To get a takeover right is extraordinarily hard. The majority of deals fail: managers overpay, overestimate the savings deals will generate and often clobber their firms’ balance-sheets by trying to make a great leap forward. So what to make of the deals that have taken place so far this year, against the worst economic backdrop for a generation? The surprise is that there is any activity at all. Deal volumes are down but not out. They have stabilised since the nadir of the fourth quarter of 2008 and the run rate is about 80% of the average over the past decade, according to Dealogic, a financial-analysis firm.
About a third of the volume of big deals relates to restructuring banks. Much of the remainder is composed of what might be called “housekeeping” in which two firms rejig an existing relationship, usually with the dominant partner taking full control. This accounts for five of the ten biggest deals. Enel, an Italian utility, is buying out minority shareholders in Spain’s Endesa, for example, and PepsiCo has bid for full control of its two biggest bottling affiliates.
In uncertain economic times these sorts of deals make particularly good sense, for several reasons. The buyer knows the target well, minimizing the risk of nasty surprises; most share prices have fallen; and in a bear market minority shareholders may be keener for an exit.
But what happened to the glory days of investment banking, when bosses could be persuaded to sign off on a huge deal just by being shown the new logo, and their new position above their peers in the industry league table? In fact, “strategic” mergers and acquisitions are not dead. This year the pharmaceutical mega-deal has made a long-awaited return, with Pfizer bidding for Wyeth and Merck for Schering-Plough. Two oil companies, Suncor and Petro-Canada, combined to create Canada’s second-largest firm by market value. RWE, a Germany utility, swooped on Holland’s Essent. And in technology Oracle, a software giant, is buying Sun Microsystems, a troubled computer-maker.
These deals share two characteristics. First, they make broad industrial sense-something of a novelty after three years of intense, and largely disastrous, financial engineering. An easy way to measure this is by the cost and capital-expenditure savings they are expected to create. For the five strategic deals listed above, these amount to annual savings before tax of $8.5 billion, which compares well with the targets’ combined existing annual profits of about $10 billion. Such synergy estimates are almost always too optimistic, but that leaves a huge margin for error, particularly as the earnings multiples being paid look fairly modest-except in the case of Sun.
The second characteristic is the importance of balance-sheet strength. Several companies undertook deals that made strategic sense during the bubble, but were lured into taking on too much debt. Last year’s purchase by InBev, a Belgian brewer, of Anheuser Busch, an American rival, is expected to yield over $2.2 billion of annual cost savings, for example, but lumbered InBev with over $50 billion of net debt. (This week it agreed to sell a South Korean brewery to pay down debt.) For the strategic deals so far in 2009, about a third of the consideration has been paid in shares and, more importantly, the buyers have strong balance-sheets: indeed, three of the five buyers have no significant net debt at all.
Low share prices, despite the recent rally, should mean more deals. The boss of ABB, a big Swiss industrial concern with cash burning a hole in its pocket, spoke for many executives when he recently talked of opportunities “we may never see again in our lifetimes”. But in a much tougher financial climate, transactions will have to pass those two tests: they must generate big cost savings and they must leave the combined firm with low gearing. That suggests it is worth watching those industries that have little debt-energy and technology in particular. Perhaps not coincidentally, these two industries last had a really big bout of consolidation in the late 1990s. After a decade of digestion it may be time for them to return to the table.