Joint Ventures: Are they a viable alternative to a full merger or acquisition?

Much of the research and reporting in M&A get done about the headline-grabbing large acquisitions and mergers.  However, the unsung hero of corporate alliances are joint ventures.  But we expect to see more of these, including some very big JVs.  Note the announcement on 1 February of a $12 billion joint venture between oil companies Shell and Cosan.  The Telegraph, one of London’s leading daily newspapers, noted in their Sunday paper (21 March 2010) the need to consider alliances and joint ventures instead of acquisitions — citing the recent announcement by Prudential to acquire AIG’s Asian business and whether Resolution should do the same when planning for the next year.  You can see this in the three paragraphs at the end of the article here.

Liam Vaughan, of Financial News, in an article on 23 March, also commented on the study and linked it to the above-mentioned Royal Dutch Shell joint venture with Brazilian counterpart Cosan, and then wrote that ‘Shell’s Brazilian JV follows high-profile joint ventures in the telecoms and natural resources sectors, announced in the second half of 2009. In Septembers Deutsche Telekom and France Telecom announced a joint venture between their UK operations T-Mobile and Orange; and in October Rio Tinto and BHP Billiton ditched merger plans in favour of a 50-50 iron ore joint venture.’  His article can be found here (although do note that access to that article is by subscription).

Cass Business School, through its M&A Research Centre (of which I’m the Director) recently completed what we understand to be the largest global study ever of joint ventures and strategic alliances.  Together with the sponsorship and support of the law firm Allen & Overy, investment bank Credit Suisse, accountancy and advisor Deloitte and the Financial Times / Mergermarket, the M&A Research Centre looked at over 122,000 deals over a 24-year period from January 1985 to May 2009.

The full report is entitled ‘Sharing Risk:  A Study of Corporate Alliances’ and can be ordered here.  Some of the key findings include:

  • Historically, joint venture activity is highest in the recovery period following a major economic downturn.  This is very significant, as we have (hopefully!) recently entered such a period and therefore, if history is any indication, should be seeing greater use of JVs over the next several quarters.  This increase is over 20% higher than average levels.
  • Joint venture deals reduce the participating company’s risk.  These firms see their beta decline by 3.9% as a result of the announced deals, and following a major crisis (such as we’ve recently had), the decrease is larger at 6.2%
  • Overall, joint venture deals create value for participants’ shareholders both in the short- and long-term.
  • Some joint ventures are listed companies themselves.  These do demonstrate year-on-year improvement in a number of financial factors, including return on equity over a five year period.
  • However, most JVs don’t last that long.  Contrary to conventional wisdom, the average JV lasts around three years.  Fortunately, when the termination of the venture is announced, the owners are rewarded with an improved stock market reaction.

We also noted some factors of note for companies considering such alliances.  For example, don’t do a JV with too close a competitor, look for a partner who is similar in size and consider a JV if you are entering a new geographic market.  JVs are an excellent precursor to an M&A deal, probably as an example of ‘dating before getting married’.

Details about all the above findings, as well as additional findings, are available in the full report.

Another view on the M&A Market in 2010 and 2011

On Thursday, 18 March, the Financial Times in a special section (‘Deals and Dealmakers’) had an article that I authored entitled:  ‘A tough challenge for M&A markets’.  In it, I argue that that a number of unavoidable behavioural factors are the principal impediments to a rising M&A market:  just as the growth of the market from 2004 to 2007 was driven by some of these factors, there will be a stickiness to the lack of M&A activity over the next year or two.  I’ve touched before on some of these behavioural factors (see ‘Mergers & Acquisitions and Behavioural Finance‘), but have expanded the discussion in the FT article to include additional factors such as optimism, over confidence, belief perseverance, data anchoring, bias towards recent events, and, of course, management hubris. 

I would very much like to see more debate over the role of behavioural finance in the mergers and acquistitions market, and would welcome further comments here.

‘Upside Risk’ in M&A

I saw a recent posting on the possibility of the stock markets having a ‘buyers’ panic’ as occurred in late summer 1982.  At that time, the market increased by 37% in less than two months, having started with an increase of almost 20% as institutional buyer kicked off the rally, which then had retail buyers coming in.  The posting on Seeking Alpha, entitled ‘Upside Risk Returns – Is Buyers’ Panic Next?‘, notes some interesting parallels with today’s markets, although the author is very clear to state that he doesn’t expect to see a similar market increase at this time.  But the possibility exists, and is worth noting.

I think there may be some parallels in the M&A market, although not necessarily with 1982 (which was not a particularly strong time for M&A … certainly in comparison with the developments and growth in the market that occurred later in the decade.  The issues to note are the pent-up demand for M&A deals from almost three years of slow activity.  Once the markets begin their upward path, will they break out rapidly?  Or, are the behavioural forces of inertia stronger (see my blog on ‘Mergers & Acquisitions and Behavioural Finance’).

In talking with people in the industry, they are quick to note that they have a large back-log of deals, the financing of M&A deals is now easier to obtain than any time in the past two and one-half years, there is a lot of financial sponsor (hedge fund, private equity fund, venture capital, etc) funding available and waiting to be invested and the M&A advisors at all points in the industry are hiring new employees (although these are often people who were made redundant two years ago when the M&A downturn was severe).  Thus, there could be a stampede to do deals if there’s a concensus that the markets will quickly increase and prices will be higher.  There may be a perception that there’s a very narrow window of opportunity.

More later…

Should you do an IPO or M&A deal now?

There has been a lot of discussion recently about whether the IPO markets have re-opened.  IPOs have been announced, but also many retracted as well (note the withdrawal on 10 February of Blackstone’s Travelport and, one day later, Merlin offerings, followed a few days later by Permira’s and Apax’s withdrawal of New Look).

Now, it hasn’t been the strongest market for M&A deals either, especially for deals requiring large amounts of debt.  And few financial sponsors (such as Blackstone, Permira and Apax) have been able to participate in that market recently either.

