After the relative hiatus that followed the credit crunch, when most corporations were focused on simply cutting costs and growing organically, this year has seen mergers and acquisitions (M&A) activity returning with a vengeance. According to data supplied by Thomson Reuters, volumes have recently seen a seven-year high. A combination of factors – including executives looking to outmanoeuvre rivals in rapidly consolidating markets; investors providing support that aims to produce quick, short-term gains; and US (for the most part) corporations lowering corporate tax liabilities by buying out their overseas rivals and subsequently relocating their headquarters there – have all proven to be major drivers in this situation.
While private equity companies provided much of the impetus for deals seven years ago, this time round it is rich corporations boasting strong balance sheets and looking to deliver knockout blows to their rivals that are doing much of the running. Opportunities have never been greater for these companies than they are at the moment, in what has become known as a time of ‘cheap’ money.
Rising numbers
It remains to be seen how long the corporate sharks will continue to feed upon one another, however – especially since US authorities belatedly decided to take action against this tax inversion. But in the meantime, global deal volume through June 2014 was up 75 percent year-on-year at $1.75trn, according to Thomson Reuters. This is almost comparable to the $2.28trn witnessed in 2007, when activity last underwent a boom on such a scale. However, as the actual number of deals fell in 2013 – from 17,820 to 17,698 – this also reflects an increase in deal sizes, as a number of cash-rich blue chip companies became major players again.
While private equity companies provided much of the impetus for deals seven years ago, this time round it is rich corporations… that are doing much of the running
Most striking, though, has been the frequency and magnitude of hostile or unsolicited bids. Thirty-eight, totalling more more than $150bn, were launched during the first six months of 2014, compared with 19 totalling just $8bn in the same period last year. Data from the Mergermarket H1 2014 report shows that when announcements were made regarding US acquisitions worth $1bn or more, nearly 70 percent were subsequently followed by a rise in the stock prices of the buyers involved. This figure, which compares to 60 percent during the same period last year, suggests that the risks being taken by executives have seemingly been rewarded by investors, who often view acquisitions as a ‘quick win’ in terms of boosting overall earnings.
However, while the era of cheap money still has some time left – despite the US Federal Reserve abandoning its version of quantitative easing – the recent pullback by major global stock markets has only highlighted the fragility of the global economic recovery. Especially given how, previously to now, investors had mostly ignored any ongoing geopolitical tensions, this development may seriously impact M&A activity over the medium term.
Prior research
One often-cited justification for making an acquisition is the ability to generate synergies post-merger – but this mostly ignores the fact that many M&A deals actually fail to yield the savings that companies expect them to. In a recent survey of 352 global executives by US-based management consultants Bain & Company, overestimating synergies was identified as one of the major reasons for disappointing deal outcomes. Part of the problem is that companies routinely set aggressive targets in order to justify deal prices to financers and shareholders. However, the Bain analysis – which involved comparing deal announcements with the performance of more than 22,000 companies across a range of industries – unveiled another fundamental contributor to rampant overestimation: the fact that most merging companies entering deals simply fail to have a clear understanding of the level of synergies they can expect through increased scale.
Typically these companies make broad estimates using prior deal announcements, without considering whether the cost structure of the combined entity is realistic based on benchmarks of like-sized companies, Bain & Company says. As a result, two $1bn companies may merge without any knowledge of what the resulting cost structure will look like based on the existing $2bn companies in their industry.
Synergies have arguably become an overhyped concept to the point of cliché in recent years, and so corporate executives – particularly in the US – have begun to move on to more creative solutions in order to justify their existence. This includes the use of corporate tax inversions. While this method of avoiding US taxes by replacing a US parent with a foreign corporation is still completely legal, US Treasury officials have now concluded (admittedly, rather later in the day) that companies avoiding US corporate taxes are placing an increasing burden on those who do actually pay the correct amount. The Department of the Treasury therefore recently announced that it intended to take targeted action to reduce – or, if possible, stop – the tax benefits that come from corporate tax inversion.
US Secretary of the Treasury Jacob J. Lew said: “These first, targeted steps make substantial progress in constraining the creative techniques used to avoid US taxes, both in terms of meaningfully reducing the economic benefits of inversions after the fact, and when possible, stopping them altogether.”
Corporate history is littered with the shells of mergers that looked good on paper, but ultimately imploded
He added, “While comprehensive business tax reform, that includes specific anti-inversion provisions, is the best way to address the recent surge of inversions, we cannot wait to address this problem… Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share.”
