Deal Mania

Sorry I have been absent for awhile. But I have several thoughts to blog about over the coming week. To start off, here are some musing aboyt mergers and antitrust.

A fresh round of merger and acquisition headlines has brought home a clear point: Many U.S. industries are consolidating. With the prospect of fewer, and more powerful, players in many sectors, shouldn't antitrust alarm bells be going off in Washington?

The "deal flow," as financial pros like to call it, is regaining momentum after a brief credit crunch-induced hiatus. In the beleaguered airline industry, both management and Wall Street see salvation from horrendous cost pressures with mergers. The pending deal between Northwest Airlines (NWA) and Delta Air Lines (DAL) is expected to be the first in a new round of megadeals.

More earthbound industries are also joining in. The profit-starved newspaper business is seeking to slash costs and shore up profits through consolidation, too. The candy business is shrinking, with Mars purchasing rival Wrigley (WWY). And then there are the deals-that-may-be, such as Belgian brewer InBev contemplating a takeover of American icon Anheuser-Busch and Barnes & Noble (BKS) mulling a deal for its troubled adversary Borders (BGP).

Cyberspace is not immune, either. Consider the intriguing dance among Microsoft (MSFT), Yahoo! (YHOO), Google (GOOG), and famed investor Carl Icahn that could end up in a merger between Yahoo and Microsoft, an advertising deal between Yahoo and Google, some other combination, or none of the above. Stay tuned. Meanwhile, the takeover deal book is long and growing.

Does the current consolidation wave mean consumers will pay higher prices to fly, read the news, and eat a candy bar? Or to drink beer or hawk their wares on the Web? Perhaps not in each of these examples listed above, but it's a safe bet the answer could be "yes" in many consolidating industries.

So where is the Justice Dept.? Shouldn't antitrust regulators flex their muscles and start blocking deals? In many cases probably not--especially if the welcome mat stays out for international competitors. The risk that mergers will lessen competition and strengthen market power in an industry can be significantly reduced when competitors from Brazil to Shanghai to Frankfurt compete for profits and markets in a business. (Still, carrying a foreign pedigree doesn't automatically ensure adequate competition. The antitrust authorities will--and should--take a close look at the marketplace implications of combining InBev and Busch into a $100 billion revenue brewer powerhouse.)

On the surface, recent U.S. antitrust policy or, more accurately, competition, has been remarkably laissez faire, especially compared with far more interventionist European policy. Before the mid-1970s, merger litigation was commonplace and a surprising number of cases even ended up before the Supreme Court. But since the '70s, deeply influenced by industrial organization economics in general and the Chicago School of Economics in particular, trustbusters have been increasingly reluctant to intervene in the marketplace. Indeed, economists are now the crucial experts in antitrust. For instance, as of early 2008 the Justice Dept. has 60 PhD-level economists and the Federal Trade Commission has 70 PhD-level economists, according to Lawrence White, economist at New York University,

The numbers bear this out. For instance, of the 37,201 mergers or acquisitions filed with the U.S. antitrust authorities from 1991 through 2004, about 97% sailed through without much scrutiny, according to a recent paper by economists Orley Ashenfelter of Princeton University and Daniel Hoskin of the Federal Trade Commission "The Effect of Mergers on Consumer Prices: Evidence from Five Selected Case Studies"; National Bureau of Economic Research, working paper 13859).

Clearly, trustbusters have moved away from a clear-cut yes-or-no; approach. What remains is much back-channel negotiation. For instance, in the remaining 3% of deals between 1991 and 2004 that were looked at closely, some two-thirds were modified, abandoned, or blocked. "Through negotiation, companies get the benefit that they see, and antitrust authorities get rid of the downside from their perspective," says Randal Picker, professor at the University of Chicago Law School and co-author of the scholarly article "Antitrust and Regulation" (NBER working paper 12902).

In essence, there are two measures by which to judge the success or failure of antitrust policy. First, keeping quality constant, what happens to prices and, second, whether mergers encourage innovation or squash it. While both are hard to judge in the real world, the track record of prices and innovation in the U.S. economy over the past quarter century does suggest the tally has been more on the success side of the ledger.

Still, the concern about lessening competition is real, especially when it comes to the microeconomics of prices. Take the paper by Ashenfelter and Hoskin. The scholars looked at five big consumer business mergers, and they examined the impact of the deals on prices by going over retail scanner and similar data. The deals were: Procter & Gamble's (PG) purchase of Tambrands, Aurora Food's (Mrs. Butterworth) buying Kraft's Log Cabin breakfast syrup business, Pennzoil's purchase of Quaker State motor oil, General Mills' (GIS) acquisition of Ralcorp's branded cereal business, and the merger of Guinness' and Grand Metropolitan's distilled spirits businesses.

In no instance did prices drop. In four of five mergers, the companies engineered increases in some consumer prices, ranging between 3% and 7%. In one case--Aurora/Kraft--there was little effect on prices. "However, given the large amount of commerce in these industries, the implied transfer from consumers to manufacturers is substantial," they write.

But airlines are an entirely different animal from consumer products businesses. Certainly, airline management would like higher prices. (What business doesn't?) The industry has been battered by a brutal combination of $130-plus oil, steep debt burdens, and fares that often do not cover costs. A favorite guessing game on Wall Street is which airline will file for bankruptcy next or merge itself out of existence. The proposed marriage between Delta and Northwest was greeted by commentary that the era of cheap airfares was over. A 20% price hike is the number frequently bandied about.

Little wonder trustbusters might have blocked a comparable deal several years ago or at least forced the divestiture of many assets before letting it go through. However, it's a part of antitrust policy"the so-called failing firm doctrine--to let some deals go through if there is a risk that one of the firms could go under.

That said, Congress and the White House can ensure the market stays competitive and consumers don't get taken to the cleaners by making it easier for overseas airlines to own and operate in the U.S.

Many decades ago, there was a grandeur to antitrust policy. Theodore Roosevelt and his brain trust tilted against giant railroad combines, oil monopolies, and the like. Today, trustbusting is steeped in economics and it's more modest in its aims.

In a sense, trustbusters are living up to the wish of John Maynard Keynes: "If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid." But if the actions of the modern-day trustbusters are modest, the stakes--the protection of consumers from price collusion and an economy that nurtures innovation--remain high.