WASHINGTON. By all indications, merger and acquisition (M&A) activity in America is on the rise. In the first five months of 2019, companies announced over $1 trillion in mergers and acquisitions. That’s a 14% increase from the same period in 2018. Healthy M&A activity generally acts as a tonic for the economy, the consumer, and shareholders. Most Americans tend to benefit from the economies of scale, the increased innovation, lower prices and stronger stock market returns that generally accompany business mergers.
The importance of business mergers and R&D in the American economy
It is difficult to pinpoint one specific reason for the increase in business mergers. But recent developments including the president’s tax reform bill, large corporate cash reserves and strong equity and debt markets may all contribute to the recent flurry of M&A activity. The constant need to maintain America’s technological edge in the face of growing global competition is another key factor supporting a healthy M&A environment.
The United States in recent years has lost its research and development (R&D) edge against the rest of the world. This constitutes a major future problem, as cutting edge R&D is another key metric of economic success. In 1960 the United States accounted for over two-thirds of all R&D activity around the globe. Since then, the total U.S. share of R&D fell to 28%. The country risks an even greater decline as foreign competitors continue their strong emphasis on developing new technologies.
Over the past two decades China, for example, emerged as a global science and technology leader. Since 2000 China’s share of global R&D more than quintupled, from 4.9% to 25.1%. At this pace of growth they may soon overtake the rate of American innovation. Synergistic business mergers in this country can help reverse this trend.
Synergies derived from business mergers
Pooling collective corporate resources offers economies of scale that increase capabilities and help advance technologies. By eliminating the redundancy of fixed costs, merged companies can pass savings down to consumers. This frequently takes the form of lower product prices. Internal advantages include the availability of funds to support additional R&D activities.
Ultimately, strategic mergers ensure that companies can compete in rapidly changing markets domestically and abroad. The Trump administration constantly searches for ways to even the playing field against China. They have leveled tariffs against a significant number of Chinese imports. Additionally, they recent labeled China a currency manipulator in response to Chinese government efforts to devalue the yuan. Allowing companies to take advantage of natural synergies to streamline costs and make them more competitive remains an underutilized tool in the government arsenal. The Trump administration should employ it more often.
Recent M&A activities: Defense and aerospace
While the headlines of business pages primarily focus on tech and pharmaceutical mergers, recent business mergers in the defense and aerospace sector are making headlines. The proposed corporate marriage between Raytheon and United Technologies, for example, demonstrates how strategic mergers can prove beneficial to national security as well.
Just as technology companies must continuously compete with foreign developments, so does America’s defense industry. Unfortunately, U.S. defense-related R&D fell from 36% of global R&D pre-Great Recession to 4% today. Further drops could become routine. Defense budgets will almost certainly come under additional pressure in future years, squeezed by the ever increasing encroachment of out-of-control entitlements.
To ensure America maintains its edge against foreign adversaries, the Federal government must rely more heavily on contractors and commercial companies. In so doing, the government can leverage corporate America’s integrated capabilities for cost-effective innovation to obtain more for less.
Big business mergers tend to incite big opposition
Naysayers predictably raised anti-trust concerns about the Raytheon / United Technologies merger. They argue that joining the two companies via their proposed business merger will remove a source of competition and increase the pricing power of the new entity. But defense only accounts for 25% of United Technologies’ business and a mere 1% of the two companies’ sales overlap.
Many of the most vocal critics of this and other proposed mergers also happen to be “activist” investors. However, these shrewd corporate bargain hunters focus more on potential short-term profits generated by than what it takes to generate long-term corporate value. This modus operandi frequently proves devastating to private research and development. Companies find themselves forced to hire an expensive army of attorneys to defend against misguided “activists.” This in turn causes a negative impact on quarterly earnings. The reason? Companies under activist attack must commit significant capital and corporate personnel resources to defending a hostile external attack.
One study, for example, found that after a significant number of company shares were held by activist hedge funds for a median period of 423 days, corporate R&D funding ended up getting slashed by more than half. Another study found that companies under pressure from activist investors, generally made defensive cuts to R&D. This ended up harming long term technological innovation in the economy over time.
At the end of the day, commonsense business mergers remain essential to American competitiveness. Every business merger deserves appropriate government and public scrutiny to allay relevant anti-trust concerns. Unsurprisingly, many such proposed transactions will faile the sniff test. But deals like the Raytheon-United Technologies business merger and similar partnerships in innovation are an important key to ensure that America maintains its technological edge, particularly in the commercial and defense sectors of the American economy.
— Headline image: Looking north from the New York Stock Exchange, New York City.
(Image via Wikipedia entry on Mergers and Acquisitions, GNU 1.2 and CC 3.0 licenses)