Land of the Giants

By Daren Fonda

Forget the accounting scandals, the CEOs fending off fraud charges, the churning stock market. The business world has become obsessed with corporate nuptials. Merger mania is back, executives are cashing out and, if history is any guide, investors should be running for cover. A couple of months ago, Kmart and Sears got engaged. Then Nextel and Sprint announced their $35 billion wedding. Johnson & Johnson is buying Guidant, a maker of medical devices, for $24 billion. Two of the splashiest deals came last week: SBC, the Baby Bell based in San Antonio, Texas, looked poised to swallow its former parent, AT&T, in a deal that could top $15 billion. Then Procter & Gamble said it would acquire Gillette for $57 billion, forging a consumer-products giant with brands ranging from Gillette's Right Guard deodorant and Mach3 razors to P&G's Crest, Pampers and Tide.

For all the talk of profits and synergies, investors would be wise to view these deals with a wary eye. Blockbuster mergers tend to be duds for stockholders of the acquiring company. In seven of the nine mergers valued at more than $50 billion, the acquirer's share price is down an average of 46% from premerger levels, according to FactSet Mergerstat, a research firm in Santa Monica, Calif. Maybe you already knew that if you're a longtime owner of Hewlett-Packard, whose stock has flatlined since the company acquired Compaq in 2002. AOL's merger with Time Warner (parent company of TIME) may have set a new standard of paired futility, erasing some 80% of the merged company's stock value. After the hype subsides, more often than not, investors wind up with tax write-offs.

Yet that hasn't slowed the latest blitz of deals. December 2004 saw $147 billion in mergers vs. $41 billion a year earlier, according to Thomson Financial. In January an additional $150 billion worth was announced. A recent survey by Bank of America Business Capital found that 23% of chief financial officers expect to do a major deal this year.

Why the shopping spree? In part, it's a self-perpetuating cycle. Once a few big companies in an industry join forces, everyone else feels compelled to hook up. (In consumer products, the betting now is that Kimberly-Clark and Colgate will be next.) The buying binge is also being fueled by rising stock prices--and the loads of cash piling up on corporate balance sheets. The S&P 500 is up 40% from its 2002 low, and companies in the index are sitting on $2.3 trillion in cash. Writing dividend checks is one way to spend the largesse. Microsoft paid $32 billion in dividends last year, and dividends are expected to rise 10% on average this year. Many executives, though, are cracking open the piggy bank and looking for acquisition targets. P&G, for instance, is using its stock to acquire Gillette, but it also plans to spend up to $22 billion to buy back shares to support the merged firm's stock price.

Investors in Gillette, headquartered in Boston, can't complain. Their shares were already up sharply over the past year, even before the 18% premium that P&G's bid provides. CEO James Kilts, for one, stands to make an estimated $123 million from selling his firm to P&G, based on last week's stock prices and options that will vest when the ink on the deal dries. Famed investor Warren Buffett has also scored big, reaping a paper profit of $567 million for Berkshire Hathaway, which owns 96 million Gillette shares. "It's a dream deal," he said in a statement, pledging to raise his stake to 100 million shares as a vote of confidence.

But what about P&G shareholders? While Wall Street has reacted coolly to some recent mergers (investors pummeled software firm Symantec after it announced a $13.5 billion bid for Veritas), the assessment on this one has been largely positive. P&G chief executive A.G. Lafley has argued that the combination will rev up sales of Gillette's men's grooming line, particularly in markets like China, where P&G is strongly embedded, and Procter's business stands to gain from Gillette's formidable operations in countries like India and Brazil. "Together, P&G and Gillette could grow at levels neither of us could sustain on our own," Lafley told investors last week. Specifically, he and Kilts (who will stay on as a P&G vice chairman) pledged to squeeze $14 billion to $16 billion in "revenue and cost synergies" out of the firm.

Sounds pretty good, but do the numbers add up? With few overlapping products, neither company was talking last week about cutting lines of goods. As for job cuts, the plan calls for eliminating a relatively small number--6,000 of the combined firm's 140,000 employees worldwide. That won't save billions. Another argument from deal enthusiasts: the merger will give the firms greater bargaining clout with big retail chains. "This is a response to the Wal-Martization of America," says Joseph Altobello, an analyst at CIBC World Markets. A similar case is made regarding advertising purchases--that together the brand-swollen behemoth will be able to wring more favorable terms for ads. Yet P&G and Gillette were megafirms separately. How much more leverage can they truly gain?

The hardest advantage to measure is that merger buzzword synergy. "P&G knows a lot about women. Gillette knows a lot about men," Lafley told investors. "It's very simple, but it's a potent combination." Robert McDonald, a P&G senior executive, hinted to TIME at new products that could capitalize on each firm's strengths. "We have the best-selling male fragrance in Hugo Boss," he says. "How about a Hugo Boss designer razor?" Problem is, with P&G already so big, boasting more than $50 billion in sales, it needs the equivalent of a new megabrand like Tide each year to hit its targets of 5% to 7% annual growth. That would be a lot of Boss razors.

So, will bigger be better? Unlike the mates in the HP-Compaq and AOL--Time Warner deals, both partners here are marrying from positions of strength. P&G, for one, has had several recent hits, like Crest Whitestrips and Swiffer cleaning products, and Wall Street loves Lafley for increasing operating income and turbocharging the growth of brands like Iams pet food (another acquisition). On the other hand, P&G has never absorbed a company as large as Gillette, with its 30,000 employees, and the price it's paying is steep. "We are skeptical that simply going from $55 billion to $65 billion in revenues really changes all that much," wrote J.P. Morgan analyst John Faucher in a note to investors last week. We'll know when the honeymoon ends. --With reporting by David Bjerklie, Barbara Kiviat and Dody Tsiantar/ New York

With reporting by David Bjerklie; Barbara Kiviat; Dody Tsiantar/ New York