It was thus no surprise that one of the leading participants in the M&A and Corporate Finance markets, Marsh, would sponsor a breakfast briefing in the heart of one of London’s financial districts to discuss this topic.  On 10 February, they assembled a group of experts from the London Stock Exchange, a major law firm, one of the private equity firms (in fact it was Permira), and myself (as the academic and ‘independent’ commentator), all hosted by the editor of Private Equity News.  Close to 100 people were in attendance.

It was a fascinating morning, with some interesting and sometimes heated discussion about whether the IPO market would be open again soon.  Interesting especially as the Travelport withdrawal didn’t occur until later that day, but the discussion anticipated such withdrawals without being specific about which ones.

We discussed as well which companies in today’s market should look to go public and which should look for a trade sale (acquisition). It was my suggestion that ‘if the firm needs to be sold in order to inject fresh capital to bolster a weakened balance sheet or because its cash-strapped owners need to offload the asset, then an IPO would not be the best option. It would be better for them to seek a buyer for that firm.”

The markets for public offerings will reopen again, but it is likely to require a significant change in confidence of both the buyers (potential shareholders) and sellers.  It looks as if acquisitions may continue for a while as the preferred route.

The full report of the session is available here.

M&A market not doing as badly as you think

Where have all the mega-deals gone?  There’s certainly been a dearth of deals since year-end.  It’s been a long time since I’ve opened up the newpaper in the morning and seen any front-page headlines about a new deal.  In fact, it’s been more about cancelled deals (IPOs such as New Look, Travelport and Merlin) or more about last year’s deals (such as Kraft / Cadbury and their final agreement).

So it was encouraging to see a monthly briefing report by Regent Corporate Finance Services that talked of an increase in at least one section of the market, European technology, which fortunately also would tend to be a leading indicator of future volumes in other industries as technology is often one of the first in a new merger cycle (after the large cyclical businesses such as pharmaceuticals).

Here’s what Regent said:

‘Although there were few big acquisition deals in January 2010, the overall volume of transactions was up by 12% on the month before. More importantly for those companies seeking a sale in 2010, valuations have continued their steady rise as both the trade and private equity buyers are active in seeking growth or extensions to their portfolio. Acquisition valuations are once again close to their normal relationship with valuations on the public markets.’

It particularly nice to see the participation again of the financial sponsors such as the private equity firms … who have been missing from the market since mid-2007 but who had been so important to the growth of the last merger wave that started in 2004.

Let’s hope this pace continues and that the small- to medium-size market will kick-start the upper, and more public, M&A market as the year progresses.

M&A Volumes were up, but what’s happened?

Typically, the volume of deals in the first quarter of the year are higher than at other times of the year.  In fact, if you look at the largest deals since the mid-1990′s (all around $60 billion or more),over one-third of them were announced in January and almost half in the first quarter.  Obviously, we didn’t  hit the January figure this year, but could still be heading for the first quarter figure if markets settle a bit (perhaps the political interference this year has affected January).  Also, two-thirds of all these mega-deals were announced in the first half of the year. I’ve looked at the figures slightly differently (that is, all deals over £10 billion), and the figures aren’t quite as skewed, but still directionally the same.

The trend in the market had been up.  Intralinks produces an excellent report each quarter (‘Deal Flow Indicator‘) which looks at these trends.  They noted the strength of the market in the fourth quarter of 2009, driven largely by the following factors (taken with their permission verbatim from their fourth quarter report, issued in mid January):

  • Continued stability in the equity markets
    –– Dow Jones Industrial Average: Up 7% versus Q3 2009 and 16% for full-year 2009
    –– European Markets: DAX, FTSE and CAC up more than 5% versus Q3 2009 and more than 17% for the full-year 2009
    –– Asia-Pacific Markets: Hang Seng and Nikkei up more than 4% versus Q3 2009; Hang Seng up more than 40% for full-year 2009
    These gains in the equity markets have continued to help narrow the valuation gap that has existed between buyers and sellers and free capital sources globally.
  • Increased buying activity in Venture Capital/Private Equity-backed companies as a result of corporations’ stronger balance sheets and increasing cash reserves
  • Resurgence in financial sponsor activity
  • Thawing credit markets

But there are other factors involved as well, principally from the behavioural side that are holding back a strong resurgence.  More on this in another blog.

Mergers & Acquisitions and Behavioural Finance

I’ve not seen much discussion of the behavioural finance aspects of M&A, so it was refreshing to see this noted in a recent article in Q6, the publication in Fall 2009 of the Yale School of Management (full disclosure:  I am a graduate of the charter class of that school).

In that article entitled ‘What is behavioral?’, Professor of Finance Nicholas Barberis notes that M&A is one of the prime examples of one of the three ‘areas of behavioural finance’:  corporate finance, where he says ‘we’re trying to understand whether managers of firms do things that might be the result of less than fully rational thinking’.  [The italicised emphasis is mine.]   Mergers and acquisitions certainly are an excellent example of this, as they more often than not reduce shareholder (and other stakeholder) value, not increase it.

For your information, the other two areas of behavioural finance are related to asset pricing (that is, how stocks, houses and other assets are priced in the market) and investor behaviour (why people buy certain assets and not others).  Notably, all three of these areas of behavioural finance defy the logic of rational decision-making, not just M&A deals.

