THE URGE TO MERGE : ...

The Year of the Mega-Deal may just have ended, but takeover activity is likely to keep up at a spirited pace through 1989.

Certainly, the $25-billion buyout of RJR Nabisco has stirred concerns about the social and financial effects of takeovers. Despite rising rhetoric, however, Congress is not expected to derail the buyout boom anytime soon.

And with the lure of returns that far exceed traditional stocks and bonds, “my prognosis is that you’re going to see a lot of deals continuing,” said Mario L. Baeza, a New York City attorney who specializes in the field.

“Everywhere you look there’s a (buyout) fund,” he added, “and they’re all trying to chase opportunities.”

The amount spent on the takeover chase shattered all records in 1988. As of late December, corporate acquisitions completed or pending cost more than $457 billion, overshadowing the $302 billion spent in 1987 and the $264 billion spent in 1986, according to IDD Information Services in New York.

At the same time, deals

have been getting bigger: Despite the bigger dollar figure for 1988, there were just 1,312 publicly reported purchases completed as of early December, compared to 1,515 in 1987.

For a clue to the future, consider this: $25 billion from pension funds and other professional investors is parked in investment pools just waiting for new buyout opportunities. Based on normal arrangements, the $25 billion could be “leveraged” into deals worth $250 billion, according to Dun & Bradstreet, the financial information firm.

Whether you believe the buyout boom is good for the U.S. economy or shortsighted and unwise, it is likely to continue this year for a simple reason: money.

“Obviously, the guys that are doing this expect very high rates of return,” said Mickey D. Levy, chief economist with Fidelity Bank in Philadelphia. “They’re doing it for economic reasons.”

Cash Also a Vehicle

The takeover approach known as a leveraged buyout (or LBO), for instance, has brought investors returns of an astounding 40% compounded annually, Baeza said. The headline-making RJR Nabisco transaction was an LBO, a deal financed mostly with debt and that typically forces asset sales and fierce cost-cutting to repay lenders.

But LBOs were not the only form of acquisition taking place in merger-happy 1988. The $13-billion purchase of Kraft by Philip Morris was a classic takeover, made possible by the buyer’s huge surplus of cash, not debt.

Other takeovers, such as the $5.7-billion purchase of Pillsbury by Grand Metropolitan, a diversified British firm, highlighted another important trend: growing foreign investment in U.S. industry.

Various forces propelled the feverish takeover pace, some unique to 1988.

As the year dawned, many executives and analysts viewed stock prices as too low, in the wake of the October, 1987, stock market crash. One consequence: Price tags for entire companies were seen as bargains--and were shopped around by takeover specialists intent on stirring business.

Moreover, as the year progressed, professional investors began to wonder whether the merger movement would survive the post-Ronald Reagan White House. Would Reagan’s successor oppose deals that the current Administration had allowed for eight years?

Seemed Opportune

“There was a fear that the Reagan Administration’s laissez faire would be reversed,” recalls Norman E. Mains, chief economist with Bateman Eichler, Hill Richards investment firm in Los Angeles.

By late in the year, some on Wall Street may have perceived an opportune time for deals, with members of Congress campaigning for re-election and the White House preparing for a transition. “From a political point of view, the fall was the ideal point to attempt a merger,” said Stan Turesky, a Washington lobbyist who represents financial services firms.

Politics aside, advocates say there are sound business reasons why merger mania swept through food manufacturing, supermarkets, department stores and other industries in 1988. Among them: gains in efficiency and inexpensive entree to new markets.

Mergers may remain an important theme in the post-Reagan era for other reasons, too. Some are as tangible as tax policy; others as abstract as the attitudes of today’s generation of investment bankers.

For one, current law has a built-in bias toward debt financing: Interest payments to bondholders--including holders of high-risk, high-yield “junk bonds” used in takeovers--are tax deductible. By contrast, dividends paid to holders of a company’s stock are not.

