Many mergers being derailed by insider case
The fall of Ivan Boesky, and the increasing possibility that he could bring key junk-bond financiers with him, has stopped many mergers in their tracks. It has also aroused an already anxious Capitol Hill to examine the tidal wave of mergers, junk-bond financing, and newly revealed cheating on Wall Street. [What is a junk bond? See back page.]
But most observers say the federal investigation will be little more than a hitch in the frenzied restructuring that has swept the country in the last two years.
``I don't think the 3,000-plus merger transactions that occur during the year are driven by a handful of people putting companies into play,'' says David Wittig, who is on Kidder, Peabody & Co.'s merger and acquisition team.
``Cutting off an arbitrageur here or a raider there won't have much effect'' on the pace of mergers, says John Stoppelman, a Washington, D.C., securities lawyer. But, he says, ``if the investigation [continues to] widen into major- league players, that will have a big impact.''
The Securities and Exchange Commission is investigating Drexel Burnham Lambert, the investment bank largely responsible for the surge in takeover attempts through its junk-bond financing, for criminal violations of insider trading.
The investigation stems from Drexel's relationship with Mr. Boesky, who has admitted inside-trading abuses and is now cooperating with the government.
The impact of the Drexel investigation has been swift and painful. The stock market, led by takeover issues, fell 43.31 points Tuesday, the fourth-largest drop in history. Takeover stocks fell sharply.
Wickes Cos. says it is putting off its $1.7 billion tender offer for Lear Siegler. Gillette is trying to thwart the hostile bid of Revlon, a Drexel client, by accusing it of insider trading and subpoenaing records of several investment firms. USX, Borg-Warner (a rumored target of Drexel client GAF) and several other targets of Drexel clients all slid.
Capitol Hill, too, is bearish on takeovers. Sen. William Proxmire (D) of Wisconsin, who will chair the Senate Banking Committee, says he wants to question Boesky. And in an often acrimonious hearing Tuesday on Sir James Goldsmith's hostile bid for Goodyear, legislators blasted the merger trend.
Corporate raiders who focus on healthy companies are ``parasites,'' said Rep. Mary Oaker (D) of Ohio. Sen.-elect Barbara Mikulski (D) of Maryland decried the ``increasing trend toward corporate strip mining.''
Democrats and Republicans alike expressed concern that the Reagan administration's passive approach toward mergers has added to their momentum, and several legislators said they would seek tighter rules governing hostile takeovers.
But whether rhetoric becomes law is another matter.
``It's certain there's going to be a new round of hearings addressing takeovers,'' says David Laird, who watches mergers for Dressendorfer Laird Associates. ``I would be surprised if Congress could actually agree on anything. There's a great reluctance to tinker with the system.''
Last year, legislators introduced 64 bills involving takeovers, including insider trading, tightening disclosure and voting-rights requirements, and curbing junk-bond financing. None were passed.
Attempts to regulate mergers have failed in the past as Wall Street found alternate ways to push mergers through. For example, in January the Federal Reserve Board barred many shell companies from financing 50 percent or more of a takeover with junk bonds, theoretically forcing them to come up with more cash. The rule, however, has had little effect on the pace of mergers.
Even a Democratic-controlled Congress is unlikely to make sweeping changes. States have jurisdiction over corporations, and many already restrict hostile takeovers of home-state firms.
Martha Donovan, who is on the staff of the House Subcommittee on Telecommunications, Consumer Protection, and Finance, says the Boesky case shows that ``the SEC is doing its job'' and does not need further legislative help.
David Moulton, an aide to Rep. Edward Markey (D) of Massachusetts, who will probably head the subcommittee, says, ``Whatever changes you see would likely not be radical, since the effects are too difficult to foresee.''
If anything can slow the restructuring of corporate America - a process condemned by some as mortgaging America's future competitiveness, praised by others as ushering in new, more efficient management - it is the new tax law. Companies will have to pay taxes when they sell assets, which adds a substantial ``transaction cost'' to any merger, acquisition, or spinoff. New depreciation rules would also make some mergers less attractive.
The pace should slow in December, when it will be too late to consummate a merger before Jan. 1. ``The pipeline's being cleaned out,'' says James Kelly, president of W.T. Grimm & Co., which tracks mergers, ``but it will pick up in the second quarter'' of 1987.
Mr. Wittig at Kidder, Peabody agrees that a drop in merger activity ``will in effect force prices down and will generate another wave of mergers.''
But future deals might not be so damaging, says Henry Reiling, a Harvard Business School professor. The new law will eliminate many transactions that were tax-driven and ``may encourage companies to acquire businesses that make good strategic sense.''
Still, he and others worry that corporate America will eventually have to pay the piper for the past wave of mergers, which has piled companies with debt. If the economy goes into recession, dwindling cash flow will have to go into paying off corporate debt, not into new plant, equipment, research and development.
Mr. Reiling concludes, ``The high levels of debt will have a competitive cost that is more subtle than bankruptcy.'' Just what is a junk bond?
Junk bonds carry high risk and potentially high return. One of the most controversial financial fads of the 1980s, they are often held responsible for fanning the merger flames and lowering corporate creditworthiness.
A corporate raider typically gets an investment bank such as Drexel Burnham Lambert to issue these bonds to a network of ready investors. In a kind of financial legerdemain, the bonds are secured by the assets of the company that the raider wants to acquire.
Money from the bond issue is then used by the raider to purchase the stock of the target company. If the raider takes over control, he begins selling off corporate assets to retire the debt.
Junk-bond financing is behind most of the big takeover attempts today. Many economists worry that a junk-bond takeover can turn formerly sound companies into shaky ones overnight. But officials at Drexel and other junk-bond issuers note that, corporate raids aside, these instruments have benefited companies that have had difficult raising money in the past.
Because of the high returns, these bonds are popular investments even for conservative institutions such as savings-and-loans. But if the company tied to the bond falls on hard times, a default could occur. Junk-bond advocates, however, say so far the default rate has been modest.