But it is the M&A deals that to me are most interesting, of course.  Why do managers insist on doing deals when the deals are not likely to be successful?  There have been numerous studies looking at the drivers to these deals.  One of my students at Cass Business School in a project for Mergermarket (the data providers and subsidiary of the FT Group / Pearson) has recently completed his dissertation looking at these drivers.  In alphabetical order, these drivers are:

  • Communication
  • Culture
  • Deal value
  • Due diligence
  • Financing of the deal (cash vs stock)
  • Frequency of acquisitions / Previous acquisition experience
  • Hubris of management
  • Organisational fit
  • Overpayment
  • Size of the acquirer (relative to the target)
  • Small vs large targets (absolute size of the target)
  • Speed of integration
  • Strategic fit
  • Timing of the acquisition (whether taking place in a bull or bear market, for example)
  • Type of acquisition (domestic vs cross border)
  • Role of leadership

Not all of these are behaviourally related, of course, but you can see that most are and even those that appear not to be (such as deal value or timing) have strong aspects to those factors that will impact behaviours.

Determining which are the most important behavioural factors definitely requires more research.  In my opinion, however, it would appear that (in agreement to many other observers) hubris and management ego / overconfidence is evident in just about every single deal — and no one will argue that this is a ‘behaviour’.  But other areas of behavioural finance also come to play, including the basic human nature of remembering the positive and discounting the negative (from earlier deals) and  believing that ‘this time is different’ and that history won’t repeat itself (which is particularly galling to an amateur historian such as me).

I very much like to see more work on this, would be particularly interested in hearing if there are any new studies on the linkages between behavioural finance and the drivers to M&A deals … or just some observations by any readers.

Symmetry of M&A in the last Decade (2000-2009)

The first decade of the new millennium is over.  Happy New Year everyone!  So along with so many other observers of the financial markets, I would like to comment on the past ten years.  Some of these comments have appeared elsewhere – and in fact from me as a number of publications have asked me about my thoughts on M&A in the ‘Noughties’ (including the Financial Times, Financial News, Reuters and Bloomberg).

Most telling I think is how much HASN’T changed:  I like the symmetry of the AOL / Time Warner deal:  10 days into the new year in 2000 the deal was announced and only 9 days into the last month of the decade the deal was unwound.

The new millennium started with the merger of the two companies (it was 10 January 2000 when Steve Case of AOL and Jerry Levin of Time Warner announced the deal) and, in late 2009 on 9 December and less than a month before the decade ended, the two companies finally split up again.  Other deals were bigger, other deals took place first (Vodaphone Mannesmann was a great kick start to the new millennium, wasn’t it).  But nothing bracketed the decade as the AOL Time Warner deal.

That particular merger was actually structured as a purchase of Time Warner by AOL.  Long ago, the AOL name was dropped.  Long ago did shareholders turn away from this deal.  At its peak, AOL had a market capitalisation of around £242 billion.  Now, it has a market value of $3 billion – a staggering loss in value of 98.8%.  It is now run by a former Google exec:  who would have thought a decade ago that a Google man would be running AOL?

That deal did mark the end of the hubris.  We’ll need a few more years to find out, but maybe the 2009 split-up marks the end of the restructuring of the markets and could (along with some other big deals of 2009) be taking place around the time of the resurgence in the M&A market.  That’s the symmetry that I like.

Worst Mergers or Acquisitions of all Time

With the year-end coming, there’s lots of talk about the good, the bad and the ugly aspects of not just the past year, but the first decade of the new millenium.  Naturally, this talk then moves to which deal was THE worst in either 2009 or the period from 2000 to 2009.

I’ve certainly discussed this topic before.  I’ve been quoted in national newspapers on the subject (see The Independent’s article entitled ‘Was ABN the worst takeover deal ever?‘).   It’s a difficult topic to avoid in academia (where I now sit) or amongst practitioners, whether active or retired, as I also am.  Certainly at business schools, much of the discussion is about failed deals and what we can learn from them:  in my own M&A course at Cass Business School, I include a number of case studies of failures (such as the classic of Quaker Oats’ acquisition of Snapple) or failures at consumating a deal (Sir Philip Green’s aborted attempt to take over Marks & Spencer, for example).

It was thus with great interest that I saw a survey of market participants recently in Here is the City entitled:  And The Worst Bank Merger Of All Time Is…. The top ten in that survey of 30 are:

1. Royal Bank of Scotland / ABN Amro

2. Bank of America / Merrill Lynch

3. Citibank / Travellers Group

4. Credit Suisse / DLJ

5. Fortis / ABN Amro

6. Wachovia / Golden West

7. Commerzbank / Dresdner Bank

8. General Electric / Kidder Peabody

9. Allianz / Dresdner Bank

10. Midland Bank / Crocker

It should be noted that Here is the City is followed largely in London by bankers and often is the first source for many readers of industry news and gossip.  Thus, the survey respondents — albeit 2,375 of them — are not a representative sample of anything other than a cross-section of such bankers.  And the London base of the readership does bias the survey results to UK and European deals:  I’m certain a more global survey wouldn’t have Midland / Crocker in the top ten and notice the lack of any Asian deals (shouldn’t Mitsubishi UFJ be in the top 30 somewhere?).

What is fascinating, I think, is that a ‘worst merger of all time’ list that extended beyond banking would still have many of these banking deals in the top ten.    Certainly the ABN AMRO deal of 2007 must be in the top three (although I’m not sure whether to include this as one deal or three, as Here is the City did, with the RBS and Fortis purchases of ABN AMRO being considered failures but not Santander’s part of that deal).  It may actually still be too early to determine if Bank of America’s purchase of Merrill Lynch is a failure (although it certainly looks that way and, if you use another criteria which is how long the CEO lasts after a major acquisition, then I’m sure Ken Lewis of BofA would think it a failure).  Likewise, I wonder if Citigroup would be where it is is the Travellers deal hadn’t taken place … and therefore the impact of that acquisition may be coloured by recent events but not again the long term.  Another consideration is certainly the opportunity costs:  what would the acquirer have been able to do with the purchase money if they hadn’t done the deal and what would management have been able to be doing strategically if they hadn’t been distracted or fired (see our other blog on Surviving Mergers).

