Are Companies Getting Better at M&A

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                                                     Are companies getting better
                                                     at M&A?
                                                     The latest boom in merger activity appears to be creating more value for
                                                     the shareholders of the acquiring companies.




 Richard Dobbs,                                      With announced merger activity approaching $4 trillion globally in the first 11 months1
 Marc Goedhart, and                                  of 2006, the year had already surpassed the record levels set in 2000 (Exhibit 1). That
 Hannu Suonio                                        earlier boom was known not only for the number of deals completed but also for a lack
                                                     of discipline and the number of deals that destroyed value for the shareholders of the
                                                     acquiring companies; in fact, earlier McKinsey research shows that as many as two-thirds
                                                     of all transactions failed to create value for the acquirers.2 Are shareholders doing any
                                                     better this time around?
1 As of December 11, 2006.
2 Tom Copeland, Tim Koller, and Jack Murrin,

  Valuation: Measuring and Managing the              They appear to be. But there is still room       From our analysis of announcement effects,
  Value of Companies, first edition, Hoboken
  NJ: John Wiley & Sons, 1990, pp. 318–21.           for improvement.                                 we compiled two indexes of M&A value
3 Paul Healy, Krishna Palepu, and Richard
                                                                                                      creation. The first, deal value added (DVA),
  Ruback, “Do mergers improve corporate
  performance?” Journal of Financial                 We reviewed nearly 1,000 global mergers          tracks the financial markets’ assessment
  Economics, 1992, Volume 31, pp. 135–75;
  and Todd Hazelkorn, Marc Zenner, and
                                                     and acquisitions from 1997 to 2006,              of how much total value a deal will create,
  Anil Shivdasani, “Creating value with mergers      comparing share prices two days before and       irrespective of whether the buyer or seller
  and acquisitions,” Journal of Applied
  Corporate Finance, 2004, Volume 16, Issue          two days after each deal was announced in        captures it. DVA measures the aggregate
  2–3, p. 84.
4 Announcement effects are useful to assess
                                                     order to assess the financial markets’ initial   value change at the time of announcement
  the impact of M&A on its own, as they              reaction to the deals. Academic research         across both companies as a percentage of
  strip out many of the other factors that drive     has found a positive correlation between         a transaction’s value (adjusted for market
  share price movements beyond just the M&A
  announcememt. But because the market’s             these so-called announcement effects             movements). The second index, proportion
  initial response to deals can be either wrong or
                                                     and long-run value creation,3 so in the          of companies overpaying (POP), examines
  affected by factors other than the value of the
  deal (such as bid speculation before the deal,     aggregate, announcement effects are useful       the success of acquirers in capturing value
  signaling, and tax and market liquidity issues),
  announcement effects cannot be used to assess
                                                     in assessing trends in the ability of M&A to     from deals, by measuring the proportion of
  the value that any individual deal creates.        create value.4                                   all transactions in which the initial share
                                                 MoF 22

                                                 M&A index
                                                 McKinsey on Finance                                  Winter 2007
                                                 Exhibit 1 of 5
                                                 Glance: Global M&A activity in 2006 surpassed the peak level reached in 2000.
                                                 Exhibit title: A new boom in M&A activity


Exhibit 1
A new boom in M&A activity                        Volume of announced M&A deals,1 $ trillion
                                                                                                                                                                      Private equity
Global M&A activity in 2006 surpassed the peak                                                                                                                        Corporate
level reached in 2000.

                                                              4.0                                                                                                              3.8

                                                              3.5                                           3.2     3.3
                                                                                                                                                                      2.9
                                                              3.0
                                                              2.5                                    2.3
                                                                                                                                                         2.0
                                                              2.0                                                           1.7
                                                                                            1.5                                              1.4
                                                              1.5                                                                    1.3
                                                                                     1.0
                                                              1.0           0.8

                                                              0.5
                                                               0
                                                                           1995     1996   1997      1998   1999   2000    2001     2002     2003        2004     2005        2006



