Despite the uncertainty in global markets, M&A made a comeback in 2011 from its Great Recession low two years earlier. Now, as the market rebounds, both strategic and financial buyers are eyeing ways to turn piles of cash idled by the economic downturn into profitable growth.
But given the well-documented list of failed deals, should M&A be a preferred growth strategy?
The consensus from a host of studies focused on M&A during the 1990s and before would seem to be no. Using a variety of quantitative approaches, these analyses have pegged the merger failure rate as high as 70 percent and, in some cases, even 90 percent. Yet despite clear evidence that M&A deals had destroyed value more often than not, corporations and private equity firms pursued a steadily rising number of them from 2002 through the record-breaking year of 2007, before the economic downturn.
|Could these seasoned acquirers have been wrong? Far from reckless, these management teams were on to something. In fact, Accenture research on deals from 2002 through 2009 (research that also takes into account the financial implications of those deals through 2011) shows that 58 percent of all mergers and acquisitions during that period did, in fact, create value (see chart). That value was attributable, we believe, to a variety of factors (see Sidebar 1).
And that’s not the only myth our analyses debunked. A number of other commonly held beliefs about mergers and acquisitions are also showing signs of strain.
Indeed, our research indicates that companies can create substantial amounts of shareholder value in any industry or region at any point in the economic cycle and using various financing options.
Myth: Timing is everything
While a deal’s timing can be vitally important, our findings demonstrate that M&A success is nonetheless possible for top-quartile performers—and even median performers in most industries—at any point in the macroeconomic cycle. We saw examples of success in the most recent economic cycle’s trough as well as during its peak. We also discovered examples of deals that destroyed value at the cycle’s top and bottom.
It also turns out that M&A success does not correlate strongly with the movement of the stock market in general. In essence, savvy acquirers can create outstanding value at virtually any time, anywhere.
Myth: The industry doesn’t matter
If M&A key success factors can be applied across different industries, then the industry itself shouldn’t matter, right? Wrong. Whether or not an industry is poised for growth turns out to be very germane to its ability to create value from M&A.
|Our research shows a wide range of value-creation potential across industries, from a median total return to shareholders of 25 percent for deals in banking and capital markets to a discouraging negative 23 percent in retail and services (see chart). While the competitive dynamics in the two sectors may seem superficially similar—both have bricks-and-mortar branches, both are moving to Web-based interactions with their customers—the pertinent factor that may explain why banks succeeded in creating value while retailers didn’t could be their outlook toward growth.
Bankers relentlessly acquired and consolidated from 2002 to 2009, generating more M&A volume than any other industry as consumers across the globe valued established banking brands (the financial crisis that broke out in 2008 does not appear to have significantly accelerated consolidation in the industry). Cross-border deals, such as the Royal Bank of Canada’s acquisition of RBTT Financial Group and Vienna-based Erste Group Bank’s acquisition of a substantial stake in Banca Comerciala Romana, were particularly successful in bringing trusted, stable brands and global capabilities to consumers in emerging economies.
Retailers, on the other hand, thought small and looked inward. Leading players have suffered well-documented challenges in trying to move into new markets to capture growth. As a result, from 2002 to 2009, there were no acquisitions in the emerging-markets retail sector by developed-economy acquirers among the 500 largest deals.
Industry is also important in the sense that less concentrated industries tend to create more value from M&A than more heavily concentrated industries, as measured by the Herfindahl–Hirschman Index. Our findings show this relationship is fairly loose—after all, banking and retail are both relatively fragmented. But it’s possible that we would have found more evidence of this trend if we hadn’t confined our research to the 500 largest deals.
As earlier researchers have reported, less concentrated industries offer prospective acquirers a target-rich environment where they can find and acquire smaller best-fit companies that meet their exact screening criteria—an advantage that’s somewhat blunted if the acquirer is determined to do a very large deal. Further, earlier researchers have reported that less-concentrated industries tend to be less mature and less regulated than more concentrated industries, making change easier to enact during a deal’s critical merger integration phase.
Myth: Size matters
The bigger the deal, the bigger the return. In fact, usually just the opposite is true: Smaller deals actually do better than larger ones. That’s probably because smaller deals minimize a variety of risks, such as building executive and board alignment regarding the deal, or maintaining the secrecy that keeps other potential suitors in the dark. Smaller deals also typically make it easier to conduct effective due diligence and mobilize the resources required for governing complex merger integration efforts.
|The largest deals could also represent a significant shift away from a company’s core business and strategy and as such present higher risks. Simply put, an ambitious M&A effort can distract and drain the resources of even the biggest and most capable acquirers. Even within our data set of deals greater than $2 billion, we found that deals of less than $20 billion performed significantly better than larger ones (see chart).