In any case, of the strategic (not financial sponsor) deals that must be included, I would suggest the following in rough order:

1.  The Royal Bank of Scotland -led purchase of ABN AMRO

2.  AOL / Time Warner

3.  Daimler / Chrysler

4.  Quaker Oats / Snapple

5.  Invensys / Baan

Those five have to be in anyone’s list of the top 10, I’m sure.  But others?

By-the-way, if you do want to see some discussion of financial sponsor (private equity firms, venture capitalists, hedge funds, etc) deals that failed, the Wall Street Journal blog Deal Journal has started a discussion on this here.

Measuring M&A Deal Success

How do you measure M&A deal success?

This has certainly been the focus of many studies, whether in academia or amongst practitioners.  We’ve looked at it here on this blog (‘What is success in an M&A deal?‘) and also in our book (Intelligent M&A:  Navigating the mergers and acquisitions minefield).

It was thus with great interest that I read a study conducted by Mergermarket for Merrill Datasite that discussed this (amongst other topics) within their overall report entitled ‘Post Merger Integration:  The Key to Successful M&A‘.  That study surveyed over 100 corporate executives globally.

Most observers of the M&A markets use shareholder return as the measure of deal success:  it’s easy to determine and is easily understood.  Differences only exist in determining

  • a pre-deal starting point (do you use the share price the day before, one week before, a month before, etc in order to eliminate any impact of market leaks about the deal)
  • the end point (immediate reaction on the day of announcement, closing (which may be months away from deal announcement), 90 days after closing, one year later, etc)
  • which index to compare the share performance against (historical performance of the company itself, an industry index, an overall country index, etc).

The basic challenge is that it is difficult to isolate the impact of the deal when so much else is going on inside the firm and outside.

But if that’s what academics and analysts do, what do these internal senior executives use to determine success?  Interesting, of the five factors mentioned most frequently, share price performance was last!  Higher up the list (and in order of use) were 1) cash flow, 2) quality of new products / services, 3) expansion into new markets and 4) revenue of the newly-combined entity.

These factors do take time to determine — unlike share price performance, you don’t get an immediate, day-1 impact or result.

Thus timing is an issue and therefore there’s the question about what do these executives consider the correct time period within which to determine success?  Only 5% said 6 months or less (even though a period less than 6 months is often used in academia).  The largest group of executives — almost half at 46% — said one year after deal completion (which may be 15-18 months after the deal was announced) and another 38% said two years after completion.  The remainder (10%) said that the success could only be determined after more than two years.

Lastly, related to this is how often the senior management team meet to discuss the progress of the integration and therefore the on-going success.  Needless to say, they don’t wait long.  Almost two-thirds (64%) said this was done monthly after the deal completed.  Another 20% said weekly.  Thus, the senior management team IS frequently looking at success in terms of the factors above, checking the changes in cash flow, new product introductions, new market opportunities, revenue changes and, of course, share price.

So we now know how executives themselves determine deal success.  Why, then, do they continue to do these deals when the same survey showed that only 42% of these executives considered their acquisitions or mergers to be successful more than 50% of the time … which means that 58% considered most of their deals to be failures.  Looks like we need to hold executives to their own determinants of success more often.

2010 M&A Forecast

It’s December and the M&A market is mostly closed for the year.  This isn’t the month when many deals are done (although I would love to be surprised by a big announcement in the next several weeks, it would be a surprise!).  We’ve discussed this recently here, where we showed that it is rare for deals to be announced in the last quarter of the year.  Note by the way that this dearth of year-end announcements is related to the very large (mega-) deals, as smaller ones don’t show such an historical trend.

In any case, the focus is now on 2010.  Will it be better than 2009?  2008?

Of course, my crystal ball is as foggy as anyone’s.  However, ever willing to stick my head out, here goes:

First, despite an overall lack of European outbound M&A in 2009 (Financial News reported in mid-November that volume of such deals was its lowest since 2004), I believe the interest in globalisation hasn’t diminished in the board room, although the appetite to take on such risks has decreased.  Especially in Europe, it appears.  I believe as the new year starts and 2008 and 2009 are put behind us, the interest in growth will reappear including acquisition as a means of such growth.

Second, financial sponsors (hedge funds, private equity funds, venture capitalists) will return.  In the first nine months of 2009, only about 3% of global M&A volumes were from these groups — the lowest since 2000 and well down from the approximately 25% of 2007’s volume.  Of course, they helped drive the last merger wave that ended in 2007 (indeed, one-third of all deals in private equity’s 30-year history took place in 2006 and 2007).  Check out this report  from Private Equity News. Even a small increase in this percentage in overall terms could be a catalyst to the growth of M&A in 2010.  I may eat my words, but I don’t think it can go any lower what with the backlog of money to invest in the pipeline (it was reported that at the start of 2009, there.  It has to go somewhere, and the financial sponsors are very reticent to return it to their limited partners!

Third, the emerging markets remain of great interest.  China’s M&A market (again, according to Financial News) is up 6% on last year, which makes it one of the bright spots in the global M&A market.  Not just China, but other Asian markets will be places where firms need to expand.  I actually believe this trend may be the catalyst to the next merger wave when it appears — hopefully in 2010!

Fourth, and perhaps even most important, there’s optimism in board rooms.  We noted in an earlier blog (see:  ‘What Next in M&A‘ and the related research from Intralinks) that there’s an expectation now that more deals will be done next year by a majority of board-level executives interviewed.  This can be a self-fulfilling prophesy, as the M&A market rises and falls based on the willingness of boards to approve deals and their confidence (usually misplaced, by-the-way, even in rising markets) that the deals will increase profits, market share, shareholder returns, etc.

