Seize the Opportunities in M&A

With the global economy returning to growth after the worst financial crisis in the lives of most business executives, the outlook for mergers and acquisitions (M&A) is improving. Yet, while M&A activity appeared to bottom out in 2009, the recovery in the number and value of deals remains patchy and the prospects for the rest of 2010 are mixed. Although financial markets are reopening and risk perceptions are well below the peaks reached at the height of the crisis, concerns persist about the prospect of a double-dip recession.

Previous research by The Boston Consulting Group demonstrated that while the initial market response to acquisition announcements is usually negative, buyers can create significant value over the longer term through M&A. This edition of BCG’s annual M&A report includes the findings of a new study by the BCG M&A Research Center into the long-term value created by acquisitions. Drawing on a unique global database of more than 3,500 deals since 1992, it confirms that downturn deals create significantly more value on average than deals initiated during boom times. It also identifies the key drivers of success for buyers in both downturn and upturn periods.

A recent BCG survey found that despite the uncertainties, many senior executives of large European companies were planning either to make a major acquisition or to divest businesses in 2010. As the M&A outlook improves, companies must be ready to take advantage of the opportunities that present themselves.

The M&A market appears to have bottomed out in 2009, providing opportunities for financially strong companies to make acquisitions, including significant consolidation deals.

• The number of deals fell by 14 percent in 2009, and their value fell by 44 percent. However, 2009 was a game of two halves: the decline that began with the insolvency of Lehman Brothers in September 2008 ended in the second quarter of 2009; the value of M&A deals turned upward in the second half of the year—though it leveled off again in the first few months of 2010.
• M&A activity involving private-equity (PE) firms fell even more steeply, with the number of deals down almost 28 percent in 2009 and their value 61 percent lower than in 2008. As the shortage of financing for PE deals reduces the degree of leverage in acquisitions, PE is struggling to recover.
• Consolidation deals were a dominant feature of 2009, with ten very large transactions contributing more than 20 percent of total M&A value. At the smaller end of the spectrum, there has been a continuing increase in the percentage of acquisitions worth less than $125 million, as companies sell noncore activities and underperforming assets.
• Asian buyers continued to acquire targets in the Americas and Europe in 2009. While the numbers of such deals were down compared with previous years, they fell less than the number of acquisitions in Asia by companies from other regions.
• Buyers in 2009 were typically cash-rich companies that were not constrained by financing issues. Their targets were more vulnerable than before the financial crisis, with lower margins and higher leverage, on average. The short-term returns from M&A in 2009 were down relative to 2008.

A new BCG study has analyzed about 3,500 deals from around the world since 1992 to understand better how acquisitions can generate long-term value for acquirers. This approach complements the conventional methodology, which focuses on short-term returns during the period around the announcement of a deal. The study found that there was a significant correlation between short-term and long-term returns, and it identified key drivers of value creation through M&A.

• While most acquisitions dilute value for the buyer, approximately 40 percent of deals create value over both the short and the long term.
• A comparison of value creation in the 2001–03 economic downturn and in the 2004–07 upturn confirms BCG’s earlier findings that returns from M&A are higher on average in downturn periods. There is no perfect time for doing a deal in a downturn, however: during the 2001–03 downturn, returns from acquisitions two years after the announcement date were 9 percent or more, on average—no matter whether the deal was done during the first, second, or third year of the downturn.
• Deals involving acquirers and targets from the same sectors are much more likely to deliver short- and long-term value for the buyers, illustrating the importance of operational and cost synergies as sources of value.
• For the buyers, cash-only deals outperform acquisitions using other forms of payment over the two years following the announcement.
• While the short-term reaction to a deal is a good predictor of its long-term return, markets can occasionally underestimate the value created.

The M&A recovery has been anemic, with uncertainties hanging over the economy. However, there are many signs of an improvement in the M&A environment that could lead to an increase in deal-making activity in the coming months.

• Confidence has returned to the debt markets, with high-yield debt issuance heading back toward precrisis levels and a continuing increase in investment-grade issuance. The cost of debt financing continued to fall in 2009, though it remains about double the level before the crisis began.
• Initial public offerings (IPOs) have risen, averaging $35 billion per month in the fourth quarter of 2009. The number of secondary-equity issues surged to 3,152 in 2009—almost double the number in 2008.
• Despite recent turbulence caused by the debt crisis in Greece and fears of similar crises in other countries, the global economy seems to be returning to growth in 2010. GDP growth has been a significant driver of M&A activity over the past 30 years.
• Most companies have emerged from the recession in reasonable health. Large companies have increased their cash reserves, and many companies are reporting increases in profits.
• Previous downturns in M&A ended after two years of decline. If this pattern holds true, M&A activity should increase in 2010.

Despite the positive indicators, there are many concerns about the economy that dampen enthusiasm for M&A. Investors have tended to greet deal announcements with caution.

• Early recoveries in some previous recessions—notably in the 1930s—were followed by a second downturn.
• Sustained growth might be undermined by factors such as deleveraging, which could reduce consumption and investment; withdrawal of liquidity by central banks; increases in interest rates; and stubborn levels of unemployment.
• Potential bidders are deterred by the valuation gap between what they are willing to pay and the prices that targets expect. There is uncertainty around valuations, increased by volatility in stock market ratings and fears about the degree of recovery in some sectors. That uncertainty is heightened by continuing concerns over credit availability and liquidity.
• Reactions to recent sovereign default threats, especially in the euro zone, have exposed the jitteriness of markets and disrupted new issues even after the €750 billion rescue package organized for Greece.

A recent BCG survey found that, despite concerns about the outlook, a significant proportion of senior executives in the largest publicly listed European companies were preparing for a major deal in 2010. There are deal opportunities for companies with robust finances that are ready to take advantage of them.

• Consolidation deals will be attractive as companies emerge from the crisis—especially because they create the most value.
• Acquirers will include companies that scaled back investment during the crisis and need to accelerate their growth to meet investors’ expectations.
• Corporate restructuring will continue to provide divestment candidates, which are often attractive targets. As corporate orphans, they offer the prospect of turnaround under new owners able to refinance or improve their performance.
• PE will be a source of distressed sales as firms face problems in refinancing debt accumulated in the easier credit markets of the precrisis era. The recovery in the IPO markets could allow PE to exit from assets held through the credit crunch, releasing funds for a limited return to the M&A market on the buy side as well.
• Acquisitions by buyers in emerging markets—including sovereign wealth funds—will continue to develop.

Acknowledgments

This report is a product of The Boston Consulting Group’s Corporate Development practice. The authors would like to acknowledge the contributions of their colleagues Pedro Esquivias, Daniel Friedman, Tawfik Hammoud, Gerry Hansell, Jérôme Hervé, Daniel Stelter, and Olivier Wierzba.

The authors would also like to thank Stefan Bornemann, Blas Bracamonte, Markus Brummer, Sonja Dittrich, Kerstin Hobelsberger, Florian Mezger, and Dirk Schilder of BCG’s M&A Research Center and Corporate Finance Task Force for their extensive support.