David Stockman, President Reagan’s Budget Director and one of the architects of the Reagan Revolution, then an early partner at the private-equity firm, Blackstone Group, and now bestselling author, graciously gave me permission to post the particularly relevant Chapter 23 of his book, The Great Deformation: The Corruption of Capitalism in America. Here is the third installment.
One of the great ironies of the Greenspan bubbles was that the free market convictions of the maestro enabled the Fed to drift steadily and irreversibly into its eventual submission to the Cramerite intimidation. It did so by turning a blind eye to lunatic speculations in the stock market, dismissing them, apparently, as the exuberances of capitalist boys and girls playing too hard.
By the final years of the first Greenspan bubble, however, there were plenty of warning signals that there was more than exuberance going on. Hit-and-run momentum trading and vast money flows into the stocks of serial M&A operations were signs that normal market disciplines were not working. Indeed, the M&A mania was a powerful indictment of the Fed’s prosperity management model.
These hyperactive deal companies with booming share prices were being afflicted ever more frequently with sudden stock price implosions that couldn’t have been merely random failures on the free market. Yet, as in the case of the subprime mania, the central planners undoubtedly read the headlines about these recurring corporate blowups and never bothered to connect the dots.
The WorldCom train wreck of 2001, for example, was as much a consequence of Bernie Ebbers’ penchant for serial M&A as it was the result of his desperate efforts to cook the books when his deal making failed. Years of overpaying for acquisitions and the incurrence of massive debts finally came home to roost when WorldCom announced a shocking $20 billion goodwill write-off in the spring of 2001. Celebrated for years by the financial press for its prowess in deal making and as a pioneer in the deregulated long-distance phone market, the stock imploded on the spot. It had been a debt-ridden house of cards all along.
The two telecom equipment flameouts of that era, Nortel and Lucent, had also been hotbeds of serial M&A. In the short span between April 1998 and late 2000, for example, Nortel had completed nearly two dozen deals valued at more than $30 billion. Not to be outdone, Lucent had executed a new deal almost every month during the same period, racking up $44 billion in total M&A transactions in less than three years.
Yet after the 2001 crash landing of these two telecom equipment giants, any residual value from this barrage of acquisitions was hard to find. By September 2002, for example, Lucent’s market cap had plunged to just $4 billion, meaning that its three-year spree of M&A deals were being valued at essentially zero after giving even minimum value to its massive base of assets, customers, and technology inherited from its prior one-hundred-year history as Western Electric.
Likewise, Nortel’s market cap peaked at $400 billion. Twenty-four months later it crashed and burned, its market cap reduced to a $5 billion rounding error. Again, Lucent and Nortel had not been shooting stars off the pink sheets or highflyers inhabiting the margins of the economy. They were the giant former equipment divisions of the Bell Telephone monopolies in the United States and Canada, and had $60 billion of sales and 200,000 employees between them.
As monsters of the deal maker’s midway, they had dominated financial TV and were omnipresent in the investment banking and trading precincts of Wall Street. So when they imploded in a sudden, fiery crash, it was a sign that something was haywire in the stock market.
Still, the ultimate monument to the merger mania which became pandemic by the end of the first Greenspan bubble was the JDS Uniphase acquisition of SDL. The deal had been announced on July 10, 2000, a date which was virtually the high noon of the tech frenzy. At that moment the market cap of JDS Uniphase was $90 billion and it paid $40 billion for SDL.
Soon thereafter, however, the market value of the combined firms deflated so rapidly and violently as to evoke Ross Perot’s famous “sucking sound to the south.” By early 2002, the post-merger company traded at just $2 billion, meaning that 98 percent of its high-noon market cap had been wiped out. What had been advertised at the time as the largest M&A deal in tech industry history had, in fact, been a merger of bottled air all along. By David Stockman.