While the rise in both appetite and capacity of deals indicates a return of confidence in M & A, the main concern is that they may hurt competition (and hence, the customers) in the affected markets.
In their publication “M & A Strategy to Deliver Value from Your Transaction” PwC, a consultancy, draw on a broad spectrum of field studies to support several of their conclusions: That M & A is one of the quickest path to growth, but not the surest; that most often, stakeholders don’t get the enterprise value promised from the M & A deals; and that irrespective of whether M & A deals occur domestically or in a foreign market, they are inherently complex and laden with risk.1
Yet after a lull following the financial crisis, mergers and acquisitions (M &A) deal-making seems to be back with a vengeance, with the media filled with headline-grabbing deals. The numbers tell the story: Worldwide, $3.6 trillion of mergers and acquisition deals were announced last year2 – a value that is very close to the peak reached in 2007. In the pharmaceutical and media industry, the rush to buy is coming from the massive stockpiles of cash most of the major players in the industry have on hand, and deals worth more than $10 billion are common again.
The most popular deals in 2014, in which the affected companies strived to buy growth that they cannot get organically, include that of the medical device maker Medtronic’s $42.9 billion acquisition of rival Coviden, SanDisk’s $1.1 billion takeover of flash technology company Fusion-io, telecom giant Level 3 Communications’ $5.7 billion purchase of tw Telecom and Williams Companies’ $6 billion controlling stake in natural gas driller Access Midstream Partners.3 It should be noted here that America and Britain account for a disproportionate share of the action due to their open markets for corporate control. In general, the broader trend here is that historically low interest rates coupled with strong corporate balance sheet are making cross-border deals more attractive: it has grown from a sixth of merger and acquisition activity in the mid-1990s to 43 percent today.4
Mergers and acquisitions had historically led to booms and slumps in the corporate world. This experience had made investors to be wary of such deals. In view of this, veteran fund managers and academics argue that such deals destroy value for shareholders even though they do satisfy executives’ vanity and enrich their bankers. Hence the share of a firm have tended to fall when it announces an acquisition. When this happens, investors naturally fret that the gains from such acquisition is less than the benefits from the synergies the deal will produce. However, since the year 2012, the outcome from merger deals have been different, with the acquirers’ share prices remaining stable or, in some cases, even going up.
It is not an exaggeration to say that, on paper, mergers and acquisitions do make sense. Provided that companies adhere to some basic principles, they can cut duplicated overheads and raise their margins when they combine operations. They can also gain pricing power over customers and suppliers by adding together their market shares. In addition, merging firms can make their combined sales a lot bigger than the sum of their individual ones if they cross-sell each other’s product ranges in each other’s geographic markets.5
Yet, there are many sad stories involving M & A. Good examples include that of the Royal Bank of Scotland(RBS) and ABN AMRO which took place in 2007 just as the subprime crisis struck,6 and the combinations of Time Warner and AOL in 2000 when the dotcom bubble burst.7 There are also good stories involving successful M & A. As a matter of fact M & A had produced some of the world’s most successful firms. For instance, Mobil, an oil company used to have under-appreciated collections of global assets. When Exxon purchased the company in 1999, it became the energy industry’s top dog. AB Inbev also became the world’s biggest brewer with thirst-quenching profits because it had participated in billions of M & A deals over two decades.8 So in as much as M & A has bad reputation, the evidence of history does seem to be on their side since most deals creates value particularly in the short term. In a broader sense, since the year 2000, our experience with M &A is that the combined market capitalizations of the buying firms and their target firms has typically risen when the deal is announced to the public. However, the problem is that it is the shareholders of the firms being bought who receive 100 percent of these gains in value. The reason for this are many. It can be that the acquirer exaggerated or overestimated the synergies that will result from the merger in its lust to justify a deal, overpays for these synergies, or had simply botched the subsequent integration of the companies.
The latest boom in M & A deals seems to indicate that the acquirers and the targets will equally benefit this time around. The reason is that today’s investors, such as activist funds, are now flexing their muscles more than before and are keen for firms to buy back their own shares cheaply instead of buying other company’s shares expensively. Also, since the 1990s, institutional shareholders such as private equity and sovereign fund managers have become so powerful that they can act as a brake on corporate CEOs’ empire-building. Added to this rising militancy and engagement of shareholders is another important issue: the too-big-to fail banks that usually finance big M & A deals has become more restrained and careful due to tighter financial regulations and rules.
