Time, Life and Takeovers

It is odd to see the media giant, Time Inc., as the target in a takeover battle. Time, after all, is almost an American institution. Life maga zine’s picture coverage of the American scene and Time magazine’s backward reel of sentences seem part of the national consciousness.

Time’s managers put themselves “in play” by working out a delicate no-cash merger agreement with Warner Communications Inc., the movie (“Batman”) and cable television giant, thus creating the world’s biggest media company. The problem was shareholders of Time and Warner got nothing out of the deal--just a new piece of stock in a bigger company and a management promise that they would now be more successful than ever.

Paramount, a movie (“Indiana Jones”) and publishing (Simon & Schuster) giant in its own right, came swooping in with a $10.7 billion preemptive offer for Time. Time countered with a cash offer for Warner, on the theory that if it loaded up with debt it would be too bloated a morsel for Paramount to swallow.

Paramount countered, raising its bid to $12 billion; now the whole matter is in the Delaware Chancery Court, where a judge will try to sort out shareholder and management rights. The battle between media giants, however--hard on the heels of last year’s $25-billion RJR Nabisco deal--raises the question of whether any company is immune from an outside raid.

A really ambitious raider, for instance, might decide General Motors is a tempting target. It has a long history of flaccid management and notorious overstaffing; and it owns valuable subsidiaries, including Electronic Data Systems, Hughes Aircraft and 50% of South Korea’s Daewoo Motor Co., that could be sold to pay off takeover debt. The same logic applies to the financial services giant, Merrill Lynch, Pierce, Fenner & Smith .

But these are companies that invite trouble because of past managerial mistakes. Time knew it was courting disaster by announcing the Warner deal at a time when many analysts were less than ecstatic about its performance.

The real question is whether any company should be immune from raids? Is there any value served by giving management the freedom to pursue its business strategies without looking over its shoulder at the hovering raider?

The key example--the limiting case as an economic theorist might put it--would be a hypothetical takeover of International Business Machines, one of the best of all U.S. companies. If the “national interest” arguments floated by Time executives sound like self-serving puffery, they ring truer in the case of IBM. The company spent more than $6 billion in research and development last year, much of it in basic science. Amid all the worries about American technology, IBM is still the one company that enjoys a clear lead over Japanese rivals in almost all areas of semiconductor technology.

At first glance IBM seems too big for a takeover. With annual sales in the $60- billion range, and a current stock market valuation of about $75 billion, it overawes potential pirates. But RJR Nabisco’s managers also thought they were too big to be challenged, and there’s no reason to assume IBM is immune.

The company generated about $16 billion in cash last year, before capital expenditures and taxes. With ingenuity and a syndicate of banks, a daring raider could leverage that cash into an offer twice as high as the current stock price. It’s hard to see how company directors, who are supposed to represent shareholders, could turn down such an offer.

The problem is that a highly leveraged IBM would be a less effective company. With a heavy debt load, research and development spending would have to be cut back sharply, plant modernization curtailed and new-product lines reduced. Raiders could decide to reduce debt by selling off pieces of the company. Fujitsu, the biggest Japanese computer company, would no doubt be delighted to pay $25 billion or so for IBM Japan, now Japan’s No. 2 computer company. The price for IBM Europe would be much higher.

In the current superheated competition between Japan and the United States, breaking up IBM sounds like a perfectly awful idea. But it is not clear on what principle a court--or Congress--could prevent it. U.S. government trustbusters, after all, spent more than 10 years of hard work and millions of dollars trying to achieve exactly that before they were called off a few years ago. They may have been misguided, but the episode demonstrates that highly intelligent people can disagree on the value of an intact IBM.

Delaware courts, where most big takeover battles are decided, have implied that directors can judge competing offers on other than a purely monetary basis--decide, for example, that one group would provide better management than another. But that reasoning applies to cases of several bids more or less in the same price range. Directors cannot dismiss an attractive offer just because they like the status quo.

Most alarms raised over the decade’s takeover boom are unfounded. Corporate America is not as mightily leveraged as scare stories would have us believe. Perhaps surprisingly, the ratio of corporate debt to assets has been virtually unchanged throughout the 1980s. Debt service consumes about 23% of corporate cash flows. Nothing terrifying about that. And while IBM can make a good argument that it spends extra cash on research and product development, many companies dissipate earnings on corporate jets and country club dues. After a decade of takeovers and restructurings, corporate America is leaner, sharper and more competitive than in the 1970s.

But the fact remains: If a transaction arose that seemed against the national interest, there is no obvious mechanism to block it. And, within the practical limits of the U.S. political structure, it is hard to imagine an effective system of controls. The performances of both Congress and the executive branch during the savings-and-loan crisis, for example, offer little hope of effective microeconomic regulation from Washington.

The path to wisdom may be to recognize that there is no obvious solution to this conundrum. The best course may be to eliminate provisions in the tax code that provide a positive incentive to the raider, such as the preferential treatment of interest payments over dividend payments. Careful scrutiny by the Federal Reserve of bank portfolio exposure to leveraged companies would also keep the buyout frenzy within reasonable limits.

At the day’s end, the buyout phenomenon will be self-limiting; as stock prices rise to reflect takeover values, windfall-profit opportunities disappear. But for the moment, the major protection for the IBMs of the world is only lack of chutzpah on the part of the raiders.