The record $2.5 trillion (Rs102.5 trillion) of mergers so far in 2007 shows no sign of reversing the 15-year trend that has most shareholders on the losing side of acquisitions, while enriching the executives and bankers who arrange them.
UniCredit SpA’s shares dropped 10% since Italy’s largest bank announced plans in May to buy smaller Rome-based rival Capitalia SpA for almost $30 billion. UK drugmaker AstraZeneca Plc. lost 9% of its market value after unveiling its $15 billion bid for MedImmune Inc. two months ago. Sacyr Vallehermoso SA, the Madrid-based builder, fell 19% since bidding in April for French rival Eiffage SA.
The laggard stock performance isn’t just a short-term phenomenon. About 58% of acquisitions completed from 1992 to 2006 reduced shareholder returns, according to an analysis by Boston Consulting Group Inc. of more than 3,200 transactions. Meantime, securities firms stand to earn as much as $25 billion of fees from arranging deals announced in the first five months of this year, industry consultants at New York-based Freeman & Co. estimated.
“There are few home runs for shareholders,” said David Harding, co-head of the global mergers group at Boston-based consulting firm Bain & Co. and co-author of Mastering the Merger, published by Harvard Business School Press. “It’s a different picture for the investment banks.”
Take Daimler-Benz AG’s 1998 purchase of US auto maker Chrysler Corp., one of the worst corporate blunders of all time. Former Daimler chief executive officer Juergen Schrempp hailed the $36 billion deal as “an historic agreement that will change the face of the auto industry”. Chrysler CEO Robert Eaton predicted DaimlerChrysler AG would become the world’s largest auto maker within three years.
Instead, Schrempp’s decision wiped out about $12.6 billion of market value in nine years. Last month, Daimler handed control of Chrysler to New York-based private equity firm Cerberus Capital Management LP for about $7.5 billion.
“They were trying to mate two elephants from different parts of the world,” said Roy Smith, a finance professor at New York University, who ran Goldman Sachs Group Inc.’s London office in the 1980s.
Investors have more at stake in 2007 after companies announced $2.5 trillion of takeovers, up 38% from last year’s record first half, according to data compiled by Bloomberg. The average size of the deals jumped about 40% to $300 million. Investment bankers have a vested interest in promoting the biggest mergers because they earn fees of as much as 0.5% on deals valued at more than $1 billion.
Goldman collected a $33 million fee for advising Hewlett-Packard Co. (HP), the world’s largest printer maker, on its 2002 purchase of Compaq Computer Corp. Goldman told Palo Alto, California-based HP that the transaction would boost earnings per share (EPS) by as much as 34.3% and dilute them by no more than 6.5%, US regulatory filings show.
The deal never came close to meeting Goldman’s projections. HP lost $903 million in 2002 and EPS didn’t recover to 2000 levels until last year. The company’s shares fell from the day the purchase was announced in September 2001 to the day it closed eight months later. When they hadn’t rebounded by February 2005, HP’s board ousted Carleton Fiorina as CEO.
On the flip side, New York-based Goldman, the biggest US securities firm by market value, played a role in pushing Procter & Gamble executives to acquire its client Gillette Co., the No. 1 razor maker, for $57 billion. Shares of Cincinnati-based Procter & Gamble Co., the world’s largest household goods company, advanced 13% since the purchase was unveiled in January 2005. Goldman pocketed $30 million for advising Gillette.
“Bigger deals are more complex,” said John Sunderland, a London-based partner at consulting firm PricewaterhouseCoopers LLP. “The biggest mistake a lot of the CEOs make is underestimating the risk of integration.”
More recently than the DaimlerChrysler debacle, shares of Pfizer Inc. fell 19% in the four years since the US drug maker plunked down about $60 billion for Pharmacia Corp. French investment bank Natixis SA slid 13% since it was formed from the merger of Groupe Caisse d’Epargne and Banques Populaires units last November. UK-based health-care company GlaxoSmithKline Plc. slumped 31% in the seven years since Glaxo Wellcome Plc. acquired SmithKline Beecham Plc. for $72 billion to create the company.
In many cases, “the strategic logic for the deal is faulty and the price paid is too highbecause the valuation is built on compound optimism”, said Jeff Gell, a Chicago-based partner who runs Boston Consulting America’s mergers practice. “Integration is ineffective and fails to capture the value identified.”
