In the Classroom
Buyer’s Market: Financial Knowledge and Market Shifts Create M&A Opportunities
Although deal flow in mergers and acquisitions has dropped significantly in the current economic downturn, companies with the right financial knowledge can acquire firms or assets for attractive prices, especially target firms that are experiencing some distress because of the lack of credit but still have strong businesses. The retreat of private equity firms also means a lot less competition when pursuing acquisitions.
"Valuations tend to be a lot trickier because there is so much economic uncertainty and volatility," says Robert Holthausen, a Wharton professor of accounting and finance, who is academic director of the Mergers and Acquisitions program and a faculty member of Wharton’s Finance and Accounting for the Non-Financial Manager program. "That is part of the reason people are hunkering down now and waiting to see what happens. Managers are also concerned about their businesses due to the current economic turmoil, but there are tremendous opportunities in this environment for companies with stable businesses and strong balance sheets."
In the turmoil rocking today’s economies across the globe, businesses and individuals need to be even more diligent in making decisions, whether they are managing businesses or portfolios.
–Robert W. Holthausen, Chairperson, Accounting Department; The Nomura Securities Company Professor; Professor of Accounting and Finance; Academic Director, Mergers and Acquisitions
Less Competition for Deals
The collapse of the mergers and acquisitions market and the disappearance of the private equity deals creates a "golden opportunity" for strategic buyers, says Holthausen. M&A deals roared through 2006 and 2007, rising to $4.5 trillion in 2007, and continued into the first half of 2008. "These were banner years for M&A, but deal flow dropped by 35 percent to $2.9 trillion in 2008 and it appears that deal flow in 2009 will be even lower," Holthausen says.
"Private equity firms accounted for about one-third of total deal volume worldwide in 2007, but they were bidding in 60 or 70 percent of sales, and often were able to outbid strategic buyers. Private equity deals have now slowed to a trickle because of the unavailability of credit to finance these deals, and this is a great opportunity for strategic buyers."
There are many strategic reasons for engaging in mergers and acquisitions, including: to achieve economies of scale; access foreign markets; address deregulation; consolidate; capture technology or expertise; gain control over a supply chain; improve management; combine complementary resources; increase market share; or address overvalued stock by buying real assets, just to mention a few.
Difficult to Create Value
Finding and valuing an attractive deal is just part of the challenge. Research shows that realizing the expected gains from such deals is challenging. A multiyear study of McKinsey & Company, for example, found that 61 percent of acquisitions programs failed. Success was highest for small and related companies (45 percent). A KPMG study concluded that 53 percent of mergers destroyed value.
Even more troubling, despite these results, 82 percent of boards felt their acquisitions were successful. "There was a disconnect between what the boards believed and the actual results," Holthausen says. Only 45 percent of the companies carried out post-deal evaluations, which may explain why the board members had an inflated opinion of their successes.
"Probably 60 percent, and some estimates are as high as 80 percent, of acquisitions fail to create value for the acquirer," Holthausen says. "There is disagreement about the right benchmarks, but whether you agree or disagree with these numbers, the evidence suggests that it is not that easy."
What Goes Wrong
There are many reasons why mergers fail. Among them:
- Overbidding: Bidders often pay too much for a deal due to competitive auction pressures, advisors who are incented to complete the deal, overvaluing synergies, underestimating competitive responses, and other factors. It is important for acquirers to think about what it would take to replicate the company instead of acquiring it. This also helps in negotiation with the target.
- Due diligence failures: These failures include ignoring integration challenges identified during due diligence, overestimating synergies, or missing key issues. Targets often dress up for sale. A Bain and Company study found that 34 percent of acquirers uncovered things in due diligence but did not update their valuation model. Only 30 percent were happy with their due diligence process.
- Poor integration and culture clashes: Companies need specific integration plans for achieving synergies, retaining key talent, ironing out cultural issues, and ensuring the strategy and integration plan are harmonized. "You can do all the valuations you want to do, but at the end of the day if you can’t get these two organizations to cooperate with one another, you are not going to have a viable business," Holthausen says.
- Poorly run acquisition process: Companies need to ensure continuity and accountability throughout the process. Lou Gerstner at IBM created a policy of setting up an accounting system to track major investments and acquisitions. Gerstner would hold quarterly meetings to compare the proposed numbers and actual results, using green, orange, and red to highlight successes and failures. "He was making people be accountable for what they had proposed," Holthausen says.
Companies that can address these issues can achieve a higher success rate in their merger and acquisition deals. "Some deals are enormously successful and others abysmal failures," Holthausen says.
The Power of Financial Knowledge
In today’s tough markets, financial knowledge can provide a competitive edge in making acquisitions and other financial moves. "In the turmoil rocking today’s economies across the globe, businesses and individuals need to be even more diligent in making decisions, whether they are managing businesses or portfolios," Holthausen says. "They need to be sure that they understand both the value proposition of their decisions as well as the inherent risks that they will face from those decisions."
Wharton's programs can help managers recognize and realize these opportunities, Holthausen says. "Wharton Executive Education's finance offerings will help you navigate the uncertainties and opportunities in today's world whether you are contemplating growth through an internal expansion opportunity or an M&A transaction, are interested in managing business risk more effectively, or are managing a portfolio of investments for yourself or others."
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