Mergers and acquisitions (M&A) activity is on the rise worldwide. In the U.S., this increase has been accompanied by the return of mega-deals (exceeding $10 billion in value) driven primarily by large multi-national corporations flush with cash. These deals (and the anticipation of more to come) have helped drive markets up in the first quarter of this year.But the question on the minds of many investors is whether acquiring companies are at risk of overpaying for acquisitions that"”while deemed "strategic""”may only end up transferring (not creating) value from shareholders of the acquiring to the acquired companies.
A Busy Year-to-DateThe table below summarizes the 30 largest (based on announced value) mergers, acquisitions and divestitures"”in the case of businesses being spun off from corporations to shareholders"”year-to-date through May 16. As the final column of the table indicates, nearly all of these deals are still pending and might be rejected (by shareholders or regulatory authorities) or renegotiated with respect to value or payment type. Ten of the 30 transactions listed qualify as mega-deals given their size. In addition, 21 of the acquiring companies are U.S.-based corporations or investment entities.
Perhaps most interesting is the payment type column for these 30 deals. Despite the robust performance of equity markets over the past two years, only five of the 30 deals are stock-only transactions (i.e., an exchange of shares between the acquiring company and the acquired company's shareholders). Instead, in 22 of the transactions, cash is a key component of payment for the acquired company. And in 15 of the 29 shown where we have details on the payment type, the transaction is all cash-based.
The types of deals shown run the gamut of industries and sectors including energy (e.g., Duke Energy and Progress Energy), health care (Johnson & Johnson and Synthes, Inc.), materials (DuPont and Danisco A/S), commercial real estate (Blackstone Group and Centro Retail Group), telecommunications (AT&T and T-Mobile), mining & minerals (Arch Coal and International Coal), consumer services (Hertz and Dollar Thrifty) and information technology (Texas Instruments and National Semiconductor). Most of these deals can be classified as either business or industry consolidations (e.g., AT&T and T-Mobile, Hertz and Dollar Thrifty or Arch Coal and International Coal), or strategic extensions into new or related businesses (e.g., Microsoft and Skype, or DuPont and Danisco).
Largest Mergers and Acquisitions Year-to-Date (Through May 16) Announce Date Target Name Acquirer Name Announced Value (Bill$) Payment Type Deal Status March 20 T-Mobile USA Inc AT&T Inc $39.0 Cash and Stock Pending January 10 Progress Energy Inc Duke Energy Corp $25.5 Stock Pending August 29 Genzyme Corp Sanofi $19.6 Cash Complete April 27 Synthes Inc Johnson & Johnson $19.4 Cash and Stock Pending January 31 ProLogis AMB Property Corp $16.5 Stock Pending May 9 MAN SE Volkswagen AG $15.9 Cash Pending April 3 Societe Francaise du Radiotelephone Vivendi SA $11.3 Cash Pending May 16 Nomura Tochi Tatemono Co Ltd Nomura Holdings Inc $11.0 Cash Pending April 28 Constellation Energy Group Inc Exelon Corp $10.2 Stock Pending February 15 NYSE Euronext Deutsche Boerse AG $9.5 Stock Pending March 1 U.S. Malls of Centro Retail Group Blackstone Group LP $9.4 Cash Pending March 14 Lubrizol Corp Berkshire Hathaway Inc $9.2 Cash Pending May 10 Skype SARL Microsoft Corp $8.5 Cash Pending February 7 Pride International Inc Ensco PLC $8.5 Cash and Stock Pending January 29 Massey Energy Co Alpha Natural Resources Inc $8.3 Cash and Stock Pending January 18 The Mosaic Co. Private Investors $8.1 Undisclosed Pending April 8 EDF Energies Nouvelles SA EDF SA $7.9 Cash or Stock Pending February 15 Family Dollar Stores Inc Trian Fund Management LP $7.7 Cash Pending April 25 Equinox Minerals Ltd Barrick Gold Corp $7.7 Cash Pending January 9 Danisco A/S EI du Pont de Nemours & Co $7.1 Cash Pending February 16 Cia Espanola de Petroleos SA Int't Petroleum Investment Co $7.0 Cash Pending February 7 Beckman Coulter Inc Danaher Corp $7.0 Cash Pending February 28 Nationwide Health Properties Inc Ventas Inc $6.8 Stock Pending April 4 National Semiconductor Corp Texas Instruments Inc $6.4 Cash Pending March 7 Hitachi Global Storage Technologies Western Digital Corp $4.3 Cash and Stock Pending May 2 International Coal Group Inc Arch Coal Inc $3.1 Cash Pending January 5 Atheros Communications Inc QUALCOMM Inc $2.9 Cash Pending April 11 Global Crossing Ltd Level 3 Communications Inc $2.5 Stock Pending April 5 Pringles Business (P&G) Diamond Foods Inc $2.4 Stock Pending May 9 Dollar Thrifty Automotive Group Inc Hertz Global Holdings Inc $2.1 Cash and Stock PendingSource: Bloomberg Notes : (1) All deals remain pending as of May 16 except for Genzyme/Sanofi (2) The Pringles Business seller was Procter & Gamble (3) The Mosaic Company seller was Cargill, Inc. (4) The T-Mobile USA seller is Deutsche Telekom AG
