Download (direct link):
Two broad types of research provide this warning. Academic studies typically look at the ex ante market reaction to the announcement of a deal, taking into account not only expected costs and benefits of the deal, but also the market's expectation of whether the deal will actually be consummated. This approach assumes the market is smart and able to size up the price paid, potential synergies, and integration ability of the managements involved to arrive at an unbiased estimate of the likelihood of a deal adding to the value of a company. Another analytical approach is ex post, assessing merger programs after their completion—looking back to see how what did happen compares with what had been hoped for.
Ex Ante Market Reactions
Exhibit 7.1 summarizes the results of dozens of academic studies of transactions involving public companies. Shareholders of acquired companies are the big winners, receiving on average a 20 percent premium in a
Exhibit 7.1 Empirical Studies of M&A Activity
friendly merger and a 35 percent premium in a hostile takeover. Shareholders of acquiring companies, on average, earned small returns that are not even statistically different from zero. The shareholders of acquired companies receive most of the benefit, because competition among acquirers forces the target's price up to the point where little or no expected benefit to acquiring shareholders is left.
This does not mean that acquirers never succeed after the fact nor that the market's reaction to a deal is always lukewarm or unfavorable. However, it does serve to point out how skeptical investors are about the likelihood of acquirers getting more than they pay for in a deal. Likewise, a favorable initial reaction by the market is merely an expectation that the deal will create value—whether it will is revealed over time.
To know that overall the market is unimpressed with acquirers' deals, despite undoubtedly glowing promises when the deals were announced, is certainly interesting and sobering. But it masks additional information about what types of deals the market might expect to create value. To probe this, several colleagues analyzed the market's ex ante reaction to all transactions with a deal size greater than $500 million among publicly traded U.S. companies from January 1996 to September 1998. The results are consistent with prior academic findings—acquirers on average were not expected to earn exceptional profits from their deals, while selling shareholders gained significantly 90 percent of the time.
Peering beneath the surface of the results reveals that there were many transactions the market thought were good deals for the acquiring shareholders. The problem is that there are also many that were expected to be poor deals—leading to an insignificant overall effect. For acquirers whose stock moved significantly one way or the other near the announcement of a deal, 42 percent were winners and 58 percent losers.
What types of deal were expected to be good ones? The research suggests the following factors at work, all of which comport with common sense:
• Bigger value creation overall. An acquirer can increase its chance of success significantly if there is seen to be substantial value creation in the whole deal. If the deal is judged a marginal or losing proposition overall, acquirers' share prices dropped 98 percent of the time. If there is seen to be substantial juice—believable, unique synergies—in a deal, it's much more likely that the acquirer will be able to capture a portion for its shareholders, while paying a ''fair" price to the sellers.
• Lower premiums paid. Acquirers who pay lower premiums (less than 10 percent or no premiums) are three times as likely to see their stock prices affected favorably by the announcement. Moreover, acquirers who buy subsidiaries or divisions of other companies are more likely to have deals seen as favorable than buyers of entire publicly traded companies. This could be due to lack of a publicly traded price to anchor price negotiations, the desire of sellers to complete a transaction so management can rid itself of a problem division, or perhaps the ability of the acquiring company to integrate the business more rapidly and effectively.
• Better-run acquirers. Below-average operators fared less well than acquirers whose financial performance was above average for their industries. Acquirers whose five-year returns on invested capital (ROIC) were above average for their industries were statistically more likely to see their stock price rise upon announcement of a deal—whereas below-average performers were more likely to see their prices drop.
Ex Post Results
So much for the stock market's prognostications—what really happens? In the late 1980s, McKinsey's Corporate Leadership Center studied 116 acquisition programs, usually involving multiple acquisitions in the United States and the United Kingdom, between 1972 and 1983. They started with companies in either the Fortune 200 largest U.S. industrials or the Financial Times top 150 U.K. industrials. A program was judged successful if it earned its cost of capital or better on funds invested in it, after giving the programs at least three years to season. Programs usually involved multiple acquisitions such as General Mills' 47 acquisitions of small, high-growth, consumer-oriented companies. Unfortunately, sixty-one percent of the programs ended in failure, only 23 percent in success. For the 97 programs that were clear winners or losers, the greatest chance of success (at 45 percent) was for those programs where acquirers bought smaller companies in related businesses.1 If