<THE DRIP PORTFOLIO>
Blood is thicker than water, but oil?
By Frank Bosley (email@example.com)
WAYNE, NJ (Jan. 25, 1999) -- "If there's an original thought out there, I sure could use it right now..."
-- Bob Dylan, "Brownsville Girl"
Ahh, 1998 is quickly becoming nothing more of a fading memory, but what memories we have of that year! Brian (TMF Panic) claimed that 1998 was the Year of the Drip! Nobody here at The Motley Fool can argue with that! The Fools started Drips in Campbell Soup (NYSE: CPB) in April of 1998, and Mellon Bank (NYSE: MEL) in October of 1998. Of course, CPB started instituting those bothersome optional cash (OCP) purchase fees. (For the record, I wanted Coke rather than Campbell, and as Brian mentioned in his article, it's up to us Fools to bombard CPB with letters and e-mails of disappointment -- though the latter is much easier to compose, it is also probably much easier to dismiss.)
In addition, the Chinese Zodiac calendar listed 1998 as the Year of the Tiger.
Now let's put this all together: Brian tells us about Drips, the Chinese Zodiac tells us about tigers, Jeff and Co. worked steadfastly toward selecting the next Drip acquisition (or is it a merger?) in the oil industry, and everyone knows how I feel about Exxon (NYSE: XON)! So I decided to name 1998 as the year of the Merger/Acquisition! Now this isn't some original thought (thanks Bob) because everybody's been talking about the major mergers of late! For your recollection, here's a recap of the five biggest mergers/acquisitions for 1998:
1. $77.2 billion: Exxon (NYSE: XON) and Mobil (NYSE: MOB) (Dec/98)
2. $72.6 billion: Bell Atlantic (NYSE: BEL) and GTE (NYSE: GTE) (Jul/98)
3. $69.9 billion: SBC Communications (NYSE: SBC) and Ameritech (NYSE: AIT) (May/98)
4. $58.5 billion: British Petroleum (NYSE: BP) and Amoco (NYSE: AN) (Aug/98)
5. $41.5 billion: NationsBank (NYSE: NB) and BankAmerica (NYSE: BAC) (9/30/98)
I think the merger that is most interesting in light of the Drip Port is the biggest one of last year: Exxon + Mobil. Now mergers/acquisitions are nothing new. People, companies, even whole nations have been joining together ever since Ramses II signed a peace treaty with the Hittites in 13th century B.C. to provide mutual protection against invaders across the Aegean. Interestingly enough, it's always easier to unite against a common foe, rather than for a common cause.
Now I'll let some other Fool who is more familiar with the financial aspects of these two companies try to explain how they are actually coming together from positions of weakness rather than strength. I think that what makes this merger so interesting is that not only could we have a Drip in the world's largest oil company (if we select Exxon), but that it is a reunion of long, lost cousins!
Most mergers are done to provide two (or more) companies with a stronger position within a certain industry (horizontal integration), or to provide avenues of expansion into arenas that were not part of either company's business (vertical integration), which can save money on R&D. The recent Excite/@Home merger is a perfect example of this. It gives each of the respective mergees (I just made that word up!) exposure in new sectors. Now, the Exxon/Mobil merger is a perfect example of horizontal integration and appears to be just one large oil company (Exxon) acquiring a smaller one (Mobil) to gain dominance in a specific market. The $64,000 question is, will this merger gain the requisite approval of the Federal Trade Commission?
Exxon used to be known as the Standard Oil Company of New Jersey and Mobil was the Standard Oil Company of New York. These two companies were part of John D. Rockefeller's enormous Standard Oil Trust of some 30 different companies, which made up the trust that completely dominated the industry. Rockefeller began developing this trust in the late 1800s and he completely controlled the industry, often with ruthless consequences to those who dared opposed him.
All was well and good until Congress recognized the unfair business practices being utilized to maintain power. This brought about legislation known as the Sherman Anti-Trust Act. The Sherman Act basically was separated into two sections:
"Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."
"Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony."
Notice that the first section deals with agreements that restrain and require two or more participants, whereas the second section specifically references monopolies. The punishment for either offense was "by fine not exceeding ten million dollars if a corporation, or, if any other person, three hundred and fifty thousand dollars, or by imprisonment not exceeding three years, or by both said punishments, in the discretion of the court."
Standard Oil controlled most of the oil refineries throughout the nation (the small renegade companies that tried to get in the business, were either bought out or burned up), as well as the pipelines used to get the oil from the wells to the refineries. While some may argue that this was at the very root of the free enterprise system (that's what the Standard Oil's lawyers argued during the appeal), the Supreme Court of the United States did not agree. The Supreme Court upheld a lower court's decision that Standard Oil Trust was indeed a monopoly in violation of the Sherman Act and forced Standard Oil to divest itself of property (divestiture is the means through which a monopoly is broken up into smaller companies). For more on the actual text of this landmark case, check out this site.
But what exactly is a monopoly? In the simplest light, the primary measure of a monopoly is market share. If Company X controls 50% of the market, and it wants to merge/acquire Company Y, which controls 25%, the resultant combination will be a 75% control of the respective market. Such control, while not explicitly illegal, can result in a dampening of competition. Perhaps the hardest part of the equation is defining what makes up a market! As suggested in my West's Business Law book, do hot and cold cereals represent one market or two? Certain characteristics are taken into consideration such as the interchangeability between the two. Can one be substituted for the other? Exxon and Mobil obviously can be, so they are considered part of the same market. Courts also consider geographic locations.
Once the market has been defined, the courts must determine the amount of market-share under one specific company's control that is contrary to the law. There is no set amount, but the Justice Department has provided guidelines. The Justice Department used to look solely at market share in terms of a percentage and then determine if that share was excessive. This has been modified somewhat with the introduction of the Herfindahl Index.
The Herfindahl Index adds the market shares of all firms in the industry, but only after the market shares have been squared (if it was 16%, it is now 256). An index is established for the different sectors and any merger that would exceed the index is immediately blocked. Unlike the concentration ratio, the Herfindahl Index effectively captures the market power of firms that dwarf their competitors. Since 1982, the Justice Department has been using the Herfindahl Index to settle antitrust cases and the big oil merger will certainly come under this scrutiny.
So, the larger questions before us are: Will the proposed merger of Exxon and Mobil fall under the index established for the oil industry or will the two remain blood brothers separated by law, and what impact will this have on shareholders (especially for us long-term Drip holders)? Only time, and the interpretation and application of law by the Federal Trade Commission and the Justice Department can answer that.
Would you work for a bunch of Fools?
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