Now, what about the timing?  I hear from many advisors that the backlog isn’t great.  This would indicate that we won’t necessarily see an immediate increase in deal.  Offsetting this is another fact from talking to those advisors:  most are busier than they have been in a couple years.  Part of this busy-ness is due to the reduction in the size of the M&A teams in the past 18 months, but this doesn’t explain it all as even those teams not reduced (and yes, there ARE some around in the more forward-looking advisory firms) say they are working flat out.  I’ve been trying to meet up with one of them for the past several months and it was never was possible in evenings or even weekends, and we finally had to settle for a 7:30am breakfast earlier this week — at which I was informed that she hadn’t had more than 5 hours sleep in any day in the past three weeks.  Although probably not good for her personal health, it probably IS for the health of the advisor’s bottom line and the M&A market in general.

And let’s not forget as well that the debt markets are not fully open again for acquisition finance.  No one expects an era of easy financing to return anytime soon, but it does have to ease up somewhat for the market to return to anything like the volumes of a few years ago.

Anyone else with thoughts on the timing?

Where have all the M&A mega-deals gone?

I was asked the other day whether I thought that mega-deals have disappeared for a while, because not many have been announced recently.  The commentary on M&A in the press is still focussed on the Kraft / Cadbury / Hershey / etc deal that was announced back in September (here’s the original press statement from Kraft which valued Cadbury at £10.2 billion).

If you look at the past 20 years of super mega-deals (the top 20 deals of all time), you’ll find that the largest of these (which, by-the-way, all took place after 1997) do show some very strong seasonality.  From the deals in our database, we noted this:

  • Over one-third (35%) were announced in a January (including Pfizer / Wyeth in 2009, JP Morgan Chase / Bank One in 2004, Sanofi / Aventis also in 2004, Glaxo-Welcome / SmithKline Beecham in 2000 and Vodaphone / AirTouch in 1999)
  • Almost half (45%) were announced in the first quarter of the year.
  • Almost two-thirds (65%) were announced in the first half of the year.
  • Four-fifths (80%) were announced in the first three quarters (January to September) of the year.

Which leaves only one-fifth (20%) for the fourth quarter of the year, split pretty evenly across all three months of that quarter.

By the way, if you look at all of the announced mega-deals over $50 billion (there’s around 40 of these), the figures are very similar, although only around a quarter were announced in a January of the year and almost half in the first third of the year — still quite significant percentages;  the fourth quarter did still show only 20% of the announcements.

Of course, history is an unpredictable predictor of the present or future, but it does give us some useful guidance as there may be some interesting behavioural factors at work here.  Human nature, as we know, doesn’t change very much, which is why the study of history is so critical.

Perhaps even more than in other years recently, there is a risk aversion in the markets — including at the CEO- and board-levels where acquisition and merger decisions are made.  In most board rooms, the past six months have been better than was expected at the start of the year, and the recovery in the markets since March have reflected this as well (recent corrections notwithstanding).  With year-end approaching, no one wants to give this back.  One way to do this is to hunker down, consolidate the gains and wait to see if the recovery is sustained in the new year.  Thus, despite some relative bargains in the market (based on stock prices still being well below their peaks of 2007), the conservatives sitting in the board room are probably preferring to wait before making any bold moves — or are at least sitting tight until their major competitors make the first moves.

But as the figures above show, early in the year appears to be a good time to announce a pending large deal.  With almost half of these announcements being in the first quarter of the year, that’s not just chance.  Start of the year = fresh strategic start for the company.   Also, as most of these huge deals require external financing, there’s the likelihood that the deal will be closed before year-end and any bridge financing will be off the balance sheet at the all-important year-end when financial statements are published.

There must be other drivers at play here as well, and I’d be interested in hearing anyone else’s thoughts as to why these deals overwhelmingly are announced early in the year.  There’s also the question as to whether 2010 will repeat history and see some mega-deals announced.

M&A and Strategic Change

Dr Robert Davies, in his fascinating blog on strategy (see weblink at the bottom of this page in the blogroll or check it out here), has written an interesting article on what he sees as the eight major issues that will drive corporate strategy and behaviour over the next several years (see his blog: ‘2010 AND BEYOND: The real issues and trends‘).

These issues range from the drive toward localisation (and away from globalisation) to the increase in stress in society (and on individuals).  It certainly is worthwhile considering whether these will impact the M&A market if several of these actually do turn out to be correct.   Briefly, the eight issues are (in Robert’s very conversational and catchy style):

  • ISSUE #1: GOODBYE GLOBALISATION, HELLO LOCALISATION. There are too many forces pushing against globalisation for you to bet on the end of history and a harmonised world.  Even academics are divided upon the issue of the sustainability of a single global society. Remember too that we have not suffered a global recession, we are in the midst of a series of localised depressions, recessions, recoveries or in some cases, just mere slowdowns.
  • ISSUE #2: CHANGE COMES IN PHASES. Unlike some, I don’t see a simple ‘bounce back’. The real effects of the recession in terms of your markets and the behaviours of your customers will take between three to five years to appear. Understanding and monitoring four key phases of change must be a central task for any customer focused organisation.
  • ISSUE #3: FROM LUXURY TO SECURITY. FROM CONSUMERISM TO REPLETION. Customer needs (both in consumer and business markets) will change. How they change will largely be determined by the direction taken by globalisation. For some, purely Web based customer management strategies may prove problematic in at least one future new where new consumers seek more personal inter-action.
  • ISSUE #4: BIG BROTHER, MY FRIEND. Some large corporate brands have been tarnished – especially in the financial sector. There is some emerging evidence that new consumers may trust central government more than large corporates.
  • ISSUE #5: CSR – A NEW GENERIC STRATEGY? In the face of new regulation, many especially in financial services, will find it difficult to gain competitive advantage. Is corporate social responsibility the answer?
  • ISSUE #6: BACK TO THE PAST – THE FRUITS OF CREATIVE DESTRUCTION. Within all the doom and gloom there is the prospect of quite massive levels of innovation, bringing with it opportunity.  But you may have to move quickly. So, in what shape are you to innovate?
  • ISSUE #7: THE DEATH OF ‘WHAT WORKED BEFORE’. Be careful about extrapolating from the past. The datasets and variables have changed.
  • ISSUE#8: BEWARE OF STRESS. It’s going to take time to get through this. So are you taking care of your staff?

