While the average M&A transaction destroys value for the acquirer, there are drivers of value that enable a minority of acquisitions to produce positive returns, according to a new report by The Boston Consulting Group (BCG).
The report, "Riding the Next Wave in M&A: Where Are the Opportunities to Create Value?" shows that the critical issues are the selection of targets and the timing of bids, backed by excellence in managing the M&A process.
“Successful acquirers buy what they know when they know it will deliver optimal returns,” says Jens Kengelbach, a member of BCG’s global M&A team and a coauthor of the report. “Then they standardise their M&A processes, with clear lines of responsibility and robust performance measurement. Practice really can make perfect.”
One unexpected conclusion of the report is that acquirers are more likely to create value when they buy targets abroad—even though this is often seen as riskier than making domestic acquisitions. Less unexpected is the finding that long-term returns are higher on average when acquirers buy targets in their core sector—the returns are usually lower when they diversify into new sectors.
Two optimal moments to launch a bid, the report finds, are just before an economic recovery and in the early stages of an M&A wave in an industry. The early bird gets the worm because there is less competition from other bidders. This means a better choice of targets whose valuations have not yet been bid up too high.
A New Wave of M&A?
The report says that the recovery in the M&A market, which began in mid-2009, continued in 2010, with deal values up 19 percent. Numbers and values are now back to the levels previously seen in 2004, at the start of the last wave of M&A activity, which ended with the financial crisis in 2007. Private-equity firms are ramping up their M&A activities, more than doubling the value of their deals in 2010. Another spur to growth is the increasing involvement of Asia-Pacific companies in M&A in other regions: they accounted for almost one in five deals in 2010.
As a result of these factors, 2010 was an extraordinarily good year for acquisitions when measured by share price performance. Average short-term returns on acquisitions by public companies of other public companies were at a 15-year high for both buyers and targets. For the first time since 1996, there was a positive return on average for acquirers, albeit a modest one. Average returns for targets—always positive over the last 15 years—were also at record highs.
M&A Fees Rose Sharply in 2010
Transaction fees rose sharply in 2010, from an average of 0.27 percent of deal value in 2009 to 0.60 percent. This was higher than in the boom times between 2004 and 2008, when deal fees averaged around 0.4 percent.
“While many large advisory institutions laid off entire deal teams during the crisis, the ones that have survived have been able to command higher-than-normal fees,” said Axel Roos, a BCG partner and the other coauthor of the report. “They have thus used the upturn in M&A to recover some of the costs they incurred in 2009, when deals were in short supply.”
The Secrets of Successful Serial Acquirers
One of the surprising findings from the research is that serial acquirers generate lower returns from M&A, on average, than infrequent acquirers. But successful serial acquirers outperform with three types of acquisitions that involve greater than average complexity:
1. Distressed Deals. Investors see serial acquirers as better equipped than single acquirers to turn distressed assets around.
2. Acquisitions of Private Companies. Serial acquirers earn higher average returns because they are better at evaluating such companies and negotiating with them.
3. Acquisitions on Other Continents. Serial acquirers thrive in comparison with occasional acquirers because investors have confidence in their ability to manage geographic complexity.
In addition, the returns of serial acquirers are 1.4 percentage points higher when they buy relatively small companies than when the target has sales higher than their own. Finally, successful serial acquirers excel at timing their deals when deal premiums and competition are lowest: for example, 39 percent of serial acquirers’ deals occur in the first stage of an M&A wave, compared with just 28 percent of single acquirers’ transactions.
Be Ready to Ride the M&A Wave
While optimism about the prospects for M&A has risen, economic uncertainties continue to hang over deal making. Fears of a double-dip recession have receded, but growth is still weak in the developed countries, particularly in Europe. Markets remain prone to jitteriness—especially over sovereign-debt issues in the euro zone. Finally, unforeseen developments in 2011—political upheavals in the Middle East and the aftereffects of Japan’s earthquake and tsunami—have created new sources of volatility.
“With global economic growth around the long-term average, the world economy may be in a prerecovery period in which companies should be able to make higher returns on acquisitions than in the earlier years of the downturn,” says Roos. “However, this window of opportunity may not remain open for long, given these risk factors. If prospective acquirers want to benefit from a new M&A wave, they should be ready to ride it.”
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