Taking action
Specific action announced so far includes the elimination of certain techniques that inverted companies are currently using to gain tax-free access to the deferred earnings of a foreign subsidiary. This eradication will significantly diminish the ability of such inverted companies to escape US taxation. It also makes it more difficult for further US entities to invert, as it will enforce a requirement specifying that the former owners of the US company are only allowed to own less than 80 percent of the new combined entity. For some companies considering mergers, these actions mean – or so the U.S. Treasury hopes – that inversions will no longer make economic sense.
What it will probably mean, however, is that, while merger activity between US and non-US companies will most likely be slowed, the action will not undercut activity entirely. Moreover, the ongoing availability of cheap money, along with the threat of corporate executives looking to hang on to their well-paid jobs by being proactive rather than reactive, (as far as shareholders are concerned), could actually help to boost M&A activity. Ultimately, wherever businesses are concerned – if the deal makes sense then the deal will be pursued. But while, of course, all deals make sense to their cheerleaders, it doesn’t necessarily mean all deals are sensible.
Corporate history is littered with the shells of mergers that looked good on paper but ultimately imploded. Below you will find a history of some of these unions. They certainly can work, as some examples show – but quite often, they don’t.
DaimlerChrysler
When it comes to mergers going wrong, few can compete with the coalition between Daimler-Benz and Chrysler.
If there was any logic behind the decision for a transatlantic auto-manufacturing giant to take on its rivals, it was soon proven unfounded. A $37bn deal sealed in 1998 soured to the point where Chrysler was eventually offloaded to corporate restructuring specialists Cerberus Capital Management in 2007 for just $7.3bn.
Even worse than that was the fact that Daimler directly received only $1.4bn of Cerberus’s capital contribution to the sale – the rest being invested by Cerberus into Chrysler. Factoring in Daimler covering another $1.6bn of Chrysler losses and the overall complexities of the deal, Daimler effectively paid Cerberus to take Chrysler off its hands.
The reality was that Chrysler, the mass-market auto-manufacturer, never provided the right corporate fit for high-end producer Daimler-Benz. Daimler as a company was very hierarchical in structure, and consequently had an extremely rigid chain of command. Chrysler, by contrast, was more team orientated and egalitarian in its management approach. These management styles in many ways reflected the markets the companies operated in; with Chrysler being more likely to take risks in the US mass market and Daimler more intent on being conservative, efficient and safe. Or, to put it another way – Chrysler went for sexy designs and competitive prices, while Daimler valued reliability and quality above all else.
The inevitable clash between different management cultures – exacerbated by Daimler officials trying to impose their value systems on the new company in terms of how it would operate – eventually led to mistrust and communications challenges that would ultimately undermine the functioning of the company as a whole.
AB InBev
One example of a merger where synergies have actually worked is the $52bn takeover of US brewing giant Anheuser-Busch by Belgian-Brazilian rival InBev in 2008.
When the merger was announced, AB InBev claimed that $2.25bn worth of synergies would be achievable – significantly more than could be expected from economies of scale alone. Yet history had shown that both companies were good at generating cost reductions, and so these predictions were ultimately accepted.
As data gathered by Bain & Company notes, mergers involving consumer product companies typically increase EBITDA by 3.2 percent of target net sales. In the case of the AB InBev merger, however, those synergy gains actually contributed to a 16.8 percent improvement over the three-year period that followed the transaction.
eBay-Skype
History is littered with merger ‘what ifs’ – and, as such, we’ll never know whether eBay’s purchase of Skype in 2005 for $2.6bn (only to sell it to a group of private investors four years later for $1.9bn) was the right deal at the wrong time, or simply the wrong deal. What’s clear is that eBay misread the attitudes of its customers, even if Luxembourg-based Skype did offer technologically advanced Voice Over Internet Protocol (VoIP) telephony.
In short, eBay’s principal mistake was its failure to recognise that VoIP was of little interest to buyers, sellers and third party operators shipping products through eBay. These users had long been accustomed to communicating by e-mail, and ultimately saw no reason whatsoever to communicate in person (or thereabouts).
Alcatel-Lucent
The 2006 merger of France’s Alcatel and US rival Lucent reflected competive pressures in the global telecommunications industry at the time. However, the ensuing years haven’t been especially kind to Alcatel-Lucent.
