Why some M&A Deals work Better
Date: 28-01-2008
Source: High Yield Report
Executives want to deliver an acquisition that brings the proverbial “synergies” to their organization. Getting deals right is important when the M&A market is riding high, funding is plentiful and competition drives up prices in bidding wars. Getting deals right remains especially important when activity slows, funding is tight and investors need convincing that a proposed deal makes sense for the organization's long-term growth.
Market conditions have changed, no doubt, but not before the $3.79 trillion record pace in M&A activity during 2006 carried through to make the first nine months of 2007 the busiest nine-month period ever for the global markets, (with $3.63 trillion in transactions). History shows, however, that some of those deals will fail to provide shareholders with significant returns a year or two down the road, and business market pundits will offer a host of reasons as to why some deals failed.
All Deals Not Created Equal
Now, as the tide turns on the cyclical deal market, there's new research to offer some interesting findings that may help explain why some deals work better than others. KPMG's Transaction Services Group and Steven Kaplan, the Neubauer family professor of entrepreneurship and finance at the University of Chicago Graduate School of Business, analyzed 510 corporate deals announced between 2000 and 2004 and measured stock-price improvements 1 year and 2 years later.
The research found that the most successful transactions were aimed at building financial strength and improving distribution channels, demonstrating that some acquisition objectives are more likely to yield success. They were also completed by companies with lower market caps, pointing to a potential need for larger companies to focus more on their transaction process and due diligence approach. And the most successful transactions were also done by acquirers that made just one or two other deals in the previous two years, indicating that integration becomes difficult when too many acquisitions are made.
While stock in companies that completed all-equity deals returned a negative 2.1% one year after the announcement and a meager 3.6% gain after two years, returns for companies that used “cash only” increased with an average of 15.1% after one year and 27.5% after two years.
It may be that companies that finance transactions with stock sometimes perceive their stock to be a “cheaper” currency than cash or more expendable and less costly should the deal go wrong. Companies using stock for acquisitions may also believe their stock prices have reached their peak, especially if their stock price is accompanied by a higher than average price per share to earnings per share (P/E) ratio or other metric. In addition, as Professor Kaplan notes, “An acquirer with high P/Es may have trouble improving on their return to shareholders when their stock is already priced relatively high compared with their peers.”
Targets with low P/E ratios are likely to represent acquisitions that are more fairly priced or suggest an underperforming business is present. Indeed, the survey shows that acquirers with the highest P/E ratios in their industry had a normalized stock return of 1.7% after one year and just 0.8% after two years. By contrast, acquirers with the lowest P/E ratios in their industry had a return of 21.6% after the first year and 42.2% after two years.
Essentially, having a high P/E to start with may mean there is less upside potential. This may also be true of target companies. Companies that purchased targets with the highest P/E ratios saw returns of negative 4.2% after one year and a positive 5.5% after two years.
Conversely, said Kaplan, “Acquirers with a relatively low P/E may be more cautious when making a purchase, since their own stock is not overvalued in the market, and, as you can expect, targets with low P/Es may represent better deals as their stock is not overpriced.”
The ‘Why' Matters
Buyers whose acquisitions were motivated by a desire to increase financial strength saw their stock prices increase by 6.7%; those whose aim was to improve distribution channels saw their stock prices increase 5.7%; and those who wanted to increase earnings had stock-price gains of 5.4%.
After two years, the results were somewhat similar. Companies whose stated goal was to improve their distribution were most successful and had stock prices that increased an average of 17.8%. Companies who said their deals were motivated by financial strength saw their stock prices increase with an average of 16.8% and those who were interested in cost savings saw stock prices increase with an average of 16.5%.
Smaller-than-average acquirers performed better than companies that had above-average market capitalizations. The average successful acquirer in the KPMG study had a market cap of $7 billion.
Daniel D. Tiemann is national lead partner for Transaction Services at Audit, Tax and Advisory firm KPMG LLP. He is based in Chicago.
.jpg)
