Companies in the U.S. and the world are striking deals to merge resources to become more focused and profitable at a time of low interest and innovations are hard to come up. Activists like Carl Icahn and Steve Loeb are also after those companies because they want them to create more values for shareholders. In 2015, the values of takeovers in the world reached $4.35 trillion, half of those are in the U.S., surpassing 2007 as the top year on record for deals.
Most recent examples include the deal proposal by DuPont and Dow Chemicals, which were founded in 1802 and 1897, respectively. These giant companies are in talks to form a combined company that is worth $120 billion. Before that, the news brought another deal between Pfizer and Allergan that will create, if allowed, a giant pharmaceutical company that has a value of $160 billion. These deals are larger than the gross domestic product of some developing countries.
The U.S. government has strict guidelines for mergers and acquisitions which govern takeovers in the corporate sectors. The Federal Trade Commission and the Department of Justice require companies who wish to merge to submit data for two M&A statistics before they are allowed to merge. They are: the Hirschman-Herfindahl index, and the change in HHI.
If the HHI before the merger is above 1,800, the industry in which the two companies want to merge is characterized as “highly concentrated”. In addition, if the increase in the HHI as a result of the proposed merger exceeds 100 points, DoJ will question the merger. It asks for one or more of these four ameliorating factors: 1) Evidence that the merger will bring in new technology; 2) Evidence that the merger will enhance efficiency (e.g., reduces shipping costs); 3) Evidence of tough foreign competition; and 4) Evidence that one of the two companies is facing bankruptcy.
Any of those factors may convince the judge to let the merger go through despite bad data on the two statistics. The HHI in the jarred baby food industry which includes Gerber, Heinz and Beechnut, is greater than 4,750, and thus this industry is considered very highly concentrated. The judge rejected the merger between Heinz and Beechnut on the basis of lack of increases in efficiency as claimed by the two companies, and also their lawyer confused in court total revenue and total profit which students in Econ 101 don’t. In the highly consolidated beer industry, the judge allowed Millers and Coors to merge because they convinced him that by combining the two plants for Coors with the six plants for Millers which are placed in different locations, could reduce shopping costs and increase efficiency. The merger went through.
The companies have been merging and consolidating for a long time, and thus concentration has increased in many industries. Thus, HHIs in many U.S. industries have gone up significantly, and with them is monopoly power and anti-competitiveness. Given the difficulty of convincing the judges of the merits of ameliorating factors, the companies now merge in two steps: in the first step they combine the two companies in a much larger company, and then in the second step they split into smaller and more focused businesses. Pfizer and Allergan want first to form a giant combined company but this may be challenged by the government. To hedge against that, those companies will split the combined company into two businesses: a company that will produce the old medicine, and the second will produce new medicine. The second company may be considered as evidence of creating new technology which may be viewed as an ameliorating factor. In this breakup, those businesses can also increase prices of the well-known old medicines and then match that former increases by following increases in the new medicines, which means more monopoly power.
This new trend is also followed by the proposed deal between DuPont and Dow Chemical which also want to form a giant company but then will break it up into three smaller businesses along the line of vertical mergers. The objective is to consolidate, add more value and then increase market power.
Wall Street welcomes this new trend, hoping it will create more values. But is it good for the American consumers? Well, if it increases companies’ monopoly power, it will not be good for all of us and may lead to a loss in social welfare. Let us wait and see what the regulators will say about those recent mergers.