Muhammad

Does volume of M&A transactions occurs in a recurring cycle or in a random fashion The success of a particular M&A transaction depends upon the value it has added in to the Company and the gains the stockholders has realized. At times, the underlying strategy is one of the “expansionists” where the acquirer intends to enhance its market share by consolidating or moving in to new geographic region or is of “transformative” where the purpose is to enter in to new line of business and disinvest the unhealthy portfolio. Apart from the merger strategy and the purpose behind the acquisition, factors such as market sentiments, economic cycles, stock markets, potential gains, company’s reputation, goodwill, brand equity of the company, entity’s track record are some of the catalysts influencing the M&A transactions. Let us dissect each of them so as to assess which corporate marriages ends up laying golden eggs and to conclude over the fact that which of the factors are essential to strike the deal. The historical analysis reveals the fact that there is no exact science determining the perfect recipe for success of M&A deals. For argument sake, let us consider two M&A deals carried out in year 2015 (year with the record M&A growth and positive economic indicators): a failed M&A deal of Pfizer and Allergan and an announced deal of Dell with EM Storage. The $160 billion (1) agreement of acquiring Allergan announced in November 2015 was abandoned by Pfizer as the US authorities imposed strict condition for taking tax advantage / curbing tax liabilities by way of redomiciling in a foreign country. Though the acquisition would have resulted in the synergy and the growth, the economic scenario was a plus and the economies of scale do exist, but since the intended benefits of deals could not be realized, it was abandoned. Another largest IT deal valued $66 billion (2) struck in October 2015. This was the purchase of EMC storage by Dell. This deal was highly leveraged resulting in increased debt burden on the financial position of Dell. Moreover, post announcement of deal, the equity price of the VMware (a subsidiary of EM Storage) declined by 30% showing negative stockholders sentiment following the deal. However, the Company firmly believed that if the deal went according to the plan, it will be able to reach the desired targets. Thus, to conclude; the most critical precondition for M&A transaction is the intrinsic value assigned by the Company to the intended benefits of the deal. The record M&A global transactions worth $ 5.05 trillion were reported in year 2015. The numbers indicates that US has reported the highest number of deals ever worth $ 2.47 trillion, Asia pacific reporting highest value ever of $1.27 trillion, EMEA region showing a negative trend with M&A volume of $1.13 trillion (record low share of last ten years). However, during the current year, the M&A volume in the US market have shrunk. The statistics as of May 2016 indicates that in US, 866(3) transactions with a value of $ 110 billion have been announced which is 41.1% less in value as compared to the corresponding period of 2015. Despite the stable economic signals, the volume of M&A activity has felt down in US. The election wave bringing up the political instability, the dominance of protectionist rhetoric in the legislative bodies, the market volatility has been considered as some of the factors contributing towards the low M&A volumes. If talked about EMEA region, the economy has been deteriorating with the bubble bursting and the vanishing real economic growth coupled with the declining oil and commodity prices have heavily damaged the economic activity resulting in a low M&A activity. Contrary to it, the volumes in Asia pacific region has increased significantly reflecting the investor’s confidence, availability of resources and cheap debts. Therefore, economic cycles do reflect the market sentiments, investors’ confidence, and other related essentials for M&A but this phenomena works in combination of several other forces as well and these variables together results in M&A volumes and growth. In order to build the argument, whether the merger activity occurs most when the market is peaked / occur in a recurring cycle or it does not occur in a random fashion, let us discuss the four distinct phases of the market cycles with their distinct features along with the average bid premiums paid to strike the deal. The table below exhibits the same (4). Phase Features 1 The economy is in poor shape, just a handful deals are struck, often desperation sales at low premium 2 Improving economy, the confident buyers comes in. 3 Activities start accelerating sharply. The Board, at this times feel more confident (Peaked State) 4 Badly structured deals took place Bid premium 10% - 18% 20% - 35% 50% 100% In light of the table above, the increasing bid premium can be associated with the increasing merger volumes and the rising trends; but the fact of the case is each deal must have its own strategic advantage. It has been established that acquirers who follow the lead often ends up in a mess because they are unable to recover the high bid premiums paid and the stakeholders of the acquirer / bidder often ends up in a loss situation. In case, the target has some strategic value or competitive advantage; it definitely will demand the premium for the same. The question then arises, whether the acquirer is in the position to pay such a premium and facilitate the deal or will it wait for the peak / recurring merger cycles so as to materialize the transaction. The answer again lies that in case, the acquirer thinks that the pace of organic growth is not sufficient and all the avenues have been explored, then it may enter in to M&A transaction so as to grow horizontally or vertically. Thus, the onset of the deal springs from the strategic position of both the seller and the buyer. The bullish and bearish market trends, recessions and booms, peaks and downturns do play a role in arriving at a deal; but these are all secondary factors and the most