Decline in Stocks Laid to End of Takeover Mania : Economy: Experts see world trade speeding up and investment rising in anticipation of economic growth. : NEWS ANALYSIS
Beyond anxiety about the stock market in the wake of Friday’s plunge in share prices, many people this weekend are asking if there’s deeper trouble. Is the U.S. economy heading for a long, dreadful period of business failures and unemployment? Is the stock market collapse an omen that the 1990s will be a rerun of the 1930s?
The answer, say both economic and investment experts, is no. The events of Friday on Wall Street represent a bell tolling for a peculiar kind of takeover mania that bid up prices for companies as if they were pieces of downtown real estate or Midwestern farmland. There were reasons why such amania took hold in the markets, but those reasons are now coming to an emphatic end.
What replaces them--in the nation’s business life as well as in the stock market, say investment experts--could well be more realistic appraisals based on a recognition of productive effort and traditional measures of successful business.
A rediscovery of the real world is going on. Away from the stock market, there’s a lot of productive effort being put out in America, and around the world. Trade is speeding up; investment in productivecapacity is rising everywhere in anticipation of brisk demand in the 1990s as societies that scarcely knew the meaning of the words begin to enjoy economic growth.
That’s not mere sentiment; bankers see it happening. In fact, the very demands that such economic activity makes on bank credit is partly responsible for the drying up of financing for leveraged buyouts, junk bond takeovers and similar financial peculiarities of the last decade.
Recently debt-heavy companies have had trouble getting new financing, and professional investors have been shunning junk bonds. The pattern came to a head Friday when a planned buyout of United Airlines stalled for lack of financing. That told Wall Street that the future would not be like the recent past and it was time to change focus.
Wounded animals don’t die quietly, however. There may be further shocks to the markets as companies heavily in debt encounter difficulties. But most experts disagree with the thousands of callers to discount broker Charles Schwab & Co.’s offices on Saturday who wanted to dump stock. At present price levels, the stock market does not appear to be on the edge of a precipice. Prices following Friday’s fall are at about the average level--12 to 13 times company profits--that has characterized stock markets for 100 years.
But history goes out the window in a panic. Well-capitalized companies fell on Friday along with those that have been the subject of takeover speculation. While they could fall a bit more, say analysts, recovery could be speedy.
Yet where there was a little extra in a company’s stock price because it was believed to be subject to takeover, that may now vanish. There was evidence of dwindling takeover padding on Friday in entertainment stocks. MGM/UA, where a buyout failed for lack of financing last week, lost another 7% of its value--after having already fallen 20% below its proposed buyout price.
Hilton Hotels, which has put itself up for sale, fell $21.50 a share to $85, losing 20% of its value. Trading was halted in AMR, the owner of American Airlines and the subject of a takeover offer from Donald Trump. But after the market closed, reports from London, where informal trading went on, said AMR fell to $81, from $98.625 at the last quote in New York.
Even the biggest companies, such as Eastman Kodak and Xerox, have a few dollars in their stock price on the chance that they’ll be taken over, say analysts who follow those companies. The reasoning behind takeover speculation on a Kodak or a Xerox is not that the buyer wants to enter the film or copier business, but the fact that their brand names and worldwide distribution systems are such valuable assets that it’s believed they will always appreciate in value.
It was assumptions about brand names for consumer products that likewise drove the leveraged buyout of RJR-Nabisco earlier this year and the buyout and break-up of Beatrice Foods earlier in the 1980s. Explicit in those deals was the assumption that selling a company in parts--auctioning off its brand names, buildings, divisions and, ultimately, its employees--was more profitable than operating it as a whole.
It was precisely the kind of thinking that influenced Campeau Corp.’s junk-bond acquisitions in 1986 and 1988 of the department store chains, Allied and Federated, say retail experts. There was an assumption that the individual stores--such as Bloomingdale’s, Joske’s and Filene’s--could be sold separately for big profits, providing Campeau the money to repay the high-interest bonds. That may have been a valid assumption when Campeau bought the chains, but lately stores have been changing hands at lower prices than in recent years and Campeau Corp. has required emergency financing from some of its backers.
Other companies with high-interest debt problems right now include Western Union and Ramada Inns, but analysts predict the list may grow. “The need for financing appears to be widespread,” wrote editor James Grant, whose newsletter, Interest Rate Observer, has long warned of a troubled end to the takeover phenomenon.
That end has now come, explains Charles Clough, investment strategist for Merrill Lynch, because credit creation has slowed. “You can no longer count on selling something for a higher price tomorrow,” because banks are not lending for such transactions.
Why aren’t they? One reason, of course, is that lenders fear that borrowers won’t be able to repay loans if their optimistic assumptions are disappointed.
Another reason, however, is a shift in world economic growth. For most of the 1980s, world markets have seen a surplus of lendable funds as Japan and the nations of Europe invested little internally but sent capital to the United States, where the economy frequently grew faster. But now Japan, at 5.7% annual growth, has accelerated, and the European nations at about 3.5% a year are growing faster than the United States--which may grow less than 3% this year. Thus, some big providers of capital to the U.S. market are investing back home.
In addition, growth in world trade is speeding up--possibly to more than 8% this year--extending beyond industrialized nations to developing countries as well.
Taken all together, those factors add up to a tightening in the supply of lendable funds in the United States--a development supported by the Federal Reserve, which has been restraining the U.S. money supply for more than a year for fear of rising inflation. Small wonder the takeover era is ending.
What comes after it? Many economists predict a return to traditional business valuations--where a stock price stems from rising profits, and profits in turn result from product development and commercial ingenuity.
Traditional values offer steady returns to investors. The stock of General Electric, for example, has appreciated between 4% and 5% a year on average for the last decade. And the company has paid a dividend amounting to 3% to 4% of its stock price on average, each year. That means GE has yielded a total annual return to investors of 8% to 9% over the last 10 years. That, say investment experts, is a typical, good return on stocks: It is better than could have been had in high-quality bonds and it beats inflation.
To be sure, they concede, it is not the bonanza that the takeovers have offered in recent years. But the takeovers weren’t always a bonanza for companies or employees, and in any case the special circumstances that gave rise to takeovers have changed.
And changed for the better, say many business executives. Government surveys of U.S. business show a healthy 7.5% increase in spending on new equipment in the first half of this year, and top executives of manufacturing companies large and small say business is good. “I don’t know what economists or other people are looking at, but I’m looking at a lot of business,” says the head of one major company in a typical comment.
The fears that followed the market crash two years ago turned out to be unwarranted. The real economy was stronger than the stock market then, and it appears to be stronger now as well.
