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Four tips for evaluating, planning, and executing an M&A deal in this economy.
Vincent Ryan, CFO Magazine
March 1, 2012
No one knows how the rest of the year will go for mergers and acquisitions, but 2012 indisputably got off to a slow start. The slump in deal volume that began in the fourth quarter of 2011 continued through January, as the European debt crisis rattled markets. According to data provided to CFO by Mergermarket, 250 deals had been announced in North America as of January 27, compared with 445 at the same point a year ago. Total disclosed deal volume was down by two-thirds, to $42 billion from $128 billion.
Fewer deals and shaky financial markets can create a lot of nervousness around getting a transaction done. Indeed, many finance chiefs don't want to stick their necks out right now.
"The anecdotal evidence is that companies are driving with two feet — one foot on the accelerator and the other foot ready to hit the brake at any second," says Howard Johnson, managing director of Veracap Corporate Finance. "While I expect 2012 to be a strong year, I think the level of volatility is going to be dramatic in the M&A market, just as it has been in the stock markets."
But there are signs that businesses may be growing more willing to make deals, if only because their balance sheets are loaded with cash and their shareholders are clamoring for growth. In a survey of 940 business professionals (most of whom work in finance departments) last fall, Deloitte found that just over 40% of companies plan to tap their cash reserves in 2012 for mergers and capital expenditures.
Meanwhile, a recent survey by BDO USA of more than 100 private-equity firm senior executives found that 70% expected to close two to three deals this year. That may sound lethargic, but if these executives follow through, 2012 would be an improvement over 2011. Last year, 47% of the responding firms in the survey closed no new deals, and 19% closed only one new deal.
For companies that are considering a merger or acquisition, here are four generally accepted principles of how a deal should be done — principles that experts think will be especially relevant in 2012:
1. Know the business and the industry (or at least have advisers who do). The deals being made now are being done by a very aggressive group of buyers, says Martyn Curragh, leader of the U.S. transaction services practice at PwC. That means companies may potentially be up against competition for a prized asset.
At the same time, boards of directors are asking more questions about prospective deals. Both trends point to the need for corporate finance departments to bring to bear deep sector, industry, or geographic expertise on a deal, whether internally or externally. "When you're in an auction especially, the process is run on an efficient time line," says Curragh. "There's no time to learn on deals."
2. Apply rigor to growth assumptions. A recent survey by Ernst & Young found that executives thought most deals failed because top-line revenue projections didn't pan out. In essence, acquirers often overestimated the strategic value of an asset and wound up paying too much. "You obviously will pay more if you think you can grow the top and bottom lines faster, but you have to do the right kind of diligence around that," says Rich Jeanneret, Americas vice chair of transaction services at Ernst & Young. "Do you have the ability to grow the top line as fast as you think you will? Will you achieve market and cost synergies as fast as you think?"
3. Don't overleverage. Leverage magnifies problems when an acquired business doesn't perform as projected, points out Reeve Wauld, managing partner at private-equity firm Wauld Capital. "I don't want an untenable capital structure," says Wauld, who has acquired more than 125 businesses. "If I have a lot of risk in penetrating new markets, reducing overhead, and just operating the new company, I don't want to compound that with financial risk."
4. Allow plenty of time for integrating an acquisition. Executives may think an acquisition can be integrated in three months, but it often takes years to fully integrate two businesses, says Veracap's Johnson. "It's not just the information systems, it's the culture and people integration," he says.
The best 100-day integration plans contain an abundance of detail about everything that needs to happen, from key customer meetings to the changing of business cards and signage. And there has to be an integration champion to oversee all of it. "Problems and issues tend to snowball," says Johnson. "A handful of employees get upset and disappointed, and that spreads through the organization. [Problems] become much more difficult to solve six months after an acquisition rather than six weeks."
One upside in the current economy: a poor job market can be a blessing with regard to retaining personnel, because they may have fewer opportunities to jump ship, Johnson points out. "In the current environment, there might be an inclination for employees to say, 'At least I have a job; let me see how this works out.'"
Vincent Ryan is a deputy editor, online/mobile, at CFO.
Running on Energy
Oil and gas deals have accounted for much of the activity in an otherwise sluggish M&A market.
Oil and gas companies fueled M&A activity at the start of 2012, a result of their increasing interest in unconventional resources, like shale gas and oil sands. According to a recent BDO USA survey of 100 CFOs of U.S. oil and gas companies, 25% said that new resource plays, like shale, were the most important factor driving industry growth, up from 14% last year.
Acreage in Oklahoma and Texas where oil and gas can be extracted by hydraulic fracturing, or fracking, drove one of the year's biggest deals to date: Apache's $2.85 billion acquisition of Cordillera Energy Partners III LLC in January. Apache CEO G. Steven Farris called the deal, which bought proved reserves of 71.5 million barrels of oil equivalent, "a unique bolt-on opportunity."
Three other notable deals occurred in the sector in the first week of the year. First, China Petroleum & Chemical's Sinopec unit agreed to buy a one-third stake in five U.S.-based oil and gas projects (covering 1.2 million acres) for $900 million. The seller was Devon Energy. Second, PetroChina, China's largest oil and gas company, bought the remaining 40% interest in the Mackay River oil sands project in Alberta. The seller was Canadian firm Athabasca Oil Sands, and the price was $665.8 billion.
Third, Total E&P USA agreed to acquire a 25% stake in Utica shale assets from Chesapeake Energy and Enervest Energy for $700 million. (Total E&P USA is a subsidiary of French company Total SA.) The Utica shale formation spans eight eastern states and part of Canada, and contains nearly 5.5 billion recoverable barrels of oil and 15.7 trillion cubic feet of natural gas. — V.R.