Now, what does this imply for those who are interested in M&A?  Could these issues be influencers on M&A generally?  (Actually, think about these as ‘trends’, which they areally are (aren’t they?), as most have already begun in some fashion and even have antecedents from years ago.

I’d be interested in the views of others, but first let me say that I agree with most of these issues — especially their application to the next several years.  On a longer-term basis, I do believe we’ll find ourselves largely back on the same trajectory that we’ve been for the past two or three decades and that the past 18 months won’t be considered quite the sea change that many other pundits believe.

Nevertheless, these issues will impact the M&A market.  Some positively:

  • Localisation means that there’s a greater need for local presence, which can be obtained by purchasing a local company already knowledgeable about the local markets and recognisable to the people there.
  • Creative destruction will drive the purchase of distressed and bankrupt (or insolvent) companies.  (See as well the M&A discussion of distressed deals.)
  • It may be easier to have an appreciated impact on CSR issues if the organisation is large and able to afford high-impact, high-cost CSR programmes.  How do companies get scale?  They go out and buy another company…

But others negatively, such as the ‘big brother’ trend of increased trust in governments which implies lower trust in corporations, especially the largest ones.  (But the flip side of this may be increased M&A activity as companies downsize and refocus back to the core, thus divesting divisions:  one company’s sale is another company’s acquisition!).

We’ve discussed before the need to incorporate appropriate business intelligence into the M&A process, which otherwise often seems opportunistic at best and ‘me-too’ at worst.  These trends discussed by Robert in his blog should be used by all M&A corporate development teams and their advisors in stress-testing their proposed mergers and acquisitions.  (See our writings on scenario planning as well.)

Your thoughts?

What next in M&A?

An excellent study was issued by IntraLinks and mergermarket a few weeks ago.  (You can find it here.) In August and September, they conducted a survey of experts in M&A – the people within each company responsible for deals.  The key finding:  almost two-thirds of those surveyed thought that the overall economic environment in their own regions would improve in 2010 (which is in distinct contrast to the economist, politician and journalist Cassandras who feel that we’re in for a double dip or even worse in 2010 and beyond).  Interestingly, 16% felt that this recovery was already underway and 8% that it would happen before year-end.  And in Europe, over 40% of respondents felt that corporate M&A would increase in the next year (and only 12% were pessimistic).

This is a significant finding, because the M&A market is driven at the corporate board and senior exec level by optimism (I would almost prefer to say ‘hubris’) and general business confidence.  The perception of an improving market is critical to the market’s turnaround prospects.

But caution amongst those surveyed is also noted in the study:  when asked about their own company’s activity, only about a third were optimistic or very optimistic.  (Yet only 20% were pessimistic and most (44%) were neutral.)  This is a valid cause for concern.  This would indicate that firms are reticent to commit their own money toward committed rapid expansion – and an M&A deal IS the way for a major existing firm to expand rapidly, even if most deals fail in the execution – despite those firms seeing the general business environment improving.

It was nice to see that 75% agree with me that the M&A market has already reached its inflexion point (see ‘M&A inflexion point: The turn to ‘up’ in activitywhich we published back in late September).

We’ve noted before on this site back in the summer (see ‘Distressed and bankrupt acquisitions: Should you do one of these deals?‘) that distressed acquisitions would be a major driver for some time to come.  This Intralinks / mergermarket survey confirmed that, as almost half of all respondents in Europe felt that distressed deals were the principal driver to the market for the next year (followed by 31% looking at market consolidation as the principal driver).  The overhang from the recession will still take a while to work through the M&A system, which is a wonderful mechanism to assist industry in self-correcting.

What are firms most expecting to do?  When respondents looked at what they would do in their own companies, they still feel that their M&A activity will be driven by finding undervalued targets (over 50% thought this).  If this is true, the growth in M&A activity might be faster, as a continuing stock market rise would make fewer such undervalued targets around.  Nicely, two-thirds of the companies DID expect to make an acquisition in the next 12 months.  Given the lead time to many of these strategic deals, the planning and even negotiations may be underway already.  This is support for the strong backlog of deals that many advisors note.

Overall corporate organisational restructurings were expected by 73% of respondents, and by a whopping 81% of those in Europe.  Europe really does appear to be the region that is pulling out of the recession with the greatest difficulties remaining.

I found most interesting the thoughts about which industries would see more consolidation, at least according to this survey.  There’s so much conjecture about where the next big deals will come, and each observer seems to have different feelings.  It’s nice to see a survey taking in the opinion of many experts, as this IntraLinks / mergermarket survey is.  Contrary to my own personal view, financial services was seen in Asia/Pacific and North America as being the most likely industry to see deal activity.  In Europe, the consumer area was suggested to be the most active.  Notably, pharmaceuticals, industrials & chemicals, the extractive industries and the technology industries that saw huge deals in 2009 were not in the top list.

Where next in M&A? Who will be targeted now?

According to Reuters a few months back on 10 September 2009 (‘Deal Talk — Rallying stock markets help accelerate M&A plans’), a report by Natixis predicts a higher incidence of M&A in sectors including pharmaceuticals, luxury goods, transport, IT software and oil services.  It said International Business Machines Corp could pursue SAP and lists AstraZeneca and Whitbread  among potential takeover targets.  It’s always fun to look at these predictions several months later.

It’s a dangerous game trying to predict specific deals.  I have seen a list of potential targets put together in the past and a year later they make fun reading for all their errors.  Note some recent predictions by Barron’s / Wall Street Journal, consultants such as KPMG and other journalists such as Money Morning.

