Desperately SEEKING SYNERGY.

• Author: MILLMAN, GREGORY J.
• Position: Statistical Data Included

Mergers and acquisitions are happening at a frenetic pace. But do all these corporate meldings work happily ever after?

The new millennium had barely begun when news of the AOL Time Warner deal broke and merger mania quickly replaced the Y2K bug as the obsession du jour. Analysts greeted the deal with unreserved praise. "Combined, the synergy potential of AOL Time Warner Inc. will be stunning, in our opinion," wrote Paul L. Merenbloom and Katherine Styponias of Prudential Securities. The stock market echoed that sentiment like a hallelujah chorus, rocketing up on the day the deal was announced.

The next day, though, stock prices fell again as investors shook off the initial euphoria for a belated reality check. Talk of potential synergies had been heard before, but experience shows the potential is rarely realized. A 1997 book by a New York University professor, Mark Sirower -- The Synergy Trap -- explains in meticulously researched detail why synergy is little more than a dangerous, value-destroying myth. Research to that time had consistently demonstrated that 60 percent to 70 percent of mergers failed. In the years since Sirower's work was published, the failure rate has escalated. A research report by KPMG released in November 1999, just two months before the AOL Time Warner deal, finds 83 percent of mergers produce no benefit whatsoever to shareholders.

Why? Says Jack Prouty, partner in charge of KPMG's business integration practice, "People are doing things now that create greater complexity." Deals are getting bigger, and the rationale for merging has changed. In the early 1990s, companies merged to reduce costs. Now, Prouty says, companies are trying to buy their way to strategic growth with bigger acquisition premiums and more cross-border deals.

An acquisition premium is the amount an acquiring company pays above the current market price to buy a target company's stock. Investors put a lot of effort into the job of calculating the economic value of a company's expected future cash flows, and experience shows that the market price of a stock reasonably reflects that value.

So when executives of acquiring firms pay more than market value to buy a target company, they effectively agree to pay more for the target company's stock than anyone else in the market thinks it's worth. Russ Ray, a professor of finance at the University of Louisville, says even when these deals do create value, most of that value goes to shareholders of the target company, not shareholders of the acquirer. (This may explain the broad smiles with which option-laden Time Warner executives greeted their acquisition by AOL.)

Acquisitive managers typically justify paying a premium with claims that "synergy" will somehow make two plus two equal five. In practice, though, two plus two equals four, and the merged company never creates enough value to allow the acquirer's shareholders to recover the premium. So most acquisition premiums are a gift that managers of the acquiring firm give to shareholders of the target. But the managers don't pay for the gift themselves - it comes out of their own shareholders' pockets.

YOU ALWAYS HURT THE ONE YOU LOVE

But why would managers of an acquiring company, who in theory work for shareholders, undertake the cost and effort of a major acquisition that will probably hurt those shareholders? Academics who've wrestled with that perplexing question conclude most deals are driven by factors that have nothing to do with shareholder value. "Executive salaries are highly correlated with company size, so acquirers know they'll likely make more money after the merger. Also, senior executives like power, and there's more power and prestige involved in running a bigger corporation," says Ray.

Interestingly, the KPMG report, "Unlocking Shareholder Value: The Keys to Success," lends some support to this view. When researchers asked a survey group about the business aims behind their merger or acquisition, only a fifth of the respondents cited "maximizing shareholder value" as a key consideration. Perhaps that's why 53 percent of the mergers examined actually destroyed value, and 30 percent of the deals left shareholders no better off than they'd have been without the acquisition.

Gabor Garai, managing partner of the Boston law office Epstein, Becker & Green, says he and his colleagues have worked on about 100 M&A deals in the past year. But he's at a loss to explain why so many executives ignore the undeniable fact that most mergers fail to...