Perhaps even more than usual, it’s tough to forecast what kind of year it will be for mergers and acquisitions. Globally, 2011 was the busiest year for M&A since 2008, according to mergermarket. Activity from private-equity buyouts strengthened, with the value of deals climbing 15.3% and the proportion of M&A represented by buyouts hitting 12.9%, up from 11.3% in 2010. Exit premiums in U.S. and Europe also rose, says mergermarket.
But 2011 ended on a decisive down note, with deal values in both the United States and worldwide falling 22.5% in the final quarter, as the European debt crisis rattled markets. Fewer deals and shaky financial markets can create a lot of nervousness around getting a transaction done. Many CFOs don’t want to stick their necks out right now. But some companies will have to eventually, because their balance sheets are loaded with cash and their shareholders are clamoring for growth.
For those organizations, here are some generally accepted principles of how an M&A deal should be done — principles that experts think will be especially relevant in 2012.
Know the business and the industry, or at least have advisers that 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, desiring a higher degree of certainty that a purchase will pay off.
Both those trends point to the need for deep sector, industry, or geographic expertise on a deal, whether internally or externally. Experts can get to the point much quicker. “When you’re in an auction especially, the process is run on an efficient timeline,” says Curragh. “There’s no time to learn on deals.”
Because emerging markets offer a more compelling growth story, says Curragh, knowledge of those geographies and their industries may be especially critical. Says Rich Jeanneret, Americas vice-chair of transaction services at Ernst & Young: “Make sure you really understand your exposure to liabilities like corporate income taxes, as well as other kinds of taxes,” he says, “and build that into your valuation model. You really need to nail those things.”
Apply rigor on the front end, especially with regard to growth. 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. In the current M&A climate this is of special danger, because buyers are eager to boost revenue results. “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 Jeanneret. “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?”
As the dealmaker in the highest level of the organization, the CFO has to be comfortable that there has been enough due diligence around these questions, says Jeanneret. Sometimes that means taking the reins. Michael Hagedorn, CFO of UMB Financial, a $12.1 billion bank, likes for his team to do all the financial modeling in-house, except for very large or complex deals. “I like to have control of the numbers myself,” says Hagedorn. “If we use an investment banker they are a check against the work we do inside.”
Even if creditors are willing, don’t overleverage. A bank may very willingly finance an acquisition, but that doesn’t mean the acquirer should pile the debt as high as it can. Leverage magnifies problems when an acquired business doesn’t perform as projected, says Reeve Waud managing partner at private-equity firm Waud Capital. “I don’t want an untenable capital structure,” says Waud, 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,” he says. “I’d rather get my returns from fundamentally improving the business.”
Indeed, it makes sense to limit any kind of financing risk related to a merger, even if it’s relatively short-term. When Corn Products International bought National Starch and Chemical in 2010, it set up a bridge facility to cover the entire purchase price. But three weeks before the deal closed it raised long-term funds in the bond market, so it didn’t have to actually tap the bridge. “Financing agreements can be controlling, and the terms and conditions onerous,” says Cheryl Beebe, Corn Products International’s finance chief. “We wanted to put all our energy into the integration, not the financing.”
Allocate plenty of time for integrating an acquisition — but attack problems quickly. Once a deal is done, many executives think everything will be up and running and integrated in three months, but it often takes years to fully integrate two businesses, says Howard Johnson, a managing director at Veracap Corporate Finance. “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, says Johnson. And there has to be an integration “champion” to oversee all of it. “Problems and issues tend to snowball,” he says. “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. “People are driven by their alternatives,” says Johnson. “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.’”