M&A deal flow to slow, but consolidation will continue - reports

M&A deal flow to slow, but consolidation will continue - reports

A new report from Boston Consulting Group (BCG) predicts that although prices and leverage will come down slightly, M&A deal volume will remain largely untroubled by recent market volatility. In bad news for the recent wave of mega-deals in the fintech sector such as Thomson-Reuters and Fiserv-CheckFree, it also finds that deals over $1 billion destroy nearly twice as much value on a percentage basis as deals below $1 billion.

The report entitled "The Brave New World of M&A: How to Create Value from Mergers and Acquisitions," is based on a detailed analysis of more than 4,000 completed deals between 1992 and 2006.

It finds that consolidation deals as a portion of the total value of transactions leapt from 48.7% in the period 1999 to 2000 to 71.4% last year. BCG predicts that globalisation, more liberal regulatory environments, and ample funds for M&A will continue propelling this trend.

The BCG report also says private equity firms' share of the total value of transactions has grown from 6% to 24% (1996-2006). In absolute terms, the total value of PE deals soared from $160 billion in 2000 to $650 billion in 2006.

Last week, investment bank Regent Associates published findings that indicate that M&A activity in the technology sector is slowing down. While the number of deals in H1 07 was roughly even with activity in H1 06, there was a decline in Q2 07 over Q1 07. The value of these M&A deals decreased from $221bn to $184bn.

But BCG's Jeff Gell, a Chicago-based partner and co-author of his company's report, says the strategic need for most deals is still present. "Companies are still sitting on excess cash that they need to deploy, and private equity funds still have large war chests that they need to put to work."

While The Americas account for the largest share of deal value (46.5%), BCG finds that Europe has drawn closer (29.5%). This is backed up by recent statistics from International Financial Services London, which show that private equity in the UK is growing faster than the US or Europe. Its report - Private Equity 2007 - says that faster growth in raising of private equity funds has resulted in the UK's global share increasing from 10% in 2004 to 30% in 2006.

China's and India's deal value is also growing rapidly according to BCG, growing by 20.4% per year between 2002 and 2006.

Other findings of the BCG report include:

Private equity winning by paying less
BCG's report also finds that the common assumption that PE firms have gained an increasingly large share of the M&A market by using their huge reserves of capital to pay over the top for targets is wrong. On average, PE firms pay lower multiples and lower acquisition premiums than "strategic" buyers.

One of the reasons why PE firms appear to pay less, on average, is that they tend not to bid for targets in industries where there is strong consolidation logic and where high multiples are commonly paid, so their average multiples are less influenced by large, individual multiples than those of strategic buyers.

Higher acquisition premiums do not necessarily destroy value
Between 1992 and 2006, value-creating deals had a 21.7% premium, on average, compared with an 18.7% premium for non-value-creating transactions. Paying higher premiums appears to be especially valuable during periods of heightened activity (such as now). Acquirers that pay larger premiums have destroyed less value during these periods.

Bigger isn't necessarily better
Deals over $1 billion destroy nearly twice as much value on a percentage basis as deals below $1 billion. And deals destroy progressively more value as the size of the target increases relative to the size of the acquirer. Targets worth more than 50% of the value of the acquirer destroy twice as much value on a percentage basis as targets worth less than 10% of the acquirer.

It doesn't always pay to be friendly
Hostile deals are viewed significantly more favorably by investors in today's market than they were in the preceding wave of M&A (1997-2001). This could be because most deals since 2002 have been consolidation mergers. Establishing a harmonious relationship with the target tends to be less important in this type of M&A because the primary goal is usually to realise cost synergies through rationalisation, as opposed to growth synergies by teaming-up capabilities.

M&A often creates substantial value
Although 58.3% of deals between 1992 and 2006 destroyed value for acquirers, with a net loss of 1.2% for all transactions, the average deal produced a net gain to shareholders of 1.8% when returns of the targets are taken into account. Moreover, the majority of deals (56%) created value for the combined set of shareholders. In addition, acquirers in several industries, including automotive and retail, created value, on average, as did acquirers in the Asia-Pacific region.
Cash is king
Cash-only transactions have a much more positive impact on value than deals that rely on stock, a mix of stock and cash, or other payment contributions.
The authors point out that in today's M&A environment, sitting on the sidelines holds risks as well. It not only exposes a company to the threat of a hostile bid, it also gives rivals the opportunity to snatch prime targets and gradually erode the company's competitive position.
"In consolidating industries, joining the brave new world of M&A may be the only way to survive - eat or be eaten," says Alexander Roos, a Berlin-based partner who coauthored the report with Gell, Kees Cools in Amsterdam, and Jens Kengelbach in Munich. "To avoid becoming prey, companies need to raise their game and adopt a much more professional and systematic approach to M&A."

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