The 2020 M&A Report: Alternative Deals Gain Traction

The 2020 M&A Report takes stock of an eventful first nine months of the year and looks ahead to how the COVID-19 crisis might shape a new reality for M&A. In this context of disruption and uncertainty, we examine the increasing popularity of alternative deals. In these deals, rather than acquiring control of and integrating a target, companies acquire minority stakes or establish cooperative arrangements—such as through joint ventures, strategic alliances, or corporate venture capital investments. Companies can use alternative deals to gain access to capabilities that help them address not only the pandemic-induced crisis but also ongoing trends such as technology-driven disruption and the convergence of industries.

Post-COVID M&A—A Dip or A Trough?

Once the magnitude of the COVID-19 crisis became clear, M&A activity shut down as abruptly as the overall global economy. Deal volume in April 2020 was 80% lower than in December 2019. Although equity markets quickly recovered, M&A activity, especially activity involving larger deals, has seen a slower recovery.

Is there light at the end of the tunnel? A comparison with M&A activity during the 2008–2009 financial crisis offers reason for cautious optimism. Looking at global M&A deals valued at more than $500 million since 2007, we generally see a pace of activity in the range of 40 to 70 transactions per month in the past ten years. Monthly activity fell below this range in consecutive months twice: at the height of the financial crisis in late 2008 through mid-2009 and in the first half of 2020. (See Exhibit 1.)

Initially, the drop-off in M&A activity in the current crisis was worse than in the 2008–2009 crisis. But a clearly discernible uptick occurred during June through August, as monthly deal activity exceeded 40 transactions. Indeed, the uptick in M&A activity that began in June, including the resurgence in megadeals, suggests that the M&A market has turned the corner in recovering from the crisis—notwithstanding the risk of additional COVID-19 waves and the potential for a W-shaped recession. However, a return of major COVID-19 lockdowns would likely set back the recovery.

Looking at the bigger picture, the pandemic has not materially disrupted most of the longer-term trends that are affecting many sectors. In fact, it may even accelerate them. For example, the monetary policy measures implemented to combat the economic crisis mean that low interest rates will persist, which supports deal making on the buy side. Digitization and other disruptive technological megatrends—such as advanced analytics, artificial intelligence, automation, and big data—will continue to be very relevant or become even more relevant in the postpandemic world. And, the convergence of industry sectors, such as mobility and technology, will continue to promote deal making.

The Rise of Alternative Deal Making

In this environment, dealmakers increasingly see alternative deals as effective ways to pursue strategic goals and reduce risk. There are two exemplary, and often overlapping, ways to look at alternative deal trends:

• Minority deals, in which the buyer acquires less than 50% of a company
• Joint venture and alliance (JV&A) transactions, such as equity alliances and corporate ventures, which often entail acquisition of minority stakes

Alternative deals have seen a surge in popularity in recent years and seem likely to remain attractive approaches to corporate collaboration during the pandemic-induced downturn as well as during the postpandemic recovery and beyond.

But is the importance of alternative deals justified from a value creation perspective? To find the answer, we focused our research on JV&A. From the perspective of short-term value creation, investors appear to be increasingly receptive to companies’ use of JV&A to enable collaboration or even to replace classic M&A. From 1990 through mid-2020, announcement returns trended higher for both JVs and alliances. (See Exhibit 2.)

Longer-term value creation, however, has been more challenging. Less than half of all JV&A deals create returns that outperform their industry (as measured by relative total shareholder return) after one or two years. Even JV&A deals that are signed on the basis of a sound value creation story and thorough due diligence require swift and rigorous implementation, good governance, and continuous monitoring to create longer-term value. In this respect, they are analogous to M&A deals that must overcome the challenges of integration and synergy realization in order to ultimately succeed. And dealmakers’ experience in managing the execution of JV&A deals also matters for value creation, just as it does in classic M&A.

To complement our quantitative analyses, we surveyed corporate dealmakers about their experience and opinions related to alternative deals. The results reinforce the empirical finding that alternative deals have mixed results in terms of value creation. Respondents said that approximately 40% of alternative deals fail—that is, they do not achieve their stated financial and/or strategic goals. Respondents considered only approximately 60% of deals to be successful once the dust settles (although stock market performance indicates that fewer deals—approximately 50%, depending on the metric—are successful, as shown in Exhibit 2). Alternative deals fared no better than classic M&A with respect to perceived failure and success rates.

Why do so many alternative deals fail? Survey respondents cited three main reasons. More than one-third (34%) pointed to the absence of a clear roadmap for value creation, KPIs, or monitoring mechanisms. More than a quarter (29%) cited the absence of a clear strategic rationale. A similar portion (27%) attributed failures to the lack of clearly defined and robust governance. Governance is critical for deals in which degrees of control are often fluid and interests (at the outset or over time) may diverge.

Whether a deal succeeds or fails often boils down to experience: companies with significant experience (at least three alternative deals per year) report that 61% of their deals are successful, whereas less experienced companies (two or fewer deals per year) report that 58% of their deals are successful. A company’s organizational setup and approach clearly matter, too. Self-reported success rates are 9 percentage points higher for companies with dedicated teams or team members for alternative deals and 7 percentage points higher for companies with processes for alternative deals that differ, at least partially, from those they use for classic M&A. Not surprisingly, experienced companies typically have dedicated staff and customized processes.

Applying the Lessons of Experience

How can companies maximize the value of alternative deals? Our research and experience point to the following set of best practices:

• Get an early start developing a long-term plan for alternative deals that advances your overall strategy. Unlike some classic M&A deals, alternative deals do not come out of the blue. Periodically review your plan and stick to it throughout the journey.
• Do not skimp on due diligence, even though that may be tempting given the seemingly lower financial stakes. A detailed and holistic assessment of the target and the overall deal clearly pays off and is as crucial as it is for classic M&A.
• Clearly define, negotiate, and formalize postdeal governance before signing, and make governance a top-management task.
• Use people with explicit experience in alternative deals to negotiate and manage these arrangements, and seek external support, if necessary. A “one size fits all” approach to deal making does not work.
• Define and implement transparent and feasible incentive schemes for key decision makers in the alternative deal process.