Conventional wisdom seems to be that the pharmaceutical industry has played out earlier this year … at least for a while.  Likewise in financial services, barring any further credit crises!  (And in fact this industry will see some of the larger, bailed out firms restructuring and selling off large divisions, which may make the acquisition volumes in this sector appear large for a while yet;  but I don’t see any large mergers happening soon.)

So where’s the activity?  Rather than industry, look at regions.  The sub-continent and Asia will continue to be strong.  The US before Europe, as Europe seems to be lagging in the face of slower economic recovery.

On industries?  How about consumer products – driven by changes in consumer behaviour from pre-recession as they leave behind the higher-priced goods and look for low price linked with quality.  Professional services, with Tower Perrin and Watson Wyatt being a harbinger of things to come (although they currently stand alone in that sector so haven’t yet started the stampede toward consolidation that I predict will happen).

Any other thoughts?  Please help me here, as I know that my crystal ball is very foggy at the moment…

M&A Valuation: The truth

M&A valuation is simple. Yet it often appears to be, in the words of Winston Churchill, ‘a riddle wrapped in a mystery inside an enigma…’

For the maths, all you need to be able to do is add, subtract, multiple and divide.  Oh, and to punch in some numbers to a relatively simple financial calculator that can do net present value (and therefore, if you were to do this the old fashion way, you would need to know how to take numbers to the power of).

But in most deals, this isn’t even needed.  What you do need is some research about recent deals, just as you would do if you were to sell your house.  If another house or two have sold recently on your street, then you should know a general price to sell your house – adjusted, if you can, for the number of bedrooms and bathrooms that your house has versus those other houses that sold.  And asking prices don’t matter:  what is critical is the actual price that was agreed.

You do need to know if there are also any significant changes in the market since those sales, or if you will be offering anything different (such as seller financing).  The deal terms will affect the price:  will you swap houses with the seller (similar in business to a stock offer) or will it be a cash transaction.

Your real estate agent will help you to do this pricing.  You probably buy and sell a house just a handful of times in a lifetime, but the estate agent will (in a good market) sell many houses in a month.  They will have a sixth sense about the market that no amateur could have.  Likewise the investment banker advising on a deal where the managing director will have done hundreds of deals by the time they reach the level where they are the trusted advisor to a company doing a merger or acquisition.  They will know best which other deals do look most similar to yours.

It therefore is somewhat a ‘mystery’, even if not complex.  ‘Art more than science’ as I explain in the chapter on valuation in the book Intelligent M&A:  Navigating the mergers and acquisitions minefield.

Aside from the aforementioned need to look at comparable deals and to consider the ‘art’ aspect of pricing, what else is important when pricing a public deal:

  1. Looking at the valuation from several different perspectives.  Although recent deals successfully conducted by similar companies in the same industry as yours will set the general level for your deal, usually boards of directors and shareholders require more than this to feel confident approving the deal.  Therefore, once the price has been agreed, it will be justified with other valuations (as many as possible) using other methods such as net present value (usually based on cash flows).  Of course, these other methods require a large number of assumptions (which cost of capital to use, which discount rate, etc), so again is actually more art than science.
  2. No two valuations will ever be the same if done by different firms, even if they are using the same base information.  This is because they will use different assumptions (see above) and weight the answers differently.
  3. There are two sides to every deal.  Each side will have created their own valuation, and you can be certain the seller will have a figure in mind which is higher than the buyer.  This leads to the next point.
  4. The final figure agreed is a result of the negotiation between the two (or more) parties.  The level of negotiating experience and the negotiating strength of each party (e.g., is either one being forced into the deal, or can they walk away if they wish).
  5. There will be several anchor points to the valuation.  The most important is the actual market capitalisation of the target company on the day the negotiations begins (sometimes this is structured as a price which is the average closing value of, say, the previous five or ten trading days).    The second is the 52-week high for the target company, as this is an easier sell for the target if the offer price is at a premium to any price in the previous year.  Both figures are anchor points only, and will have differing levels of importance if the market is declining or advancing during the negotiations.

Leave the very complex maths to the equity derivative traders and the designers of structured products — and for the back-up and support once the number’s been agreed (and you WILL need to justify the number for the board, shareholders and others).  M&A valuation is much more fun than that and can be done on a simple Excel spreadsheet.

YouTube Video: M&A Deal successes and failures

On 8 October 2009, I was interviewed about why merger and acquisition deals fail or succeed.  Together with several other experts in the industry (including Paul Schiavone of Zurich Financial), the conversation is now available on YouTube here: M&A – successes and failures.  This clip is actually one of eight that are available on YouTube (‘M&A: What lessons have we learnt from the boom and bust?‘ and click on the M&A Directors Forum on the right-hand side of the page), if you want to see the entire conversation including discussions of M&A risks (especially a discussion about risks to directors and officers of the merging companies) and some forecasts about the M&A industry.

Is there a link between the arrival of a new CEO and M&A deals?

A significant driver to M&A activity is the relatively short tenure of CEOs as chief executive.

At the M&A Research Centre at Cass Business School, we have been looking at the link between CEO changes and M&A deals, whether acquisitions or divestitures.  We aren’t ready yet with the final analysis (being part of a highly rated business school does mean that we have standards of research that exceed many others and therefore needs appropriate review before being released).  But as a teaser, we have found in the preliminary research that the typical CEO doing a big deal announces his first major acquisition in well under a year and, interestingly, that announcement usually precedes the announcement of his or her first big divestiture.  I certainly found it interesting that the CEO embarks on the first steps of his or her new vision before starting to unwind the previous CEO’s organisation!

Stay tuned here, as we expect to have these results soon.

What’s happening to bid premiums?

A strange thing is happening to bid premiums, at least here in Europe.  They’re dropping.  Or is this strange?  Should we have expected it?