A combination of a major economic downturn, persistent price pressures and a lack of product focus saw the company undergoing a series of restructuring plans, job cuts and profit warnings. Its October 2013 restructuring plan, which involved the shedding of one in seven of its workforce with an objective of lowering fixed costs by 15 percent (€1bn), was viewed by some in the industry as the last chance saloon.
While the company’s Q2 2014 results are expected to show a narrowed loss to one cent per share versus the previous year’s figure of 11 cents, revenues are expected to come in 6 percent lower at $4.41bn as the company continues to come to grips with its downsizing.
Pfizer-AstraZeneca
The proposed merger of US drugs giant Pfizer and its UK counterpart AstraZeneca proved to be the one that got away – although, should Pfizer revisit the issue at the end of this year, there is still a chance for it to happen.
Ultimately, the proposed £69bn offer from Pfizer was rejected by the AstraZeneca board on valuation grounds: the gap between Pfizer’s final offer of £55 a share was seemingly too much of a jump away from AstraZeneca’s demand for a miniumum £58.50. Much of the groundwork for rejection had already been laid by AstraZeneca’s CEO Pascal Soriot earlier in the year when he announced the company’s optimistic sales targets; playing up a revitalised pipeline for cancer drugs and downplaying looming patent expiries.
By implying that analysts had gotten their valuation of the company wrong, Soriot subsequently convinced other major investors to back him on the bid (on price grounds at least) – although clearly this won’t prevent further talks down the road should Pfizer renew its interest. Soriot also eventually managed to bring UK politicians on side by claiming that a deal with Pfizer would be bad for UK jobs. He implied that the company was only using the deal to gain access to AstraZeneca’s drugs pipeline, and that any merger could cost lives if it delayed the rollout of new cancer drugs.
GSK-Novartis
Contrary to popular belief, mergers in the pharmaceuticals industry don’t always destroy shareholder value. This was demonstrated by the deal made in 2000 between drugs giants Glaxo Wellcome and SmithKline Beecham.
Since this union GlaxoSmithKline has consistently been rated one of the world’s best-performing healthcare companies, led by a strong vaccines business. But it hasn’t rested on its laurels – last April saw the company agreeing to a massive swap of assets with Swiss rival Novartis, satisfying shareholders by putting them in line for a £4bn capital return. While this isn’t a conventional merger per se, the two companies will nonetheless be joining forces in the consumer healthcare sector, combining brands including Aquafresh, Beechams and Tixylix while exchanging their oncology and vaccine businesses.
The £4bn cash windfall meanwhile will be funded by net proceeds of $7.8bn from the Novartis deal, following the sale of its oncology business to Novartis for $16bn and purchasing its new partner’s vaccine business for an initial $5.25bn. A further $1.8bn is promised to Novartis if the vaccines division performs well.
GE-Alstom
Mergers can threaten to run into the sand when political interference is being exercised. Indeed, their scope can be significantly altered by such antics – a recent example being GE’s €12.3bn (€7.3bn in cash) bid for the energy business of French engineering group, Alstom.
While the French government was initially known to be in favour of a rival offer from Germany’s Siemens, it eventually signed off on the GE deal after the US giant provided job creation guarantees. This also came after the government won an option to buy 20 percent of Alstom from French construction group Bouygues – Paris had backed the merger with GE on the condition that it first secured the stake from Paris-based Bouygues.
Under the deal Bouygues will lend Alstom stock equivalent to 20 percent of voting rights to the French government. It will also give up its two board seats and allow the state to exercise an immediate role as the group’s main shareholder. The government will then have a 20-month option to purchase the stock, with a two to five percent discount when the market price is €35 or more. If the government has not acquired 20 percent of Alstom by the end of that period, either from Bouygues or the market, it can purchase up to 15 percent from Bouygues with a similar markdown.
AT&T – Deutsche Telecom
In 2011 US network giant AT&T managed to convince Germany’s Deutsche Telecom to sell its US unit T-Mobile US in a cash and stock deal worth $39bn.
The problem, however, was that US regulators didn’t like the deal, arguing that it was against public interest as it would severely reduce competition in the US mobile communications market. Moreover, it was argued that subscription fees would likely rise and existing players, such as Verizon and Sprint, would become even less incentivised to improve their services. And so, with the US Department of Justice looming large in the background making it adamantly clear that it would block any deal anyway, AT&T and Deutsche Telecom decided to throw in the towel.
The problem for AT&T, however, was that under the terms of the deal it had to pay Deutsche Telecom a break fee of $3bn. That proved very profitable for Deutsche Telecom, which then proceeded to use the cash windfall to bolster its US operations.