The word on the street
With M & A deals at all-time high, the natural question becomes whether a bandwagon is rolling and corporate bosses are jumping aboard without undertaking in-depth evaluation. For a start, something similar to this has happened in America before. There was a craze for creating monopolies in steel, tobacco and other industries between the 1890s and 1900s. This is one of the reason why trustbusting laws were created to bust them up.9 Other examples abound. For instance, conglomerates were in fashion in the 1960s. They, however, became unpopular in the 1980s when they were dismantled with the aid of the newly-created junk-bond market. Technology and telecoms firms accounted for 40 percent of business activities during the dotcom bubble of 1999-2000. And just like every other bubbles, they were among the biggest to pop subsequently. Several bandwagons were also rolling around 2003 through 2007 – a period when there was a gallop into private equity buy-outs and a rush into emerging markets and commodities. Simply put, deals of these kinds accounted for at least 25 percent of all deals in 2007. In 2014, they were down to 19 percent.10
The current boom in M & A does not have any sign of widespread mania. Of course there are some of them that doesn’t really make sense. For instance, the pharmaceutical industry is in a frenzy of what may be termed “inversion deals”, whereby American firms switch their domiciles and avoid American tax rules by buying foreign ones. Other than these, a great number of the deals are good ones. A good example is Verizon’s $130 billion purchase of the shares of Vodafone in their American mobile venture. Since Verizon already manages the business, this is considered a good deal. Other good deals that occurred in 2014 include those where some firms divest or spin off their toxic assets. Generally speaking, spin offs and divestitures tend to be investor-friendly. In the 1980s and 1990s, Altria, a conglomerate that included Philip Morris and Kraft foods was created after a flurry of deals. And since 2007, the company is worth almost double what the combined group had been worth after it split itself into four main parts that are today worth $333 billion.11
It should be noted here that as much as 15 percent of M &A deals made in 2014 were either terminated or withdrawn. For instance, when Rupert Murdock of 21st Century Fox made a $94 billion offer for Time Warner, his company’s stock took a hit. As a result, he was forced to withdraw the offer. Some experts and analysts generally see a high failure rate as a sign of toppy M & A market, believing that it is only nervous buyers that makes speculative bids. The bottom line: while the rise in both appetite and capacity of deals indicates a return of confidence in the M & A market, the main concern is that they may hurt competition (and hence, the customers) in the affected markets.
1PwC(2015): M & A Strategy to Deliver Value From Your Transaction. Retrieved January 13, 2015 from http://www.pwc.com/us/en/transaction-services/acquisitions.jhtml?gclid=CMa89fyzkcMCF YYvgQodsXMAvw
2 Economist (2014): Mergers and Acquisitions – The New Rules of Attraction. Retrieved January 13, 2015 from http://www.economist.com/news/business/21632675-latest-boom-dealmaking-appears-more-sensible-its-predecessors-valuations-are
3Solomon J. (2014): Boom Time for Mergers and Acquisitions. CNN Money. Retrieved January 18, 2015 from http://money.cnn.com/2014/06/16/investing/mergers-and-acquisitons-boom/
4 Economist (2014), op. cit., p. 66
5Boston Consulting Group (2015): The Brave New World of M & A. Retrieved January 18, 2015 from https://www.bcgperspectives.com/content/articles/mergers_acquisitions_br…
6ABC News (2007): Royal Bank of Scotland Wins Biggest Financial Takeover. Retrieved January 18, 2015 from http://abcnews.go.com/Business/story?id=3698102
7Arango T. (2010): How the AOL-Time Warner Merger Went So Wrong. New York Times. Retrieved January 19, 2015 from http://www.nytimes.com/2010/01/11/business/media/11merger.html?pagewanted=all
8 Economist (2014), op. cit., p. 66
9Weinberg M. (2002) A Short History of American Capitalism. Retrieved January 21, 2015 from http://www.newhistory.org/CH07.htm
10 Economist (2014), op. cit., p. 66