essential one is the strategic need and how well the company can maximize the benefit by redeploying the resources acquired. Some of the deals negating the idea that most mergers do occur in recurring cycle are given below:    AOL purchased time warner, American based Telecommunication Company in January 2000. This transaction took place just before the start of the recession. This was reported as 2nd largest M&A deal valuing $ 164 billion. (5) In September of 2000, Glaxo Wellcome PLC and SmithKline Beecham surprised investors by plans to merge in a $75.7 billion deal. This again was just at the start of the recession phase and was reported as 10 largest M&A deals that took place. (5) The acquisition of Verizon Wireless by Verizon Communication took place in September 2013. The markets were not peaked at that time, but still, the third largest M&A deal valuing $130 billion took place which ultimately gave Verizon a competitive strength.(5) The comparison of the causes of the merger boom periods (1980 with 2015) would also enable us to figure out what actually are the causes of the merger booms or is it simply associated to market peaks. Recently, the entities are entering in to such transaction, because there are fewer opportunities for organic growths. The financial markets are offering liquidity / debt on cheap rates. In certain situation, the Company also has assets on its balance sheet which it can simply invest on to the merger transaction so as to grow strategically and report high earnings in long terms. The ultimate focus always is to gain the stock holders in long term. However, the equity markets are not that receptive and a trend analysis depicts that a 15% - 30% decline in the share price of both the acquirer and the target has been observed after the merger announcement. Thus, there are multiple factors responsible for surge in M&A transactions in 2015 and onwards. Furthermore, the investors have now become more cautious and 20% dip (6) has been observed in M&A activity in 2016 as compared 2015. The merger wave of 1980 continued with recessionary phase were the equity market behavior was not at all predictable and the interest rates were sharply high as well. It was then concluded that ease in regulation and less restrictive antitrust enforcement were the causes of the boom in M&A transaction during this period. Acquisition was also fueled s as to avoid hostile takeover, bust up takeovers, management buy outs etc. Thus, it is evident that the prevalent regulation was one of the essential factor resulting in 1980’s boom. Therefore, this can be argued that merger cycles not only occur when the market is peaked and there are other contributing factors too. Furthermore, it also upheld the argument built earlier that M&A activity also depends on how the gain is perceived by the investors / acquirers. In this case, since the antitrust regulations are flexible enough, the gain is perceived by entering in to such transaction. Thus, it can be safely stated that a merger wave begins when some combination of circumstances convinces investors and potential acquirers that acquisitions will be more productive than they were in the past. The wave subsides as it becomes apparent that the expected gains are not materializing. (7) Now let us further explore about the future of M&A transaction and how this wave is to be settled. Since 2010, the trend of cross border M&A transactions have been increasing. This is usually in pursuit of natural resources and entry in to the new market. Furthermore, access to sophisticated technology, skilled labor, tax laws and government policies are also some of the motives behind cross border deals. These sorts of transactions are usually carried out by the companies operating in the emerging markets. In such a case, the volume and value of transaction firstly depends on how well the acquirer perceives, he would be able to gain value and secondly, the economic factors / market indicators of the target’s country. If cheap finance is available in target’s country and the regulations are supportive; the acquirer might prefer entering in to the deal. The Chinese economy has also been aggressively pursuing the merger strategy, particularly for the resources considered essential so as to compete globally on technology and military front. For example, China is looking for acquiring foreign rivals for circuits and chips and has successfully carried out acquisitions of OmniVision for $1.9 billion and NXP Semiconductor for $1.8 billion (8). Similarly, in Japan, the growth rate is 1% (9) and there are few opportunity to grow domestically, the mergers and acquisitions are considered as the preferred choice. Furthermore, the interest rate scenario in has been low ranging from 2.4% in 2006 to 1% in 2016.(9) However, the primary reason of the increasing foreign mergers in 2015 despite the low interest rate scenario for the last 10 years is the competitions offered by Chinese market and power struggle (sustainability) .Therefore, in case where the targets are driven by the aims and objective of the country and is fully backed; then the stance that the merger cycle occurs in a recurring cycle or when the market is peaked does not remain valid as the companies will go for merger transactions irrespective of the market condition so as to achieve the country’s desired target. The law of survival of fittest is also applicable and implemented in this case. The one who strikes the right deal at the right time is the ultimate beneficiary. The right time solely depends on the strategic position and the need of the company. It does not follow the notion that if the merger market is at its peak, that is the right time to go and enter in to the transaction. In the research conducted back in 2007 by University of Cantabria (10), it states that there is a quadratic relationship between acquirer’s return and the premium (amount paid for the acquisition of target which is in excess to the market value). The high premiums paid are perceived as high anticipated returns and supports the synergy