How to Add M&A Value: Pay Cash, Go Hostile

The perception that up to 70% of mergers and acquisitions destroy value is somewhat out of date, according to a U.K. study.
Andrew SawersApril 23, 2012

For years, debate has raged as to whether mergers and acquisitions add value. Academic studies have tended to find that M&A is a sure-fire way to destroy value, and yet the corporate world keeps on going down the acquisitions route to take out rivals, grow market share, expand geographically, or diversify into other industries. Now new research suggests that, on some measures at least, M&A can add value.

The research also comes with advice on what corporates should do. Research by the M&A Research Centre at Cass Business School in London provides some intriguing if sometimes contradictory evidence about the value of M&A. In short, most deals don’t add value in terms of the share-price performance for the three years after a deal is announced. However, the deals that do work well create more value than is destroyed by the deals that don’t work out. So while the odds of making a successful acquisition are less than 50:50 (in fact, the ratio is more like 60% fail, 40% succeed), the share-price returns are net positive.

Over the short term (40 days following an acquisition), the net cumulative abnormal returns amount to around 6% more than the market index, equal to an average of some £178 million (currently about $287 million) in value per deal.

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Anna Faelten, deputy director of the M&A Research Centre and author of the research, told CFO European Briefing that the perception that up to 70% of M&A deals destroy value is somewhat out of date. “People have been using those numbers for a very long time,” she said, adding that some of those studies date back to the 1980s.

So why the improvement? “The maturity of the industry as a whole,” she said. “Advisers are probably more savvy, and companies themselves are much more savvy. These days more companies of a certain size will have a corporate-development department or a strategy department and will look for deals and targets so they have a lot of experience as well.”

The longer-term picture — from 4 months before until 36 months after a deal — shows that most value is actually created in the run-up to a deal, with share price outperformance peaking at around 7.5% in the 2 or 3 months after. From then on, performance starts trending back toward just 1% after three years.

The research suggests that companies might play on this if their share price is rising so as to “structure the transaction payment more favorably by including shares as part of the deal consideration offered to target shareholders” and by timing the deal to coincide with a peak in the share price.

Faelten added, however, that “you very rarely are highly valued in isolation — usually it’s an industry thing, so you might overpay for the target.” Indeed, the findings suggest that the higher the proportion of cash in the consideration structure, the more successful the deal.

However, hostile deals — where the acquirer’s approach is not welcomed by the target — actually had the strongest correlation to postdeal performance. No explanation is offered for this, though it may be that hostile bids come with more ambition and growth targets than do more placid, perhaps defensive, agreed mergers.

One particularly intriguing result was that average costs per employee tended to decrease in each of the three years following an acquisition, while at the same time output per employee also fell, and by more than twice as much, “which does not constitute a successful strategy,” the research concludes. “Companies should refrain from building synergy strategies based on an expectation of lowering their cost-per-employee.”

Against that background, it is not surprising that median profit margins, measured as earnings before interest, taxes, depreciation, and amortization divided by sales, fall over the three years following a deal (by between 0.3% and 0.6% compared with before the deal). Average (mean) profitability, however, slightly increases, suggesting that there is a small measure of improvement in efficiency. Return on equity suffers, however, by between 1.8% and 2.7% in each of the three years after an acquisition.

The research was commissioned by the U.K. government Department for Business, Innovation and Skills in the wake of the public furor over the acquisition of Cadbury, the confectionary group, by U.S. food group Kraft in 2010. It looks at U.K. acquisitions by U.K. companies and covered more than 3,000 deals between 1997 and 2010. Without having done the analysis, Faelten isn’t able to say what the results would look like in a pan-European context, given different employment laws, for example.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.


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