Mergers and acquisitions are a key tool in the financial armoury of some major Irish companies. CRH, Kerry Group and DCC would each look very different today were we to exclude the positive effect of the acquisitions they have made over recent years. Acquisitions can also be a valuable tool for smaller, less public organisations.
But the volume of acquisition transactions has been sharply reduced by recent turmoil in global financial markets. Crises in banks across the globe reduced the availability of debt with which to fund transactions. This in turn reduced the capacity of acquirers to purchase companies. This drying up of finance can be seen in the graph below, based on transaction volumes up to 2008 as published by the S&P Leveraged Debt Review.
At the same time as financing was drying up, the downward cascade of falling asset prices reduced the motivation of potential vendors to dispose of companies. Why sell a company today when, if you wait for two or three years, you might be able to sell it for a multiple of its current, depressed valuation? The net result of reduced debt financing and falling asset valuation was that world-wide M&A volumes fell to their lowest levels for a number of decades.
But now change is on the horizon. Whereas a year ago it looked as if the global economy might fall into a deep depression, today it seems that massive global policy reflation policies are beginning to work. Economic growth is returning, financial markets are beginning to fully function once more and asset prices have already seen a significant bounce since their March lows. These positive developments have been accompanied by a resumption in M&A activity, albeit at a low level compared to historic peaks. A number of major global acquisitions have been announced recently:
- Pfizer is to acquire rival Wyeth for $68 billion.
- Kraft has made a $16.7 billion takeover bid for Cadbury.
And some leading Irish companies have resumed acquisition activity:
- CRH has increased its capacity to do acquisitions by issuing €1.2 billion of fresh equity. It also invested some €0.3 billion in acquisitions in the first half of this year.
- DCC plc, the business support services group, has acquired the oil distribution business of Bayford Oil Limited for €25 million.
The resumption of acquisition activity raises the fundamental question of whether acquisitions actually work as a corporate strategy. The evidence that they work, from the perspective of the acquiring shareholders, is mixed. An academic study in 2000, Grubb & Lamb's "Capitalize on Merger Chaos", concluded that "the sobering reality is that only about 20% of all mergers really succeed. Most mergers typically erode shareholder wealth." A July 2006 study by AT Kearney concluded that "Our latest observations are that 50.5% of the mergers create value while the other 49.5% perform below their stock value before the merger." But a 2007 study by McKinsey, "Are Companies Getting Better at M&A", concluded that "the latest boom in merger activity appears to be creating more value for the shareholders of the acquiring companies."
Most summaries of the financial effects of acquisitions indicate that they generate mixed result for the shareholders of acquiring companies. The clearest beneficiaries of the whole process may the shareholders of the acquired companies and those professionals who are paid to support acquisitions. These conclusions underline the importance of some key practical questions? When should a company consider supplementing organic growth with growth by acquisition? How should a company organise its M&A effort? What role does the financing and timing of M&A play? How much does successful post-acquisition integration matter?
Under what circumstances should a company decide to boost its organic growth rate by acquisition? How does a company decide that either its existing size or existing growth rate in a particular sector is insufficient and that it must be supplemented by acquisitions? Under what conditions are "industry roll-up" strategies - where a financially strong player builds up a dominant market position by rapidly acquiring operators in a previously fractured sector - appropriate? We have seen attempts at this strategy in recent years in the market for Irish retail pharmacy businesses. How successful have these attempts been?
A key factor that gets too little attention in the textbooks but is of fundamental importance in Ireland today is the matter of economic bubbles. For, even if an acquisition strategy makes strategic sense, it will be immensely hard for an acquisition strategy executed during a bubble phase to make sense when examined in the cold light of the post-bubble day. A good measure of the value of Irish companies - the ISEQ share index - dropped 80% from its peak, before it found its bottom in March earlier this year. It has recovered strongly since then but even a price rise of one half from a trough value equalling 20% of peak value will only bring asset prices to 30% of peak value. Looking at matters in raw financial terms then, it will be hard for any acquisition strategy executed during a bubble to be successful when viewed from a post-bubble perspective.
The question of how an acquirer should organise itself for acquisitions is another central question. Many firms will build up dedicated in-house units charged with directing the acquisition process. One factor which shouldn't be underestimated can be the large number of transactions that will be examined compared to the number of transactions that are actually concluded. This just underlines the need for dedicated and well organised team. That team will need to grapple with finding right answers to the perennial questions of:
- does our acquisition approach make strategic sense?
- have we organised our M&A efforts in a sensible way?
- are we using a logical approach to acquisition pricing and timing?
- what formal review process have we so that we learn from our mistakes?
With the right answers to these questions, companies can embark on an acquisitions strategy with a reasonable foundation for an acquisitions strategy that will be financially productive.
Cormac Lucey
The 'Acquisitions that Work' CPD course, presented by Cormac Lucey, will take place in October 2009. For more information please visit www.charteredaccountants.ie/cpd