“Wall Street needs a way to make money, and the (takeover) business is very attractive in terms of tax laws,” observed David Hale, an economist with Kemper Financial Services in Chicago.

In a more general vein, Hale said buyouts that once would have seemed mind-boggling in magnitude have proven feasible and prompted others to follow. The RJR Nabisco buyout was striking proof that investors and lenders are willing to finance deals in excess of $20 billion, far bigger than anything that went before.

“Once you break Humpty Dumpty, you can’t put him back together again,” he said.

The lure of acquisitions is not lost on foreigners. The cheaper dollar has made U.S. investment increasingly attractive for the Japanese and Europeans who continue to pour cash into this country.

Just last month, Pechiney, a French metals producer acquired Triangle Industries, a major U.S. packaging company, for $1.3 billion. (The deal is currently being investigated by French authorities for insider trading violations.)

But the trend reflects something more profound than exchange rates, experts maintain. It reflects the spread of U.S.-style financing techniques and U.S.-style thinking overseas.

Early in the year, for example, Bridgestone of Japan bought Firestone Tire & Rubber Co. for $2.6 billion. The deal, coming shortly after Sony’s $2-billion purchase of CBS Records, signaled a major change in Japan’s approach to U.S. investment--an approach once limited to building from the ground up.

Prefer Quick Returns

“It’s only recently that (Japanese) management realized that acquisitions could be a part of their strategy,” said Yutaka Ono, senior vice president in charge of mergers and acquisitions at Japan-based Nikko Securities in New York. Ono predicted a big increase in the number of deals in the $100-million to $1-billion range.

But is the interest of investors identical to the interest of the larger, non-investing public?

In many cases, investors who jump at buyout opportunities are saying in effect: “We don’t believe in the future. We’ll take our money now,” declares Margaret M. Blair, an analyst at the Brookings Institution.

Not only are investors opting for quick returns over long-term investment, they are leaving many companies saddled with severe debt obligations that could have painful consequences in an economic downturn, analysts warn.

“A sharp recession would bring a lot of casualties,” said James Van Horne, a finance professor at Stanford University. “This restructuring movement has not really been tested.”

Both the House Ways and Means Committee and the Senate Finance Committee plan hearings early this year to consider these and other buyout-related issues. A key item on the agenda will be the wisdom of the tax break for takeover debt.

Nonetheless, many observers doubt that Congress will take drastic action.

Why? Because members of Congress don’t want to precipitate a financial crisis. They remember that just days before the October, 1987, stock market crash, the House Ways and Means Committee moved to restrict the deductibility of interest incurred in takeovers.

The action triggered a collapse in stock prices of companies viewed as takeover targets. “These stocks had led the bull market up and now, during the week of Oct. 14 to Oct. 20, they would begin to lead it back down again,” reported the presidential commission that studied the crash.

Also, there is no consensus on eliminating the interest deduction.

“I don’t think Congress can pass major legislation dramatically changing the rules of LBOs,” said Turesky. “I think it will probably tinker with the rules.”

Some Uncertainty

Legislative hurdles will not prevent a public debate, however, one that Turesky said could discourage some investors from pursuing visible, giant deals. The view is that growing controversy could have at least a temporary chilling effect on mega-deals.

“The political factor begins to cloud what’s already a high-risk strategy,” the lobbyist said.

Another uncertainty is the approach of the George Bush White House toward restricting buyouts, through Administration policy on mergers, bank regulation and other areas.

On the key issue of antitrust enforcement, Bush is not expected to veer radically from Reagan’s approach, which has allowed most mergers, including those between rival firms.

“It would be very difficult--even if somebody wanted to change things dramatically--to do so, because of the way the courts are leaning,” said Assistant U.S. Atty. General Charles F. Rule in a recent interview.

Some of those who monitor such activity say that the long-term effects of the buyout wave are not yet apparent. And that means it’s unclear just what the government’s response should be.

Said Stanford’s Van Horne: “The jury is still out on today’s takeover movement.”