It is true that even among the largest deals, top-quartile performers still created value—although just barely, producing few wins big enough to justify the effort and risk. Admittedly, just over 30 of the deals exceeded $20 billion, so our observed sample is small; nevertheless, the fall-off in performance was noticeable.
Smaller is also better when it comes to the size of the acquirer. Our research confirms earlier studies showing that M&A success favors smaller acquirers. Indeed, we found that M&A deals by large-cap buyers—companies with more than $100 billion in market capitalization—actually destroyed value during a period when value creation was the norm.
Some observers have argued that large companies perform poorly in M&A compared with smaller counterparts because they lack the nimbleness and focus required to make the right acquisitions or to integrate them successfully. Large acquirers are also thought to suffer disproportionately from misaligned executive incentives, since their management team compensation is often based largely on growth (which includes growth through acquisitions).
Despite the advent of more transparent corporate governance, the prevalence of dedicated in-house M&A teams, and the promulgation of M&A key success factors by business school professors and consultants (see Sidebar 3), it appears that large acquirers still create value from M&A less dependably than their smaller counterparts.
In fairness, it should be noted that large-cap acquirers accounted for a disproportionately large share of big deals—greater than $20 billion—and that such deals can be exceptionally challenging when it comes to creating value.
Myth: All strategic objectives for M&A are equal
Our research suggests that a clear focus on growth leads to success in M&A. And while it’s true that companies can add value through M&A at any point in the economic cycle, the best chance of creating shareholder value occurs when leaders act during the ride up to the peak of a bull market, not when the market is falling into the trough or during the early phases of an economic recovery.
|By far the best years for making value-creating acquisitions relative to an industry index were the “climbing” years of 2003–2005, when the average TRS of our data set of acquirers exceeded that year’s return on their respective S&P industry indices by at least 13 percent (see chart).
We can speculate about why these were such wildly successful years for creating shareholder value through M&A. They were the key bubble economy years, characterized by inflated demand and cheaper than normal credit. In such an environment, a company’s chances of market success can increase exponentially.
Also, during these years, underlying energy and commodity prices were relatively low compared with the peaks experienced later in 2007 and 2008. Cheaper energy and raw materials mean lower costs and blacker bottom lines, which can help turn even questionable investments positive.
Conversely, the worst times for M&A value creation were the slow recovery year of 2009 and the peak of the macroeconomic cycle in 2007, when the average TRS of large acquisitions announced in those years dipped to less than negative 5 percent. In fact, we found the three industries that destroyed value from M&A from 2002 to 2009 (retail, energy, and infrastructure and transportation) all suffered from large, poorly timed deals at the peak of the cycle in 2007.
In the infrastructure and transportation industry, for example, one multibillion-dollar merger in the United Kingdom was disastrous for shareholders, since it represented a doubling down on the country’s residential housing market at the very height of the housing bubble. In the Australian retail and services sector, one major acquisition was similarly poorly timed at the macroeconomic peak in 2007. It consolidated the country’s leading home improvement retailers just as both consumer spending and housing values were set to plummet.
Finally, in the energy sector, several deals made by US acquirers to capitalize on skyrocketing oil prices in 2007 figured prominently in the industry’s overall record of value destruction from M&A.
Myth: It’s still a developed-markets game
Even in subpar years like 2007, top-quartile performers still managed to create value. But why was M&A performance in the mild recovery year of 2002 worse than in 2008, the epicenter of the Great Recession?
To be sure, management teams are simply getting better at creating value from M&A (see Sidebar 2). But another reason could be the increasing participation of emerging-market players. In fact, the practice of buying into the growth potential and low-cost nature of emerging markets had become a significant trend by 2008, which helped boost acquirer TRS performance. Geographically, the most successful deals occurred when the target company was in an emerging market, regardless of where the acquirer was based, reinforcing the importance of emerging markets as drivers of global growth.
Deals focused on emerging markets made up 15 percent of our data set, with most occurring during the latter years of the period under study. Furthermore, an interesting combination of lowest average deal size and highest TRS emerged when developed-market companies made acquisitions in emerging markets.