                                                 1 Includes   announced deals (not withdrawn) >$25 million in value; 2006 data as of December 11.
                                                  Source: Dealogic; McKinsey analysis
                                                  MoF 22
                                                  M&A index
                                                  Exhibit 2 of 5
                                                  Glance: Both cash and stock deals are doing better in the current boom than during the one that
                                                  ended in 2000.
                                                  Exhibit title: Creating more value
Exhibit 2
Creating more value                               Average deal value added (DVA),1 %

Both cash and stock deals are doing better                                       Previous M&A boom                                  Current M&A boom                                    Average,
in the current boom than during the one that                         20                                                                                                                 1997–2006
ended in 2000.
                                                                     15                                                                                              Pure cash deals       14%
                                                                     10                                                                                              Total DVA              4%
                                                                      5
                                                                      0                                                                                              Pure stock deals      –3%

                                                                    –5
                                                                    –10
                                                                    –15

                                                                    –20
                                                                          1997     1998    1999      2000   2001    2002     2003     2004      2005           2006

                                                     Number
                                                                          90        126    139       133     89      39       49        78          93         108
                                                     of deals

                                                 1 ForM&A deals involving publicly traded companies; DVA defined as combined (acquirer and target) change in market capitalization,
                                                  adjusted for market movements, from 2 days prior to 2 days after announcement, as % of transaction value; 2006 data as of December 11.
                                                  Source: Datastream; Dealogic; McKinsey analysis
                                                      Are companies getting better at M&A?                                                        




                                                      price reaction for the acquirer was negative,    DVA of +13.7 percent, compared with
                                                      indicating that the acquirer overpaid           –3.3 percent for pure-stock deals.
                                                      (adjusted for market movements). In other
                                                      words, POP represents the proportion of         This greater share of cash deals during
                                                      acquirers that the market perceives to have     the present boom partially explains the
                                                      transferred to the sellers more than 100 per-   market’s more favorable reactions. Yet
                                                      cent of the value created in their deal.        even when we compared those reactions on
                                                                                                      a like-for-like basis, both cash and stock
                                                      Our analysis of these measures indicates        deals did better in the current boom. Both
                                                      that deals in the boom beginning in 2003        kinds of deals have also created more value
                                                      are creating proportionally more value—         as it has progressed; in contrast, during the
                                                      and that acquiring companies are keeping        previous boom, both types of deals created
                                                      more of it for their shareholders.5             progressively less value (Exhibit 2).

                                                      The current boom is creating                    . . . and acquirers are keeping
                                                      more value . . .                                more of it
                                                      According to our research, the market’s         In the earlier M&A boom, the market
                                                      estimate of the value that deals created        judged that in more than two-thirds of
                                                      in the past ten years for the buyer and         the deals, all of the value created went to
                                                      seller combined (as measured by the DVA         the target companies’ shareholders. This
                                                      index) averages around 3.4 percent of the       time, however, shareholders of acquiring
5 Given the methodology, our analysis excluded

  deals by private equity and other privately         transaction value. During the current boom,     companies appear to be keeping more
  owned companies, since to measure the share         however, the average DVA has been               of that value, as measured by the lower
  price impact on both the acquirer and the
  target company both must be publicly listed.        6.1 percent, with the annual numbers            proportion of acquirers that the market
  We established other criteria for inclusion         trending upward to +10.6 percent, from          believes to be overpaying for deals (our POP
  as well: (1) The absolute size of the deal had
  to exceed $500 million, to ensure the liquidity     +2.1 percent. Today, in fact, the DVA index     index). In the current boom, the proportion
  of the target and materiality. (2) The target       is at a ten-year record high. Those numbers     overpaying has averaged 57 percent,
  had to be at least 5 percent of the acquirer’s
  size (measured by market capitalization),           stand in stark contrast to the previous         decreasing annually from 63 percent in
  so that the resulting impact on share prices
  would adequately reflect the transaction and
                                                      boom’s, when the DVA averaged only              2003 to 56 percent in 2006. In contrast,
  not other events or noise in the share price.       1.6 percent for the whole period—and            from 1997 to 2000 the overall average was
  (3) Transactions had to involve a full change of
  ownership (defined as the acquirer going from       trended downward from +8.6 percent in           65 percent, with the level of overpayment
  0 to 100 percent ownership) to ensure that the      1997 to –5.9 percent6 in 2000.                  increasing significantly, from 54 percent in
  premium paid reflected a full change of control
  and that the combined company would be fully                                                        1997 to 73 percent in 2000. Today’s POP
  capable of capturing the intended value from        The financial structure of the deals            index stands near a ten-year low, despite
  the combination.
6 The DVA is negative when the stock market’s         announced during these two periods of           greater competition from private equity
  reaction to a deal announcement is so               intense M&A activity differs as well. This      firms, which conduct more than 20 percent
  unfavorable (possibly because of the loss of
  creditability for the management team) that the     time around, cash deals represent a much        of all global merger activity. Both the DVA
  decline in the acquirer’s market capitalization
  more than offsets the increase in the acquired
                                                      greater percentage of the public-to-public      and POP indexes, which were moving in the
  company’s share price.                              transactions making up our database—            wrong direction during the last M&A boom,
7 Gregor Andrade, Mark Mitchell, and Erik