Executives do big deals in an attempt to increase shareholder returns by gaining new sources of income. Yet many are also lured by a “celebrity” culture of deal makers egging them on to do deals, Bain’s Harding said.
“They’re being treated like rock stars when they get ready to announce a deal,” Harding said. “It gets very seductive.”
Difficulties underestimating the cost benefits or integrating teams mean shareholders lose, which was the case in 2001 when Munich-based insurer Allianz SE acquired Dresdner Bank AG for $21 billion. Senior bankers, including Bruce Wasserstein, co-founder of Wasserstein, Perella & Co., and at least half-a-dozen other investment bankers left Dresdner in the seven months following the Frankfurt-based bank’s sale to Allianz.
The Allianz takeover was plagued by issues before it even happened. Dresdner spent €620 million (Rs2,480 crore then) in 2001 for a reorganization that included cutting jobs and merging with Wasserstein Perella, which it had acquired earlier that year for $1.56 billion. Allianz shares are down 40% since the Dresdner purchase was announced.
“There’s a risk that if a company migrates away from their core business it may fail,” said Jeremy Batstone, an equity strategist at Charles Stanley & Co. Ltd in London.
To be sure, investors have reaped the rewards of major deals, including Chevron Corp.’s $44 billion takeover of Texaco Inc. in 2001. Chevron shares jumped 75% since the deal was completed.
Bank of America Corp. shares climbed 20% since the acquisition in 2004 of FleetBoston Financial Corp. and Mittal Steel Co.’s shares, now ArcelorMittal, rose 50% in less than a year after its $38 billion acquisition of the Luxembourg-based Arcelor SA.
While acquisition success remains rare, there have been improvements, Bain & Co. data shows. Shares of US companies that made acquisitions beat their benchmark indexes 45% of the time from 2002 to 2005, up from 26% in the five years through 1999, Bain said.
“Every transaction is different,” said Adrian Mee, London-based head of European mergers and acquisitions (M&A) at Lehman Brothers Holdings Inc. “Where there is sound strategic and financial logic, as well as good execution, M&A transactions create substantial value for shareholders.”
Lehman is the No. 5 merger adviser this year behind Goldman, Citigroup Inc., Morgan Stanley and JPMorgan Chase & Co., all based in New York. Goldman Chief Financial Officer David Viniar had said on 14 June that the firm’s backlog of pending deals surpassed the record set in the second quarter of 2000.
Banks and financial services firms alone account for $1.3 trillion of deals announced this year, about half of the total. The biggest deal would be the $100 billion takeover of Amsterdam-based ABN Amro Holding NV by a group led by Royal Bank of Scotland Group Plc. or London-based Barclays Plc. Half of this year’s deals are in Europe. Leveraged buyout (LBO) firms have raised $215 billion this year, fuelling much of the takeover activity in 2007 and the investment banking fees that come with it. Acquisitions by LBO firms accounted for $510 billion, or 21% of M&As so far this year.Bloomberg
LBO firms will probably pay Wall Street even more than the record $12.2 billion that they shelled out last year, based on the current rate of deals tracked by Bloomberg and estimates for fees from Thomson Financial and Freeman.
“The private equity community is basically making sure no deal comes cheap,” Harding said. “The LBO firms raise shareholder activism. That’s good for investors because nothing gets the attention of a chief executive like knowing there will be another level of accountability.”
Smaller acquisitions have a better track record, according to Scott Moeller, a professor of M&As at Cass Business School in London. Shares of companies that made purchases for $400 million-$1.5 billion outperformed benchmark indexes by 7% in the 18 months following a deal, compared with 1.1% for takeovers valued at more than $1.5 billion.
“Smaller deals are easier to digest,” said Moeller who worked as an M&A banker at Morgan Stanley for 12 years and at Deutsche Bank AG for six. Compare that to the world’s biggest merger: America Online Inc.’s acquisition of Time Warner Inc. for $186 billion. The shares have dropped 71% since the deal was inked at the height of the Internet bubble in January 2000. “It was just too big, especially as they practically ignored the cultural differences of the two companies they tried to merge,” Moeller said.
Alexis Xydias in London contributed to this story.