Rome/Seoul/Helsinki: Are reports of the demise of M&A activity premature? Announced mergers reached $4.4 trillion (Rs173.36 trillion) globally in the first 11 months of 2007, and record volumes from January to July had already surpassed the record full-year level, set in 2006. But midyear, as the subprime lending crisis began to rage, merger activity plunged about 40% from the second to the third quarter.
Although the dive generated much commentary that the M&A boom had ended, a more subtle analysis suggests a different conclusion for deal makers: the slowdown over the last few months of 2007 was concentrated largely in the private equity sector. Corporate M&A lost none of its vigour as the year rolled on. Furthermore, our annual review of M&A activity finds that acquiring shareholders still appear to be getting more value from deals than they did during the last M&A upswing, in the late 1990s. Acquirers still have considerable room for improvement, but their new-found discipline appears to be keeping bid premiums under control and sustaining improvements in the flow of value to the acquirer.
Private equity deals were another story: in the second half of 2007, their volume fell by more than 50%, hit by turbulence in the credit market and a more troubled market outlook. Yet before the August credit crunch, the volume of such deals reached unprecedented levels—it not only was more than four times higher than it had been during the previous peak, in 2000, but also represented more than 20% of M&A activity in the current boom. Meanwhile, corporate M&A activity remained high throughout the year, and significantly higher than in 2006.
Some specific activities, evident throughout the current merger boom, remained prominent in 2007:
• Cross-border activity, replicating the fast-paced globalization of economic and financial flows, is increasing. It now represents 40% of global M&A, up from 20% in 2000 and 30% in 2005.
• Companies in emerging markets have increasingly and substantially established themselves as both buyers and sellers in this cross-border activity. Overall, Asia and West Asia now represent about 15% of global volumes; India, China, and West Asia are up by 110%, 47%, and 38%, respectively, over 2006. Moreover, companies in these regions can be major global deal makers, as shown by a number of large transactions: the acquisition by Tata Steel Ltd of the UK’s Corus Plc. and the acquisition by Vodafone Plc. of Hutchison Essar Ltd.
• Mega deals—deals with a value of more than $10 billion—contributed 30% of 2007’s overall volume. That is considerably above the long-run average of about 20% (over the past 10 years), though the number of mega deals fell from 54 in 2006 to 45 in 2007.
• Hostile takeovers generated 12% of total deal volumes in 2007, again considerably higher than the long-run average of about 3% (over the last 10 years).
Overall, data from the market’s reactions to deals suggest that M&A activity continues to be value creating.
Deals went on generating high total value. The year’s average deal value added (DVA)— our measure of the total value created for buyer and seller—reached 6.5%, well above the long-term average and just slightly below the record levels of the previous two years. The overall trend shows that significantly more value has been created in the current boom than in the previous one.
One major driver of the higher DVAs of recent years has been an improvement in the acquirers’ DVA, which has gone up from an average of –7.0% (1997–2004) to around –0.5% during the past three years. By contrast, the DVA for the shareholders of target companies has remained largely stable, at 10%, throughout the past decade.
In general, the news is good—acquirers no longer transfer more than 100% of the short-term value created by deals to the target—but too much of the value often still goes to the sellers. The proportion that may have overpaid, at least according to the markets’ initial reaction as measured by our proportion of overpaid (POP) index, remained low for the third year running. Premiums paid decreased modestly, to 18%, from last year’s low of 19%.
However, the strong value creation seen in the aggregate indexes hides high underlying variability in discipline and value creation.
Cash deals, for instance, generally get a more favourable market reaction than stock deals because of the trading and signalling effects. But in 2007 (and especially during its last few months) cash deals performed less well than they have historically on both their POP and their DVA.
Their performance also became more variable: in 2007, the standard deviation of DVAs (a measure of their variation) reached 32%, significantly higher than it has been in all recent years except the 2000 peak. Further, the share of bad deals (those with a DVA of less than –15%) reached a surprising 17% of total deals in 2007.
That was three times higher than their level in 2006 and consistent with their level boom (in the late 1990s), which was characterized by a significant overall destruction of value from bad M&A.
Furthermore, the value created by deals in different sectors and geographies continues to diverge significantly. The sectors with the highest levels of value creation and discipline include basic materials (such as chemicals, building products, metals and steel) and the consumer sector (including consumer products, retailing, and food and beverage).
The year 2007 was a record but highly turbulent one in M&A. Buyers went on exerting discipline to ensure that they created and captured value, as they had not in the previous boom. But the variability in performance suggests that acquiring management teams and boards must continue to focus on whether they can create value and on ensuring that they don’t overpay.
Antonio Capaldo is an associate principal in McKinsey’s Rome office. Richard Dobbs is a partner in the Seoul office and Hannu Suonio is an associate principal in the Helsinki office of the consulting firm. Reprinted with permission, ©2008/McKinsey & Co. The article was first published in the Winter 2008 issue of McKinsey On Finance and can be found on The McKinsey Quarterly website, www.mckinseyquarterly.com.