. Air France acquired control of Air Inter in the deal, giving it control of up to 97 percent of France's airline industry. Sir Leon Brittan, the European Commissioner in charge of mergers, ordered a review of the merger, but it is expected to stand, in large part because Air France is a state-owned company and therefore has substantial pull within the EC. The Air France acquisition followed similar takeovers of domestic competitors by West Germany's Lufthansa and British Airways. The concentration process will probably be checked from going further by the European Commission, but strategic alliances between companies may further limit competition. Wolitzer says, "the EC is loathe to allow only one or two airlines to survive all over Europe. People will be careful; [instead of further mergers], they will form marketing arrangements and alliances." Jurgen Weber, Lufthansa's chief technical operating officer, told World Link magazine that strategic alliances among European airlines creating blocs should be expected as part of the consolidation of the single European market.

Overall, the European Commission seems likely to take what Caudill calls a "cautious laissez-faire" stance toward mergers. Absolute monopolistic practices will be prohibited, but a relatively high degree of industry concentration will be allowed.

Underlying the rush to promote bigger enterprises in Europe through mergers and collaborative research efforts is a preoccupation with global competition. In Europe, business people and policymakers are anxious to create companies large enough to compete with Japanese and U.S. manufacturers. The consensus view, according to Gary Clyde Hufbauer, professor at Georgetown University, is that "top firms enjoy a decided advantage in financing the huge research and development costs associated with leading-edge technology, carrying the losses incurred in bringing new products to market, reaping economies of scale and financing industrial restructuring."

Ambitious European companies seeking to become world competitors, Caudill suggests, are likely to seek a significant share of their national markets and then move on to the European market. "Companies large and ambitious enough to head to the pan-European sector will first look intra-country to make sure they have a significant, and perhaps even controlling [market share] in their own country," he says. Having consolidated their operations nationally, they will "look next to cross-border" mergers and acquisitions. The aggregate effect will be an approximately even division of intra-country and cross-border mergers and acquisitions, Caudill suspects.

Professor Michael Porter of the Harvard Business School is a rare naysayer in the chorus of merger proponents. He argues in The Economist that "dominant firms, or ones caught in a web of links with rivals, will not innovate or upgrade. Supposed efficiencies from mergers will prove elusive in practice. Companies depending on collaborative activity will become mired in problems of coordination." Porter recommends that national governments and the European Commission maintain a stricter anti-trust policy and that cooperative research and development not be relied on heavily. He urges companies to expand internationally rather than focus on home markets, to be wary of alliances with other companies and not to pursue mergers merely for the sake of expanding overall size.

Even Porter's critique stems from a business perspective, however. Other constituencies and interests are almost entirely ignored in the debate over merger policy. While the European Commission's proposal for European Companeis does mandate employee "participation in the life of the company," the EC is emphasizing mergers and big companies with almost no focus on the protection of labor and consumer rights or the environment. ^