Most company acquisitions generate significant benefits. Unfortunately these accrue almost exclusively to the shareholders of the companies being bought, rather than the owners of the acquiring corporation. Time and again, major mergers and acquisitions fail to work yet this doesn't seem to stop the cycle of value destruction. Yet again, something in the corporate world seems to be a bit broken. The problem is that generally companies overpay for their acquisitions, diluting the value of their equity and, thus, damage the interests of their shareholders. Yet this is no secret, so company executives are persisting with their problematic purchases in the face of almost certain failure. Being insanely overoptimistic seems to be part of the human condition but being dementedly stupid isn't an obvious precondition for managing major corporations. So what gives?
Be a Seller, Not a Buyer
Robert Bruner in Does M&A Pay? took a look at the research on mergers and acquisitions and concluded that the evidence for their general failure is more nuanced than the headlines appear. Most company takeovers don't end up being value destroying, but most don't actually make any great difference to the purchasers and Bruner argues that this shows that most acquisitions aren't destructive of value. However, one can't help wondering if this is really the case when you take into account the time, effort and general disruptiveness of a major acquisition: would management have earned better returns simply by concentrating on their own company? Still, one group of people definitely do win – the shareholders of the companies being bought, whose returns are 20% to 30% over what they would otherwise have expected. Bruner's research comes up with a bunch of interesting but largely expected findings. So takeovers that aim to create diversification, through the acquisition of companies in different business areas, tend to do worse than those that are more aligned with the acquirer's core capabilities. This makes instinctive sense – managements should be expert in their company's areas of interest so the closer these are then the more likely it is that post-merger management will be intelligent.
The Rules of Successful M&A
Other interesting evidence suggests that most post-acquisition benefits accrue not from increased combined revenue but from decreased combined costs: so-called synergies. Similarly, value based purchases tend to work extremely well, while glamour or growth purchases tend, at best, to offer very average…
Takeover activity tends to peak at or near market highs and usually collapses near the low points – which, of course, is exactly the wrong approach for companies looking to use acquisitions enhance value.
....mmmmm....I fear this is being a bit too simplistic. There are a number of factors that may affect the outcomes on this:
a) how was the consideration paid? Paying in shares near market tops may be value additive (especially if the buyer's shares have had a good run!), whereas paying in cash may be value destructive (eg Marconi - who broke the company thanks to doing the latter)
b) availability of financiing has a huge influence. Many takeovers can be rendered impossible if market conditions mean they can't be financed - and this was most certainly the case in the recent market lows of 2009. Similarly, many deals are only financable at times of bull markets - could, for example, Vodafone have ever taken over Mannesman at a different time......and would they have gained the market reach they have enjoyed in recent years if they hadn't made the move at that time???
c) bidders frequently get little choice about the circumstances in which they can make a successful bid. For example, SOCO were approached in October 2008 by a bidder - but (I strongly suspect!) they haven't been able to get agreement on price...because the bidder wants to pay essentially for assets that have been proved up, whilst SOCO know that they have substantial assets which remain to be proved up. And because management and connections own a blocking stake, no deal will happen without agreement. BUT when the difference between the bid and ask spreads disappears or is much reduced (as will happen at some point in the next 9 months or so), a deal can then be done - and both sides are happy because they can agree on what a "fair value" for the assets is.
So it is easy to be critical of M&A activities from an academic perspective - but there are some real, practical issues that separate the "good deals" from the "bad deals".......and is is misleading to gloss over them as if they don't exist.
rgds
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