Thursday, April 21, 2005 - NYSE to Acquire Electronic Trader And Go Public - NYSE to Acquire Electronic Trader And Go Public

Merger mania continues. Archipelago is a part of the new world of trading and of course the New York Stock Exchange is part of the old world. Through the merger, the New York Stock Exchange becomes a part of the new world.

The good news continues to be that consumers are getting a better deal every which way they turn. Yes, it is true that the whiners focus on the increases in oil prices and other relatively "static" goods. They see inflation every where. Most of the whiners were not alive during the 70's or they do not remember.

Even the news that consumers are getting a better deal gets turned upside down. One reads about the price war in brokerage commissions or the new VoIP phones typically in articles telling how Schwab and SBC revenues are down. It is a fact that the new economy has forced companies in most industries to cut costs. The opportunity for substitution are great during times of revolutionary change. For example, I just received a real estate contract attached to an email. It is very easy to substitute a pair of socks made in China for a pair made in the US nowadays. In the recent past, this would have been impossible.

Another potential merger in the news is between American West and US Air. Big companies like Merrill have panned the merger but I do not know their motives. It seems perfectly logical to merge a western and eastern carrier, re-deploy assets, reduce redundancies and have a stronger surviving airline. The companies may not need the help of the merchant banks for a big recapitalization given that the financial structure of US Air has been altered during bankruptcy.

Merger mania should continue until the hoards of cash on companies balance sheets is reduced. Companies have the opportunity to increase profits at the stroke of a pen. They can buy back their own stock or buy out other companies.

The airlines industry is the obvious one with excess capacity. And yet, Delta, one of the weakest carriers, just beat expectations. DAL had another big loss, partly due to high oil prices, but, again, had a better quarter than was projected. There are too many newspapers, telephone companies and internet companies, to name a few industries. Consolidation has been happening for several years. In the internet area there are still a lot of start ups being created but even here big mergers have been the order of the day.

Merging to rationalize markets is an old story. Mergers are a part of the "gales of creative destruction". The story is often similar to the following: In a rural town there are two feed and seed stores; neither are making much money. Eventually one buys the other. The survivor does very well and expands to the next town. Sooner or later there are two competitors going head to head in several towns. Being survivors, these two play a good game of tit for tat and do not engage in destructive price wars. To grow the business, they each add farm machinery and hardware. Sooner or later, they take on "extra" costs. They may have long-term employees who make good wages, liberal return policies and even liberal donations to charity.

Under the circumstances, it is possible for an employee who really knows the feed and seed side of the business to talk a number of good customers into backing him in opening a new feed and seed store. In a good economy, it is possible that all three store do ok for a time. It is also a possibility that Home Depot or some other national chain will build next door and put one, two or all three out of business.

The point is that the economy is dynamic. There are times when companies grow and expand without much resistance. There are other times when the best way to "grow" is to buy a competitor. We are currently in a market where a relatively few "new" businesses such as cell phone providers and internet service companies are growing organically. Many businesses are not experiencing fast growth in reveunes but are successful in increasing operating margins and bottom line profits. We are also in a time where many businesses best opportunity to increase profits is to in effect shrink the total equity in the system by buying back their own shares or by buying out a competitor.

I have written often that the FON-NXTL merger is one that I believe makes good economic sense. It is a "win-win" deal. I believe airline mergers make sense because costs can be cut while resources can be allocated for their best use.

Data show that companies have unusually large cash balances. It makes good sense for these companies to increase dividends or to buy back shares. It makes sense for investors to buy shares in cash rich companies because the buying back of shares typically increases profit per share. The risk of buying a cash rich company is that it may buy a competitor at a rich price. In the current market this risk has not been high. For example, when GME bought its largest competitor, GME went up as the merger was calculated to be accretive to earnings by the end of the very first year!

Investors should over-weight stocks in their portfolios and they should under-weight bonds. Note that in many of the recent mergers, additional debt is being added and significant amounts of cash are being paid for shares. The indication is that companies are willing to borrow against assets to boost earnings. The risk factor for the companies debt goes up at the same time the earnings per share goes up--good for stocks but bad for bonds.

Buy stocks: the big bull boom bubble and finally bust are still ahead.