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Destroying mythical beasts.

At the FMI meeting in Boca Raton, Howard K. Smith suggested a heavy tax on mergers and acquisitions because "the capital used in mergers and acquisitions results in less capital available for productive investment in new equipment and machinery and new technology." This is, in fact, one of those ideas that is not only wrong but also highly counterproductive.

Consider, for example, the very simple case of the Good Food Supermarket Company, which wants to sell one of its divisions to the Better Food Supermarket Company for $10 million. The Better Food Company has $10 million in the bank. It writes a check for $10 million to Good Food Company which puts it in the bank, and the ownership of the division is transferred to the Better Food Company.

We had $10 million in a checking account one minute and $10 million in a checking account in somebody else's name the next minute. The division of Good Food that was sold is now in the hands of Better Food.

Presumably Better Food believed that it could find a way to make a higher return on investment from that division than it could from $10 million in the bank. Conversely Good Food believed that the $10 million was more valuable and that there are more interesting options for investment with the $10 million than with the division it used to own. For both companies, productivity is gained.

In real life the division that was being sold had probably been starved of investment for some time. For several years Good Food had only been putting in the capital needed to keep the doors open, since it really wasn't interested in the market, couldn't seem to make a go of it, and didn't want to spend any money when it didn't believe the returns were adequate. Meanwhile, every dime that Good Food spent on this troublesome division was less money available for investment in other places where Good Food really understood the business and believed very strongly that further investment would yield returns on capital, and therefore higher productivity.

Better Food Company had the opposite situation. The divisions it owned gave reasonable returns, but were not nearly as exciting as the division which it bought from Good Food. Under Better Food's wing, this division will now find committed management ready to make the investments necessary to make this division really fly. The major point of this little illustration is to show that mergers and acquisitions simply mean that a bunch of zeros with a number in front of them moved from one account to another in a bank in New York. It has nothing to do with the consumption of capital. Capital that is not consumed, rather only transferred from one bank account to another, is still available for investment.

The really important issue, and the one in which society has a stake, is to see to it that the capital that is consumed is invested in the most productive possible use. Had Better Food not purchased this division, its $10 million would have been invested in less productive ways.

The same little analogy holds true whether the acquisition is an enormous one, in billions of dollars, or a small one, in terms of thousands. When DuPont, for example, purchased Conoco from Conoco stockholders, all it did was transfer capital from its bank accoaunt to the bank accounts of people who previously owned Conoco stock. There was no less capital available for investment from DuPont, from Conoco, from the stockholders of Conoco who received cash and now have larger bank accounts, or for the financial markets as a whole. There was no drain whatsoever from the total capital available to the industrial economy or the nation as a whole.

Mergers and acquisitions are--in general--a way to permit capital to find its most productive use. There is no question that there are some mergers and acquisitions that do not work out well, and in which the net productivity to the nation is lowered. There are also occasions when machine tools are bought or foundries built or steel mills and blast furnaces invested in that for some reason work out to be a mistake. That some mergers do not work is really irrelevant to the validity of mergers or acquisitions, and is instead a function of poor judgement on the part of the management of those companies.

Any attempt to eliminate or reduce mergers and acquisitions would only be counter-productive. It will mean that existing assets will be used less productively, and new capital willhave less opportunity to find its most productive use.
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Title Annotation:grocery mergers
Author:Morrissey, John E.
Publication:Progressive Grocer
Article Type:column
Date:Mar 1, 1984
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