Perspective - Fall 2009 |
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JUST A FEW YEARS AGO, acquiring companies were the Titans of industry - their
aggressive expansion into new sectors and regions was admired and imitated. As
the world waits for the dust to settle from the ongoing financial crisis do the
deal-makers - and the mergers and acquisitions (M&A) activity they pursued - get
a thumbs up or a thumbs down for performance to date? Using a sample of 554
deals1 and dating the beginning of the crisis to Sept. 15, 2008, the
date of the Lehman crash, we attempt to offer insights into the effect of M&A
activity on acquiring companies, especially in turbulent market conditions2.
Retaining the crown: Are active acquirers
winners?
In the years leading up to the financial crisis in 2008, mergers and
acquisitions were in their heyday. Global M&A deals were valued at $3.9 trillion
in 2006, and by the end of 2007, their value had jumped to $4.8 trillion.3
As M&A activity peaked, some companies took the lead in both the number and size of their deals. This section focuses on these "active acquirers" that made multiple large acquisitions in the three years leading up to the crisis with an aggregate value high enough to measurably affect their own performance. An active acquirer is a company that, within the three years before the financial crisis, completed multiple (two or more) deals whose announced value exceeded 10 percent of its market cap or completed at least three deals whose announced value exceeded 5 percent of its market cap.4
In the past, active acquirers' aggressive M&A strategy seemed not only a demonstration of their strength but also a promising route to future success. The media marveled at these companies' bold vision, investors believed in their ability to make profits and followers mimicked their moves.
Our analysis, however, suggests that executing an aggressive M&A strategy prior to the crisis was not a guarantee of better performance - as measured by comparing the change in the company's stock price with the change in the corresponding sector index - during an adverse market environment. Though on average, active acquirers outperformed their benchmark local sector indices by two percent, performance of individual acquirers varied significantly. The winners and losers are almost equally distributed as can be seen in Figure 1.
That's the overall conclusion. But it's not the whole story. Some acquirers have been more successful, far surpassing the competition. So, when it comes to M&A activity in a challenging economic climate, what does work?
Diversify across regions, not sectors
Overall, we found that diversification through M&A activity across
regions is more effective and beneficial for a company than diversification
across sectors. Those that did both - diversified across regions in their core
business - beat their sector benchmark indices by an average 11 percent.
Companies that concentrated on conglomerate deals - where the acquirer and target belong to different industrial sectors - underperformed their industry sectors by a remarkable 20 percent on average.
But acquirers that focused on consolidation deals - in which the acquirer and target are in the same industrial sector - outperformed their sectors by an average of 6.3 percent.
Similarly, active acquirers concentrating on cross-border mergers and acquisitions outperformed their sectors by 7.6 percent on average, while domestically concentrated acquirers underperformed their sector's index by 2 percent (Figure 2).
Why didn't diversification to other business sectors benefit acquirers during the crisis while regional diversification did? Cross sector diversification (which only mitigates the sector-specific risk) becomes less effective in a full-scale market downturn when market risk becomes the dominating risk source, thereby undermining the rewards from sector diversification.
Experience counts
If active acquirers, on average, just managed to stay slightly ahead of
their sector average, what about less experienced acquirers5? We
studied the performance of firms that made a single large acquisition whose
total announced value exceeded 10 percent of the company's average market cap
during the three years prior to the crisis. Experienced acquirers out-performed
less experienced acquirers by an average 12.8 percent.6
These findings aren't surprising. After all, successfully making large acquisitions requires experience and expertise.7 If the company is unprepared, rashly plunging into large deals seems likely to make it more susceptible to failure in market downturns. In fact, a simple regression shows that, among inexperienced acquirers, the larger the deal they made, the more likely they were to perform badly.
Caught in the crisis: The impact on deals in
the works
When the crisis struck, some M&A deals had been announced but not
completed. We call these 'cross-crisis deals'8. Suddenly confronted
with an uncertain market environment and a lack of liquidity, the companies
negotiating those deals found themselves facing higher risks and costs than they
expected. Moreover, they had already invested significant energy and resources
in the transactions, and suspending or terminating them might have sent a
negative signal about the acquirer's business health.
So some acquirers charged ahead and completed the deals, believing that hesitation and delays would harm the company's performance. Others terminated the pending M&A deals to protect themselves from unpredictable risk and financial burdens.
Deal termination rate doubles
The termination rate9 for these cross-crisis deals jumped from
10 percent during the three-year period prior to the crisis to 20 percent during
the crisis period10. The financing method appeared to influence deal
termination rates, according to the study. Cash-financed transactions were most
affected - 19.4 percent were terminated during the crisis, compared with 8.8
percent in the previous three years. Stock-financed deals were less affected by
the crisis but continued to have the highest termination rate, just as they did
in the three years before the crisis (Figure 3).
Deal completion time drops
For completed cross-crisis deals, the average time from announcement to
completion was 128 days. That's only slightly less than the average
announcement-to-completion time of 139 days in the three years preceding the
economic crisis. But the average duration of deals announced after the crisis
struck dropped to a much lower 73 days. Our results suggest that while both
target and seller succeeded in accelerating deals once they reached the market,
economic uncertainty derailed some deals before they could make it that far.
Market reaction: Are announcements of new M&A
deals good news?
Making new, sizable acquisitions is always risky; doing so in uncertain
times is a bold and confident move by the acquiring company. To some extent, it
can be viewed as a sign of the acquirer's strengths, capability and ambition.
However, our study suggests that, the stock market reacted negatively to word of
a new deal11 during the crisis period.
In the large deals announced during the crisis, the average announcement period return was -2.18 percent over a seven-day event window (Figure 4)12. But the difference in individual deals was notable: announcement period returns ranged from -15.9 percent to 4.6 percent.
Despite the hope these deals will create value in the long run, clearly the stock market sees only a few as value-creating in the first six months of the financial crisis.
What have we learned?
The evidence suggests that an aggressive M&A strategy has not been a
ticket to stellar performance during the first six months of the financial
crisis. But acquirers that consolidated their core business while diversifying
risks with investments in other regions and markets showed much stronger
sustainability. Precautions against possible fallout from M&A transactions are
also important, such as acquiring enough experience before entering large deals
and reacting quickly in expected negative situations. Our study also shows that
even though a market downturn would generally seem to be a good time for new
acquisitions, most acquirers are not reaping economic rewards - and there is
great uncertainty in the outcome.
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