Emerging markets clearly enjoyed strong overall macroeconomic growth during the study period, which may have contributed to this success. Another possibility is that the market rewarded company expansion into high-growth markets and that acquiring firms created additional value through the transfer of capabilities and governance.
Conversely, the deals that stayed within developed economies had a higher average deal size but the lowest median TRS—evidence that these deals cost the most while delivering the least (but still positive) benefit. This could reflect lower growth expectations for developed economies and perhaps a greater sophistication of financial markets, which could be factoring acquisition targets into a company’s stock price far ahead of deal announcements.
|Finally, we discovered that emerging-market players struggle to create value from acquisitions in developed markets. This shortfall could result from governance challenges, a lack of familiarity with marketing and distribution channels, the different regulatory requirements companies face when operating in developed markets—or all of the above (see chart).
Myth: Cash is king
Cash or equity? Contrary to results reported elsewhere in M&A literature, we found that when it comes to M&A success, it doesn’t appear to matter (see chart).
A number of prior studies found that within four days of a deal’s announcement, the market tended to reward those using cash more than those using equity, due mainly to the positive signals sent by financing a deal with cash. However, we found that at the 24-month point that we used in our analysis, the so-called “signaling value” of cash has eroded entirely and has been replaced as an indicator of the deal’s value-creation potential by actual results—the synergies achieved, products launched and talent retained.
In fact, according to our findings, cash deals do not outperform equity-financed deals. The average TRS of cash deals versus the industry index was 6 percent compared with 9 percent for deals financed all or in part by equity, giving equity-financed acquisitions a slight edge—a surprising finding, especially since equity financing prevails in deals greater than $20 billion, which are also more difficult from the perspective of shareholder value creation.
Furthermore, the average price for equity-financed deals is significantly higher than for cash acquisitions, despite similar TRS results, and they occur less than half as often as cash deals. If there is any signaling value, it would appear to derive from equity-financed deals.
Historically, acquirers may have been keen to use equity to finance a deal when they’ve believed their equity was overvalued. But during the last decade, they’ve come to realize that equity is often more dear than cash in an era of plentiful and cheap credit. Far from regarding cash as a signal that the deal was a good one for the acquirer, the use of scarcer and more valuable equity should perhaps be viewed as the acquirer’s ultimate vote of confidence in a deal’s value-creating potential. In fact, we found that companies place a high value on their equity positions and as such use them only to finance larger deals in which they have greater confidence of success.
Myth: The S&P 500 drives deal value
Overall annual movements in the S&P 500 do not appear to affect M&A success rates. The year with the highest overall surge in the S&P 500—2009—was the third-worst year in our survey for acquisitions announced that ultimately created healthy TRS.
On the other hand, it’s clear that M&A success strongly matches the macroeconomic cycle as measured by GDP. For example, the best M&A performances took place from 2003 through 2005, a period characterized by rising GDP as the global economy approached its peak. Likewise, the worst value-creation years occurred in 2002 and 2009, and were characterized either by falling GDP or the weak early stages of an economic recovery.
Ultimately, M&A activity is a bet on growth. It makes sense that real growth as measured by global GDP will be a much better predictor of the median performance of deals consummated in a given year than would a secondary indicator like equity growth within the S&P 500. _____________________________________________________________
As the global M&A landscape continues to change, companies need to revise some of their assumptions about the likelihood of success and how to achieve it. Many of these assumptions may have once been valid. It remains unclear, however, whether the M&A success rates of the past 10 years will predict future dynamics or if this period benefited from a unique set of circumstances. It was, after all, an era of extensive globalization and high returns in emerging markets; productivity improvements driven by digital technology and communications; and cheap, widely available credit. Our research provides a new sounding board for leaders tempted to test the M&A waters, enabling them to move more confidently and with greater chances of success.
Sidebar 1 | About the research
We examined the 500 largest M&A deals made worldwide by publicly traded acquirers between 2002 and September 2009—and then looked at their financial performance two years after the deal was announced, through September 2011. We used total return to shareholders (TRS)—a stock’s net change in value over a period of time, including dividends—relative to a Standard & Poor’s industry index as our measure of M&A success. While we recognize that no single right way exists to measure performance, TRS provides an objective, quantifiable street-level view of a deal’s success.
We measured the acquiring company’s TRS relative to its industry index 24 months after the deal’s announcement date. This enabled us to capture the impact of integrating the target and the longer-term benefits of the acquisition. We deemed this method superior in terms of real-world impact to such alternatives as simply measuring the market’s initial perspective of the deal’s promise based on short-term share price movements.
