Most mergers fail. If that’s not a bona fide fact, plenty of smart people think it is. McKinsey and Co. says it’s true. Harvard, too. Booz Allen Hamilton, KPMG, AT Kearney—the list goes on. If a deal enriches an acquirers’ shareholders, the statistics say, it is probably an accident.
But a new study puts a twist on the conventional wisdom. It’s not that all deals fail. It’s just that timing appears to be everything. Deals made at the very beginning of a merger cycle regularly succeed. It’s the rest that fall flat.
The study, published in this month’s Academy of Management Journal, found that deals struck in the first 15% of a consolidation wave tend to do well, at least measured by the acquirers’ share performance against that of the broad market. The duds come later, when copycats jump on the bandwagon. Even in the merger game, there’s a first-mover advantage.
Downward trend: Pedestrians cross a street outside Yahoo Inc.’s headquarters in Sunnyvale, California. Notwithstanding Microsoft’s $44.6 billion takeover bid for Yahoo or Electronic Arts’ $2 billion offer for Take-Two Interactive, 2008 is likely to be an abysmal year for deal-making.
The problem is that most CEOs don’t have the guts to make acquisitions when everyone is running scared. That is usually during a volatile market—like the one we’re living in right now. Which is exactly the wrong approach.
Notwithstanding Microsoft Corp.’s $44.6 billion (Rs1.77 trillion) takeover bid for Yahoo Inc. or Electronic Arts Inc.’s $2 billion offer for Take-Two Interactive Software Inc., 2008 is going to be an abysmal year for deal-making.
Volume in mergers and acquisitions has plummeted 37% this year in the US, according to Dealogic. (Factor out Microsoft-Yahoo and the drop is a whopping 56%.) That’s partly a result of the private equity folks being taken out of the equation because of the credit crisis. But it is also because CEOs and boards become paralysed when the markets turn turbulent.
Instead of making investments, they hunker down and focus on putting their houses in order. Remember those pundits who said corporations would fill the void left by private equity? They were wrong—only they shouldn’t have been.
Baron Philippe de Rothschild, ever an opportunist, is said to have advised, “Buy when there’s blood in the streets.”
Investors like Warren Buffett do just that all the time. Hedge funds have been set up specifically to take advantage of carnage in the markets.
But for some inexplicable reason, many corporate CEOs can’t seem to stomach making a big deal when the going gets tough. It all makes sense to Gerry McNamara, Bernadine Johnson Dykes and John Haleblian, the professors behind the study, entitled The Performance Implications of Participating in an Acquisition Wave. The study examined 3,194 public companies that purchased other companies during acquisition waves between 1984 and 2004.
“Our findings suggest that the market rewards executives who perceive opportunities early, scan the environment for targets and move before others in their industry,” said McNamara, a professor at Michigan State University.
“Conversely, the market severely punishes followers, those firms that merely imitate the moves of early participants in the wave, who jump on the acquisition bandwagon largely because of pressures created by competitors. Such companies typically lose significant stock value.”
Take the telecommunications industry. AT&T Inc.’s acquisition of Cingular (now AT&T Wireless), which was announced in February 2004, has turned out to be an unqualified winner. But the merger of Sprint and Nextel, unveiled 11 months later, was and is a disaster.
The numbers tell the story. Early movers—companies that made acquisitions in the beginning of a consolidation wave within their industry—found their stock up, on average 4% relative to where the shares would ordinarily trade, according to the study.
Shares of latecomers, who bought at the end of a wave, fell by an average of 3% during that time. Of course, at the end of every wave there are bigger and more deals. After all, stocks are usually up, and so is boardroom confidence (read: exuberance).
“There’s a social pressure,” McNamara said. “They like to be in the herd.”
How do you define a consolidation wave? The professors looked at 12 industries over the 20-year period.
To qualify as a wave, merger activity had to show a pattern in which the peak year had “a greater than 100% increase from the first year followed by a decline in acquisition activity of greater than 50% from the peak year.”
Waves were as long as six years for some industries.
By the way, serial acquirers such as General Electric Co. don’t seem to surf through consolidation waves. Companies that “undertake acquisitions on a regular basis as part of their core business routines” are less likely, the study finds, “to either seize early-mover benefits or suffer from the costs associated with bandwagon pressures.”
There are a couple of caveats to the study. The professors measured the acquirers’ stock appreciation or deprecation by using a fancy calculation of what they call “abnormal returns,” which examined share prices five days before the announcement of the acquisition and prices 15 days later. The math is complicated, but they say the “abnormal return” is predictive of stock performance in the future. Of course, critics could argue the study doesn’t measure a long enough period after a deal is made.
Nonetheless, the point is clear: CEOs should stop being such scaredy-cats. While everyone else is battening down the hatches, go make a deal. The wave is just starting.
©2008/THE NEW YORK TIMES