hypothesis. However, where the premium is too high i.e 37% and above, there is a negative effect as the rate of return of the bidder is then affected. It is noteworthy, that high bid premiums are associated with Phase 3 of the cycle (refer table 1.1) where the mergers are at peak ,economy is improving and every other company is trying to utilize its idle resources or avail cheap financing and intends to enter in to a merger deal. Thus, the research in contrast of the high bid premium associated with peak phase suggests that in such cases acquirer loses as it may not be able to sustain. It has been usually observed that a functioning M&A team is usually deployed by big giants whose sole focus is to identify the targets and negotiate with them. Successful companies often formulate a set of acquisition criteria considering their needs. It has also been noted that the companies that merely react to the opportunities to purchase are less successful in acquisition than those having an overall strategy with a comprehensive plan. The mergers decisions are also driven by the people running the show. The charismatic board or a chief executive officer would go for the matter even if the odds are against him, provided he / she believes that this will contribute towards achieving the growth targets. The managers of change are the one who ensures that the process is carried out swiftly and the organizational structure and culture are realigned so as to be adaptable. The deal should not merely be a blind sail with the merger wave / cycle; rather it should always be consistent with the corporate goal. The reactive approach to the merger often lead to under/over assessment of the possible synergies / benefits and end up in to the backfire. Furthermore, in such a case; acquisition decisions are likely to be distorted by impulses and emotions and acquiring companies are victimized by the environment which typically surrounds purchase negotiations. However, proactive mergers (in accordance with the plan designed by strategists of the company) are the one which ultimately leads to its full potential reaping fruits for the stake holders of bidder firm. As per the Mckinsey Quarterly Report published in 1998, 116 merger cases were studied in detail where the success rate was only 23%. Among several factors justifying the failure, one of them was the fact that acquiring company had paid too much and is unable to generate sufficient cash flows so as to recover the investment made. The heavy payments made are mostly in the cases where the rosy picture is perceived by the company and the management agrees for a desperate move. In following the lead, company’s core requirements are not considered and it then turns out in to failure. One of the prime purposes of mergers is facilitation of the changing environment. The change in environment is usually driven by economic opportunity such as excess liquidity / cheap financing, change in regulations, technological enhancement etc. In case, any change in the variable creates high demand for a merger, the question arises whether a wave is created. The answer lies in that whether there is sufficient capability, competency and capital liquidity available. Thus, the market timings have little explanatory power to this merger phenomenon. Rather, as mentioned above; the innate needs of the company and its existing strength and weaknesses drive the phenomena. The economy is a cluster of several industries. This topology works in close isolation and the corporates along with the markets are influenced by the decisions taken by the competitors or the giants operating in the industry. Whenever, the merger activity triggers, it automatically creates an excitement in the industrial sector and activity starts. Some envious CEO’s at this time take desperate measures and enters in to a deal room. However, as discussed above the reactive approach usually does not work out. This process goes on for a while and wherever, a merger activity fails or a big player is dented, the complacency in the participants is then observed and the bubble bursts. This is how it goes on in case where the merger is not derived by strategic vision. Therefore, when it says that it occurs in a random fashion, it signifies the fact that the companies are more focused towards hitching a deal when it feels that the best way to grow exponentially is to integrate. The timing of the merger activities are hence the enduring mystery and the underlying reasons for each decade has been different. Considering the historical patterns there is no reason to believe that a single model exists to explain this phenomenon. References: (1) Richter, W. (2016), M&A boom Implodes, US deal failures in 2016 worst ever. http://wolfstreet.com/2016/04/07/end-of-boom-failed-us-mergers-acquisitions-2016-all-timerecord (2) Bort, J. (2016), US regulators have approved dell’s $67 billion purchase of EMC. http://www.businessinsider.com/us-approves-dell-and-emc-deal-2016-2 (3) Institute, I. and Mergers (2016), M&A US - mergers & acquisitions in the United States https://imaa-institute.org/m-and-a-us-united-states (4) Schumpeter, October 25, 2016; Riding the wave (5) Brodbeck, L. (2015), The 15 biggest mergers of all time. http://finance.yahoo.com/news/15biggest-mergers-time-175152979.html (6) Bloomberg.com. (2016). What's Behind the Decline in M&A Activity. https://www.bloomberg.com/news/videos/2016-06-06/what-s-behind-the-decline-in-m-a-activity (7) Lynn E. Browne and Eric S. Rosengren; The Merger Boom: An Overview https://www.bostonfed.org/-/media/Documents/conference/31/conf31a.pdf (8) Robert Cyan (December 30, 2015); US chipmaker etches path for chinese suitors .http://www.breakingviews.com/us-chipmaker-etches-path-for-chinese-suitors/ (9) Tradingeconomics.com. (2016). Japan Long Term Prime Rate | 1966-2016 | Data | Chart | Calendar | Forecast. http://www.tradingeconomics.com/japan/bank-lending-rate (10) Sergio Sanfilippo Azofra; 7th Global Conference on Business & Economics (October 13-14, 2007), Corporate takeovers in Europe : Do bidders overpay) -