Are we on the threshold of a rise in corporate mergers and acqusitions (M&A)?
According to the KPMA Mergers & Acquisitions Predictor, the answer is ‘yes.’
The world’s largest corporates are expected to show a greater appetite for deals in 2014 compared to 12 months ago, according to analyst predictions. Predicted forward P/E ratios (our measure of corporate appetite) in December 2013 were 16 percent higher than in December 2012. This reflects the last half of the year, which saw a 17 percent increase in forward P/E between June and December 2013. This was compared to a 1 percent fall in the previous 6 months, after concerns over the anticipated mid-year tapering of quantitative easing in the US. The increase in appetite is matched by an anticipated increase of capacity of 12 percent over the next year.
This prediction is based on
..tracking and projecting important indicators 12 months forward. The rise or fall of forward P/E (price/earnings) ratios offers a good guide to the overall market confidence, while net debt to EBITDA (earnings before interest, tax, depreciation and amortization) ratios helps gauge the capacity of companies to fund future acquisitions.
Waves and Patterns in M&A Activity
Mergers and acquisitions tend to occur in waves, or clusters.
It’s not exactly clear what the underlying drivers of M&A waves are, although there is a rich literature on this.
Riding the wave, for example – an Economist article – highlights four phases of merger activity, based on a recent book Masterminding the Deal: Breakthroughs in M&A Strategy and Analysis,
In the first phase, usually when the economy is in poor shape, just a handful of deals are struck, often desperation sales at bargain prices in a buyer’s market. In the second, an improving economy means that finance is more readily available and so the volume of M&A rises—but not fast, as most deals are regarded as risky, scaring away all but the most confident buyers. It is in the third phase that activity accelerates sharply, because the “merger boom is legitimised; chief executives feel it is safe to do a deal, that no one is going to criticise them for it,” says Mr Clark.
This is when the premiums that acquirers are willing to pay over the target’s pre-bid share price start to rise rapidly. In the merger waves since 1980, bid premiums in phase one have averaged just 10-18%, rising in phase two to 20-35%. In phase three, they surge past 50%, setting the stage for the catastrophically frothy fourth and final phase. This is when premiums rise above 100%, as bosses do deals so bad they are the stuff of legend. Thus, the 1980s merger wave ended soon after the disastrous debt-fuelled hostile bid for RJR Nabisco by KKR, a private-equity fund. A bestselling book branded the acquirers “Barbarians at the Gate”. The turn-of-the-century boom ended soon after Time Warner’s near-suicidal (at least for its shareholders) embrace of AOL.
This typology comes from Clark And Mills book’ ‘Masterminding The Deal’, which suggests that two-thirds of mergers fail.
In their attempt to assess why some mergers succeed while most fail, the authors offer a ranking scheme by merger type. The most successful deals are made by bottom trawlers (87%-92%). Then, in decreasing order of success, come bolt-ons, line extension equivalents, consolidation mature, multiple core related complementary, consolidation-emerging, single core related complementary, lynchpin strategic, and speculative strategic (15%-20%). Speculative strategic deals, which prompt “a collective financial market response of ‘Is this a joke?’ have included the NatWest/Gleacher deal, Coca-Cola’s purchase of film producer Columbia Pictures, AOL/Time Warner, eBay/Skype, and nearly every deal attempted by former Vivendi Universal chief executive officer Jean-Marie Messier.” (pp. 159-60)
More simply put, acquisitions fail for three key reasons. The acquirer could have selected the wrong target (Conseco/Green Tree, Quaker Oats/Snapple), paid too much for it (RBS Fortis/ABN Amro, AOL/Huffington Press), or poorly integrated it (AT&T/NCR, Terra Firma/EMI, Unum/Provident).
Be all this as it may, the signs point to a significant uptick in M&A activity in 2014. Thus, Dealogic reports that Global Technology M&A volume totals $22.4bn in 2014 YTD, up from $6.4bn in 2013 YTD and the highest YTD volume since 2006 ($34.8bn).