Mergers & Acquisitions in 2006

The pace of deal-making across the world has accelerated in recent months. Most M&As fail to create value for the acquirer's shareholders. However, today a growing body of evidence suggests that the continuing appetite for M&A can make sense. Not every deal will succeed but the probability of predicting which kind of deals will create value, has increased.

Deal-making has picked up momentum in Europe. In the United States, industries such as telecommunications and defence have already been consolidated and now contain only a few enormous companies. In Europe, only now is cross-border integration happening to the extent anticipated at the birth of the euro.
Private-equity firms seem to have understood the building blocks of a successful acquisition. Companies like Cisco and General Electric have also demonstrated that it is possible to add value through acquisitions by identifying targets carefully and planning the integration of each new acquisition well in advance.
GE spends billions of dollars a year buying companies. About 230 people work full-time in the team, roughly a quarter of them at head office and the remaining in GE's six main business units. GE has a systematic process for handling acquisitions. Regular reviews compare the performance of past acquisitions with the targets they were set. CEO Jeff Immelt is personally involved. No deal of more than $3m[1] is done without Immelt's approval. Deals are evaluated using both quantitative and qualitative criteria. GE plans the detailed integration of the target acquisition even as it is doing due diligence. When an acquisition fails, GE spends a lot of time trying to understand the reasons for the failure.

There are various signals by which one can judge whether a merger is going to add value. If the acquirer is paying in cash not shares, it shows more confidence. Paying with cash also puts pressure to produce results. Quite a few deals in the early part of 2006 were in cash. It is partly this use of cash that has raised expectations that these transactions will add value. Deals that facilitate global industry consolidation such as Mittal Steel's hostile $24 billion[2] bid for Arcelor, another steelmaker, also seem to have the potential to add value. On the other hand, grand mergers that promise synergies from combining unrelated businesses often fail to add value.
The circumstances make the current takeover boom appear more solid than at comparable times in the late 1990s. Companies in America and Europe have been through a long period of cost-cutting in the past 5 years. This has helped improve significantly both profits and cash flows, which can be used for either capital expenditure or acquisitions. Takeover premiums also have been modest. The difference between an offer price and the target company's previous share price is averaging around 20%, compared with 35-40% at the height of previous merger waves. Another reason for optimism is the cheap, plentiful debt that companies are able to use for deals, thereby lowering the cost of capital and increasing earnings per share.
Despite all this optimism, however, companies would do well to be careful before going ahead with a merger. The risks involved in a merger should never be underestimated.

References

“Learn as you churn,” The Economist, 8th April 2006, p72.
“Riding a wave,” The Economist, 8th April 2006, pp 18-19.
“Once more unto the breach, dear clients, once more,” The Economist, 8th April 2006, pp 71-72,

[1] “Learn as you churn,” The Economist, 8th April 2006, p72.

[2] “Riding a wave,” The Economist, 8th April 2006, pp 18-19.