Lessons from Adversity

The split personality of 2007 dealmaking, with its dramatic highs and lows, could teach a few things about M&A in the year ahead.

The success has shown up in value-creation measurements. Management consulting firm McKinsey & Co. used a “deal value added” index to compare market capitalization immediately before and after an announced transaction, and found that — to Wall Street, anyway — the increase in value has been steadily climbing to a current level of 10.6 percent last year, from 2.1 percent when the research started in 1997.

Some credit may go to two relatively new variables in the M&A equation: the elevated oversight of boards in corporate decision-making and the greater influence of shareholder groups that have value-creation as their central goal.

“You see a noticeable change in the role of boards,” says Bob Filek, head of transaction services at PricewaterhouseCoopers (PwC). Directors these days often hire their own M&A advisers to get a view independent of management. And certainly the ousting of Merrill Lynch CEO Stan O’Neal for unilaterally exploring a deal with Wachovia is a prime example of boards’ rising power.

As for pressure from investors, that’s seen in the thousands of hedge funds, pension funds, and private individuals that have sought to influence managements — especially in encouraging a deal, or objecting to one that has been proposed. As 2007 was ending, hedge fund Pardus Capital Management, for example, was making headway in pressing Delta Air Lines and United Air Lines to create the world’s largest carrier by merging, in one of the more visible examples of the trend. While activists may seem like flies in the ointment, evidence suggests that their positions enhance M&A value, in addition to ratcheting up dividends and squeezing executive compensation, according to a recent BCG report.

Further, says PwC’s Filek, companies have been performing more-thorough due diligence, and starting the process earlier. In fact, these days due diligence often begins well before signing the letter of intent. New technology tools for valuing, analyzing, and integrating deals also are helping companies improve their acquisition record, he says.

Cash and Consolidation

The continuing movement toward cash-only deals in 2007 was also a positive trend in the eyes of M&A advisers because of the higher return compared with stock deals; cash is also associated with lower premiums. According to research by UBS, most deals in 2000 were for stock, and the price paid above actual market capitalization was 35 percent on average. In the first three quarters of last year, meanwhile, premiums held below 25 percent, according to Thomson Financial.

In the current economic environment, companies almost certainly will use cash for acquisitions more often, although they will probably also tap the stock they’ve built up during the massive buybacks in recent months. Studies have determined that in the recent period of low capital spending, larger companies have accumulated cash on their balance sheets to the tune of $800 billion — equal to 10 percent of their market cap and about twice the historic rate. “Corporate-side [M&A] should stay strong, if not get stronger,” says BCG’s Gell. “And over the next 5 to 10 years, the companies that [spend] the most [in buying companies] are the ones that will grow the most.”


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