The facts, first:

  • According to Financial News Online (you can see the story here if you have a subscription, and apologies to those who don’t, as it is a subscription-only website) and based on information they used from Dealogic, the average bid premium in the Third Quarter 2009 was only 17.5%, down from 20.8% in the Second Quarter and 26.9% in the First Quarter 2009.  Last year’s Q3 premium was 27.0%.
  • Globally (and including these figures for Europe), the bid premium for the Third Quarter 2009 was higher than the European average, and came in at 23.5%, which was slightly higher than the 22.8% of the Second Quarter 2009, but well down on the 30.3% premium of the First Quarter.

What’s happening here?  The Financial News Online article quoted an analyst at UBS with an explanation that buyer and seller valuations were converging, and thus the lower premiums.  However, this can’t really explain the low premiums, as then we would expect these levels (high teens to low twenties) when the markets are more predictable and everyone — or almost everyone — seems to agree on the direction of the market.  But we don’t see these low levels typically.

I’ve discussed bid premiums before here in this blog (at a time when bid premiums were increasing) and in both my recently published books (Intelligent M&A:  Navigating the Mergers and Acquisitions Minefield and to a lesser degree in Surviving M&A:  How to make the most of your company being acquired).  A large number of studies have shown remarkable consistency in bid premiums over the past thirty years.  Premiums do average within a relatively narrow range from 20% to 40%, but are usually fairly tightly banded around the mid-point of 30%, although the last several years have been in the 28-30% range globally.  As there was some consistency as well in equity valuations during the past 30 years (usually, but not always, of course), if the UBS analyst’s explanation was correct, we should usually be seeing average bid premiums in the high teens to low 20’s.  But we don’t.

What I rather think is happening here is that we have the ‘52 week high’ problem.  What’s this?  One figure that is very often used by boards, senior execs and advisors alike in determining a value for a target is the 52 week high in the share price.  Why?  Because if the offer is higher than the 52-week high (or close to it), then the board can recommend to the shareholders that it is a fair valuation.  This even if the share price is recently rising, but is even more the case if there’s been a decline but management have been saying the decline is temporary.  This recommendation is tough to make if the offer price is below the 52-week high because some (and maybe the most voiciferous) shareholders may consider the bid a ’sell-out’.

With share prices so low in late 2008 and 2009, it’s easy to exceed the 52 week high with an offer these days.  Also, with a large number of economists and market analysts still predicting a second decline in the market (the second half of the so-called ‘W’ economy), it is not hard to agree a smaller premium over the 52 week high if you think it might go down again.  Also, in today’s market, the 52-week high is probably yesterday’s closing price!

Will this decline in average premiums continue?  I think not, as the market has not so fundamentally changed that we shouldn’t expect it to be much different than the long-term trend.

Now, one further question remains:  Why are premiums so much lower in Europe?  The simple answer may be the smaller number of deals and therefore a less reliable average in this very slow market for M&A deals.  Perhaps as well the lack of financial buyers to raise bid premiums and there’s also the general lack of debt in the market to finance these bids (although these are global issues as well).  But is there something else going on?

Hostile M&A Deals: The trends

There’s been a lot of attention on hostile M&A deals since Kraft launched its unsolicited bid for Cadbury last month (September).  Nothing quite like chocolate to make the headlines — in fact so much so, that several journalists I’ve spoken to recently have said that they are completely tired of writing about that deal.

Because it was an unsolicited offer — bordering on being a hostile deal (which will ultimately depend on what develops) — I’ve been asked about whether this is a harbinger of things to come:  that is, will there be lots more hostile deals as the market recovers and what’s really been happening to hostile deals recently anyway.

Here’s the facts:

  1. Hostile (including unsolicited deals) are uncommon, despite the headlines they cause as they are, by their very nature, much more newsworthy than friendly deals.  Think back to Microsoft / Yahoo and all the column inches in newspapers that deal had!  In fact, these deals represent only 1.01% of all deals announced so far this year (that’s less than 80 deals year-to-date), which isn’t far off the average of the prior three years of 1.04%.
  2. If we annualise the number of deals to date in 2009, we get only about 100 for the full year — again on average with the prior three years which included some good years and one very poor one.  Still, 2008 had 127 hostile / unsolicited deal announcements, which was a recent high.
  3. Most of these deals never get to completion:  approximately 60% get withdrawn, and unsurprisingly last year was a recent high with 63% being withdrawn — most likely because of the market turmoil in the fourth quarter which is usually a very busy quarter for M&A deals.
  4. Despite all of the hype around the Kraft / Cadbury deal, it actually isn’t one of the largest.  If we look back over the past four years, the biggest hostile / unsolicited deals were (1) BHP Billiton with an offer of $188 billion for Rio Tinto, (2) RBS (together with Santander and Fortis) at $98 billion for ABN AMRO, (3) E on’s $82 billion bid for Endessa, (4) France Telecom’s offer of $47 billion for TeliaSonera and (5) Xstrada’s bid for Anglo American of $43 billion.  Then came Microsoft’s bid of $42 billion for Yahoo, so that one didn’t even make the top 5;  the Kraft / Cadbury offer is way down at 16.  By-the-way, of those top six bids, only one was ultimately completed and, as I said on Reuters TV yesterday, I am sure that Sir Fred Goodwin wishes he had withdrawn his bid as all the others did.

So what’s likely to happen now?  My view is that hostile bids (or at least unsolicited bids) will continue at this relatively low pace.  No big surprises there but still some interesting stories because hostility always makes for a nice headline.   But there just won’t be too many of them.  CEOs and boards seem to know (intuitively?) that these types of offers just have too many ways to fail.  Which is why, of course, most get withdrawn and why most take place in non-people businesses such as metal, mining and other extractive industries and in technology and industrials where assets are purchased, not so much the employees or management.

Then again, many of these offers may have been made with the full expectation that they would be rejected.  Making an offer can be a strategic signal to the market or even a way to destabilise a competitor.  But care must be taken, because the bidder can be affected in a bad way too.