Tips for Spotting a Successful M&A Deal
If you're an investor looking for a boom in mergers and acquisitions to pump some life into a listless stock market and your own portfolio, the Boston Consulting Group has good news and bad news.
"While concerns remain about the anemic recovery in developed markets and the threat of sovereign debt crises, many ingredients are in place for a new wave of M&A," a new BCG report says. It notes that the number of deals grew by 7.6 percent in 2010 and that the value of deals rose by 19 percent.
Now the bad news: An analysis of 26,000 mergers and acquisitions since 1988 concludes that they tend to leave shareholders of the acquirers worse off than if they had not bothered making the deals at all:
"When publicly listed companies acquire other public companies, the deal on average destroys value for the acquirer in both the short and longer term."
The study then adds some good news to the bad news that follows the good news. It highlights several factors that make an M&A deal successful and that, in turn, could make for some successful investments by anyone astute enough to spot those factors on the apparently rare occasions that they occur.
Acquisitions generally work out better when companies stray from home. Cross-border transactions generate higher returns than domestic ones, the study finds.
Executives shouldn't buy any old business on their trips out of town, however. "Companies that make acquisitions in their core sectors are much more likely to deliver long-term value to their owners than those that diversify into other sectors," BCG advises.
One finding that may seem surprising at first analysis is that companies do better when they pay for acquisitions using real money rather than stock. It could be that having an inflated stock price makes bosses trigger happy and more inclined to make a deal - any deal - because the strong stock makes it easier to pay for it.
Among the study's other findings:
Transactions done in the early stages of an M&A cycle result in higher returns.
Returns have been higher in the last few years, even though premiums over existing market values have been higher too. In general, though, deals made at low premiums to a target's market value tend to do better than high-premium deals.
Promiscuity is harmful. Companies that continually make acquisitions have less to show for them, on average, than companies that make a single deal. But the study notes that the success of companies that make multiple acquisitions varies greatly. Some companies have turned M&A into something of an art form:
"Just over half of serial acquirers create value because they choose the right targets, make their acquisitions at the optimal time and expertly manage the M&A process."
The study mentions few individual companies, but it does highlight the British supermarket chain Tesco (TSCDY.PK) as a successful serial acquirer.
This study is aimed at big-time corporate barons, but it can be useful to small investors too. Before hopping on the bandwagon and participating in the next merger mania, judge each deal by the criteria that BCG emphasizes. If a cross-border deal is proposed in cash and for a company in a related industry, then the acquirer may be worth owning, as long as its stock offers strong growth prospects at a reasonable valuation before the acquisition is factored in.