  Stafford, “New evidence and perspectives on         nearly half, compared with the 1999 to          are now moving in the right one (Exhibit 3).
  mergers,” Journal of Economic Perspectives,         2000 range of 20 to 30 percent. Like some
  2001, Volume 15, Number 2, pp. 103–20.
8 One way to understand this difference is to         academic researchers,7 we also found that       While today’s lower POP could reflect
  think of a cash deal as a stock deal with a share   cash deals in our sample received a more        many factors, one explanation is lower
  buyback, with all its corresponding positive
  effects. See Richard Dobbs and Werner Rehm,         favorable market reaction than stock deals,     deal premiums (Exhibit 4). In contrast to
“The value of share buybacks,” McKinsey               possibly because of trading and signaling       the 1990s, when the typical price premium
  on Finance, Number 16, Summer 2005,
  pp. 16–20.                                          effects.8 Cash deals generated an average       hovered around 30 percent, acquirers now
                                                  MoF 22
10                                                M&A index
                                                  McKinsey on Finance                                   Winter 2007
                                                  Exhibit 3 of 5
                                                  Glance: Both deal value added and proportion overpaying, which headed in the wrong direction
                                                  during the last M&A boom, are now heading in the right one.
                                                  Exhibit title: Dramatically different trends
Exhibit 3
Dramatically different                             Trends in deal value added (DVA) and proportion overpaying (POP) during 2 most recent M&A booms1
trends                                               DVA,1 %                                                              POP,1 %
                                                          Previous M&A boom                  Current M&A boom                  Previous M&A boom                   Current M&A boom
Both deal value added and proportion                 15                                                                   80
overpaying, which headed in the wrong
direction during the last M&A boom,                  10                                                                   70
are now heading in the right one.
                                                      5                                                                   60

                                                      0                                                                   50

                                                    –5                                                                    40

                                                   –10                                                                    30
                                                      1997 1998 1999 2000 2001 2002 2003 2004 2005 2006                     1997 1998 1999 2000 2001 2002 2003 2004 2005 2006


                                                  1 For M&A deals involving publicly traded companies; DVA defined as combined (acquirer and target) change in market capitalization,
                                                   adjusted for market movements, from 2 days prior to 2 days after announcement, as % of transaction value; POP defined as proportion
                                                   of transactions where share price reaction, adjusted for market movements, from 2 days prior to 2 days after deal, was negative for
                                                   acquirer; 2006 data as of December 11.
                                                   Source: Datastream; Dealogic; McKinsey analysis



                                                   MoF 22
                                                   M&A index
                                                   Exhibit 4 of 5
                                                   Glance: Average deal premiums were around 30% in late 1990s but nearer 20% now,
                                                   helping to reduce the proportion of overpayers.
                                                   Exhibit title: Paying lower premiums
Exhibit 4
Paying lower premiums                              Median 1-week premium,1 %

