Ending M&A Groundhog Day
M&A is having a great year but is it good for shareholders and employees?
For too many of the companies involved, M&A deals end up leading shareholders to relive the worst day of their lives over and over again. But there is a way out of this M&A Groundhog Day (Groundhog Day is the 1993 movie in which a cynical weatherman, played by Bill Murray, is forced to continuously re-live the worst day of his life until he learns to become a better person). 2005 could well be the busiest year for M&A since 2000, with $745 billion in transactions as of September 27, according to analyst Richard Peterson of Thomson Financial. Deals in 2004 totaled $829 billion, which was up sharply over the preceding three years, although it’s only half the record $1.7 trillion done in 2000.
M&A goes through phases. In the 1960s, the highest flying companies on the stock market were conglomerates – such as Gulf & Western and ITT – which used their stock to buy companies that increased their earnings per share. As these conglomerates engulfed and devoured their prey, their earnings grew, their stock valuations rose, and they used their more valuable stock as currency to do new deals. This kept working until the 1970s when stagflation – a combination of inflation and slow growth -- devalued the stock of conglomerates and made it useless as currency to keep the schemes afloat. In response to the ensuing conglomerate discount – the stock market’s lower valuation of conglomerates -- a wave of divestment and corporate focus lasted the decade until the merger wave started all over again with the leveraged buyout (LBO) Masters of the 1980s.
A big reason for the recent spurt in M&A is the desire to remedy this decade’s version of the conglomerate discount problem which resulted from a 1990s merger wave – hence Viacom splitting into two: MTV and CBS and Cendant spinning off its four core businesses into separate publicly traded companies: a real estate company that includes Century 21 and Coldwell Banker; a hospitality company that holds brands Ramada and Days Inn; a travel group encompassing Orbitz and CheapTickets; and a rental-car company owning both Avis and Budget. Once the focus trend plays itself out, don’t be too surprised if a wave of mergers driven by a new ‘convergence’ trend soon follows.
Why do these waves keep repeating themselves? One reason is that people respond to incentives. If you pay enough money to encourage deal doing, that’s exactly what you’ll get. And there is no doubt that deals generate enormous pay days for those who are driving them – including M&A bankers and the CEOs who head up the companies being acquired. This year, for example, M&A bonuses are set to rise an average of 20% on strong performances for the industry’s top deal makers. Wall Street professionals typically make a base salary of $100,000 to $250,000, with the remainder coming in the form of the bonus. A senior investment banker on Wall Street could receive an average of $2.2 million to $3.3 million this year.
And CEOs can make even more as a reward for selling their companies. For example, in January 2005 Boston, MA-based Gillette agreed to be acquired by Cincinnati, OH-based Procter & Gamble for $57 billion. Gillette CEO James Kilts walked away from the deal $185 million richer while Boston lost yet another corporate headquarters and 1,100 jobs on top of the 12,000 Kilts cut during his four year tenure with Gillette. Clearly those job-losers were not cut in on the M&A loot.
Neither are shareholders. Numerous studies suggest that most mergers destroy shareholder wealth. For example, a Chicago Tribune/A.T. Kearney study of 50 mergers between January 1999 and September 1999 found that 69% of the surviving companies lagged their industry average in shareholder returns in the two years after the deal closed. About 70% of surviving companies underperformed their peers five years after the deals closed according to Kidd Stewart (2001).
But not all mergers are bad for shareholders. While the average big merger does not do much for shareholders, there are big performance differences across industries. This is the conclusion of a Peter S. Cohan & Associates analysis of 30 big mergers concluded between 1998 and 2001. These 30 mergers averaged $39 billion and the stock prices of the average acquirer lost 6% between the date of the merger announcement and March 29, 2002 as compared to an 11% loss on the S&P 500.While the average acquirer’s stock among these 30 performed 5% better than the S&P 500 from the date of the announced merger there are wide differences across industries. For example, financial services, energy, and consumer products mergers performed very well while telecom, media, and tech (TMT) mergers were shareholder value destroyers.
Consider these shareholder value-creating examples:
- Citigroup, which announced its acquisition of Travelers for $36.9B in October 1998, outperformed the S&P 500 by 224% from the date of this announcement;
- Philip Morris, which announced its acquisition of Nabisco for $19.3B in June 2000, outperformed the S&P 500 by 143% from the date of this announcement; and
- El Paso Energy, which announced its acquisition of Coastal for $15.7B in January 2000, outperformed the S&P 500 by 122% from the date of this announcement.
By contrast, consider these three telecom and tech value destroyers:·
- WorldCom, which announced its acquisition of MCI for $37B in October 1998, underperformed the S&P 500 by -90% from the date of this announcement – before ultimately filing for bankruptcy;
- JDS Uniphase, which announced its acquisition of SDL for $41.1B in January 2000, underperformed the S&P 500 by -76% from the date of this announcement; and
- VeriSign, which announced its acquisition of Network Solutions for $217B in March 2000, underperformed the S&P 500 by -71% from the date of this announcement.
While none of these studies can provide definitive answers, they do suggest that there might be a way out of this M&A version of Groundhog Day in which shareholders are forced to relive waves of acquisition and divestitures as conglomeration and focus go in and out of favor on Wall Street.
Peter S. Cohan & Associates just completed a study of successful diversification in the payment services industry – companies that process credit card and other financial transactions -- which offers general lessons for corporate acquirers. Our study of 10 diversification businesses created by eight payment services providers (PSPs) found that the PSPs added an average of $559 million to their 2004 sales and $103 million to their 2004 operating income through 20 acquisitions costing an average of $429 million.
How did these PSPs succeed? Their approach to M&A takes seriously the basic blocking and tackling of diversification strategy. Specifically, the PSPs in our study apply the following management discipline:
- Pinpoint large, rapidly-growing, profitable markets;
- Focus only on such markets where the acquirer’s core capabilities – such as operational excellence, marketing, technology-based innovation – will give the acquirer a competitive advantage in the new market;
- Negotiate a reasonably priced deal with a company that offers a beachhead into this new market; and
- Grow market share by integrating the acquired company with care while ‘pouring in’ the acquirer’s core capabilities.
If CEOs wish to end the M&A version of Groundhog Day, this diversification discipline can help them mend their ways.