We recognize that many factors can influence a company’s share price performance relative to its industry peers over 24 months. However, for large M&A deals, Accenture’s experience is that the progress and results of the integration program are by far the largest drivers of TRS performance.
We chose 24 months because Accenture’s experience indicates that even the largest acquisitions should take no longer than that to integrate. Also, research shows that the market tends not to value synergies captured after the second year of a deal.
Examining deals announced from 2002 to September 2009 enabled us to review a complete trough-to-peak-to-trough macroeconomic cycle. Our starting point was the minor recession that ended in 2002, while our end point was the Great Recession’s trough in 2009. Since we measure a deal’s success based on its TRS 24 months after announcement, deals announced later than September 2009 would not have met the 24 months’ criteria at the time this study was published.
Our analysis was limited to this roughly seven-year period to capture the M&A performance of today’s globalized world and today’s experienced practitioners. We also wanted to select a period for which the effects of new technologies, such as personal productivity tools and smartphones, were already well established. In other words, we didn’t want the increasingly wide adoption of mobile phones or the Internet in the late 1990s to potentially bias measuring and explaining the historical improvements in M&A success rates.
Finally, we chose only the top 500 deals for this study because these types of transactions carry the highest “bet the company” risk for acquirers and the careers of their executives. Only deals of this size are large and comprehensive enough and affect the acquirer’s overall fortunes enough to be understood from long-term TRS analysis. (Back to story.)
Sidebar 2 | What’s behind the better odds?
We hypothesize that M&A success rates—from the 10 percent to 30 percent success rates in the past to the 58 percent success rate we found for the 2002–2009 period—are rising for several reasons (see Sidebar 3).
First, the increased presence of more engaged boards may be forcing acquiring firms to do their homework more thoroughly and to report back on success using tested quantitative measures. Second, unique circumstances that occurred during the 2002–2009 period, such as China’s rapid rise or the bubble economy, could have tipped results in a positive direction.
And third, leading acquirers are paying greater heed to the lists of M&A integration success factors propagated by top business school professors and management consulting firms. They are involving business-unit leaders early in the process to screen and profile the right targets and to identify upfront a deal’s potential to create value or synergy. These leaders are testing their hypotheses explicitly during due diligence, and implementing key merger integration success factors (see chart). They are treating M&A as a holistic process more often, appointing a single “end-to-end” owner of the outcome who is supported by process experts along the way. Doing so enables them to avoid inefficient handoffs of ownership and information between the different phases of the M&A lifecycle. (Back to story.)
Sidebar 3 | Key M&A success factors
Accenture’s “Inside Corporate M&A: The Formula of the Fittest” highlights three core and three enabling M&A success factors:
- Strategy management: Have a strong rationale for making an acquisition as well as the right methods for screening potential targets.
- Transaction management: Reduce risk by conducting the right valuation, due diligence and negotiation while minimizing handoffs and information loss between these activities.
- Integration management: Mobilize and focus the organization on planning and executing on the deal’s strategic rationale.
The three enabling processes are:
- M&A governance: Make the right decisions using the right people at the right time.
- M&A performance management: Measure success correctly, both in leading and lagging indicators, and reward performance based on them.
- M&A knowledge management: Leverage and apply lessons from past deals.
Acquirers that create value treat M&A as a holistic process, recognizing they must seamlessly connect several important capabilities (i.e., target screening, valuation, due diligence, negotiation, integration management, KPIs and rewards). They also recognize that practice makes perfect, capturing and reapplying their knowledge from one deal to the next.
(Back to story.)
About the authors
Thomas J. Herd is the managing director of Accenture’s North America Mergers & Acquisitions group. He has 15 years of consulting experience in industries such as energy, chemicals, metals, forest products, government, life sciences and consumer products, and he has assisted with more than 35 M&A engagements. Mr. Herd has also written numerous articles on achieving success through many phases of the M&A lifecycle. He is based in Chicago.
New York-based Ryan McManus is the Accenture Global Strategy Operations lead. Mr. McManus, who is also a senior manager in the company’s global M&A Strategy group, has published a number of articles on international market expansion and emerging market entry.
The authors would like to thank Mirko Dier, Meng Yen Ti, Markus Rimner, Dhruv Sarda and the Accenture GTIN Strategy team for their contributions to this article.