Average deal premiums were around 30 percent                                    Previous M&A boom                                      Current M&A boom
in the late 1990s but nearer 20 percent now,                           80
helping to reduce the proportion of overpayers.                        70
                                                                       60
                                                                                                                                                                Proportion of
                                                                       50                                                                                       overpayers
                                                                       40
                                                                       30
                                                                       20                                                                                       Average deal
                                                                       10                                                                                       premiums

                                                                         0
                                                                             1997   1998    1999     2000     2001     2002     2003     2004      2005    2006


                                                      M&A deals involving publicly traded companies; 1-week premium = price offered per share vs target company’s share price 1 week
                                                  1 For

                                                   before announcement; 2006 data as of December 11.
                                                   Source: Datastream; Dealogic; McKinsey analysis
                                                   MoF 22
                                                   M&A index
                                                                                                                                                                                    11
                                                   Are companies
                                                   Exhibit 5 of 5 getting better at M&A?
                                                   Glance: The POP index is also lower for cash versus stock deals, but currently both deal types
                                                   receive a more positive initial market reaction.
                                                   Exhibit title: Cash deals are better received

Exhibit 5
Cash deals are better                              Proportion overpaying (POP),1 %

received
                                                                        Previous M&A boom                                   Current M&A boom                            Average,
                                                            90                                                                                                          1997–2006
The POP index is also lower for cash versus
stock deals, but currently both deal types                  80
receive a more positive initial market reaction                                                                                                       POP for pure          69%
                                                            70                                                                                        stock deals
than during previous boom.
                                                            60
                                                                                                                                                      Total POP             62%
                                                            50                                                                                        POP for pure          49%
                                                            40                                                                                        cash deals

                                                            30

                                                            20
                                                                 1997     1998    1999      2000   2001     2002     2003      2004     2005     2006


                                                  1 ForM&A deals involving publicly traded companies; POP defined as proportion of transactions where share price reaction,
                                                   adjusted for market movements, from 2 days prior to 2 days after deal, was negative for acquirer; 2006 data as of December 11.
                                                   Source: Datastream; Dealogic; McKinsey analysis




                                                   pay just slightly more than 20 percent to                              (Exhibit 5). The overall POP index has
                                                   win their target acquisitions, suggesting                              improved considerably, thanks to the
                                                   that boards and management teams may                                   growing proportion of cash deals. Even
                                                   be more cautious about overpaying. Not                                 when we consider cash deals and stock deals
                                                   that prices are low—indeed, acquirers are                              separately, however, the POP index is consi-
                                                   paying very high multiples. But on average,                            derably lower today than it was in 2000.
                                                   price premiums are lower than they were
                                                   before, and especially lower than they were
                                                   at the last boom’s peak, in 2000.
                                                                                                                          Mergers can and often do create value in
                                                  Another explanation for the lower                                       the eyes of investors. The improvements
                                                  proportion of deals that are deemed value                               reflected in our M&A indexes are
                                                  destroying to the acquirer is the market’s                              encouraging: despite the recent intense
                                                  reaction to cash deals versus stock deals                               volume of M&A, it appears that acquirers
                                                  at the time of announcement. In pure-cash                               have been disciplined about creating value.
                                                  deals an average of around 49 percent of                                Nonetheless, plenty of room remains for
                                                  acquirers overpay, compared with 69 per-                                acquirers to improve their M&A perfor-
                                                  cent for pure-stock deals—a difference that                             mance by focusing on the scope to create
                                                  has remained fairly constant over time                                  value and to ensure that they don’t overpay.
                                                                                                                            MoF




                                                   The authors wish to thank Himanshu Wardhan and Silvo Wenzel for their contributions to this article.


                                                   Richard Dobbs (Richard_Dobbs@McKinsey.com) is a partner in McKinsey’s London office, Marc Goedhart
                                                   (Marc_Goedhart@McKinsey.com) is an associate principal in the Amsterdam office, and Hannu Suonio
                                                   (Hannu_Suonio@McKinsey.com) is an associate principal in the Helsinki office. Copyright © 2007 McKinsey &
                                                   Company. All rights reserved.

				
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