What's Driving the Increase in Activity?As noted earlier, many large corporations and businesses are flush with cash after their remarkable recovery from the Great Recession. Due to tight cost controls and limited hiring of new employees, their operating and profit margins have rebounded dramatically. And because (at least here in the U.S.), aggregate demand and capacity utilization have not fully recovered from the recession, they have limited the amount of operating and free cash flow spent on capital investment and expansion. The result (as the chart below illustrates) is that U.S. nonfarm, nonfinancial businesses have seen their short-term liquid assets grow to over $1.8 trillion by the end of the fourth quarter last year. If we normalize this value as a percent of total balance sheet assets, it reached 7% in the fourth quarter, which is its highest level in 49 years.
There are a number of reasons why this high level of short-term investments on the balance sheets of businesses has led to a substantial uptick in M&A activity. One reason is financial markets do not reward businesses (in terms of stock price appreciation) for sitting on unused and uninvested ca
Mergers and acquisitions (M&A) activity is on the rise worldwide. In the U.S., this increase has been accompanied by the return of mega-deals (exceeding $10 billion in value) driven primarily by large multi-national corporations flush with cash. These deals (and the anticipation of more to come) have helped drive markets up in the first quarter of this year.But the question on the minds of many investors is whether acquiring companies are at risk of overpaying for acquisitions that"”while deemed "strategic""”may only end up transferring (not creating) value from shareholders of the acquiring to the acquired companies.
The table below summarizes the 30 largest (based on announced value) mergers, acquisitions and divestitures"”in the case of businesses being spun off from corporations to shareholders"”year-to-date through May 16. As the final column of the table indicates, nearly all of these deals are still pending and might be rejected (by shareholders or regulatory authorities) or renegotiated with respect to value or payment type. Ten of the 30 transactions listed qualify as mega-deals given their size. In addition, 21 of the acquiring companies are U.S.-based corporations or investment entities.
Perhaps most interesting is the payment type column for these 30 deals. Despite the robust performance of equity markets over the past two years, only five of the 30 deals are stock-only transactions (i.e., an exchange of shares between the acquiring company and the acquired company's shareholders). Instead, in 22 of the transactions, cash is a key component of payment for the acquired company. And in 15 of the 29 shown where we have details on the payment type, the transaction is all cash-based.
The types of deals shown run the gamut of industries and sectors including energy (e.g., Duke Energy and Progress Energy), health care (Johnson & Johnson and Synthes, Inc.), materials (DuPont and Danisco A/S), commercial real estate (Blackstone Group and Centro Retail Group), telecommunications (AT&T and T-Mobile), mining & minerals (Arch Coal and International Coal), consumer services (Hertz and Dollar Thrifty) and information technology (Texas Instruments and National Semiconductor). Most of these deals can be classified as either business or industry consolidations (e.g., AT&T and T-Mobile, Hertz and Dollar Thrifty or Arch Coal and International Coal), or strategic extensions into new or related businesses (e.g., Microsoft and Skype, or DuPont and Danisco).
Source: Bloomberg Notes : (1) All deals remain pending as of May 16 except for Genzyme/Sanofi (2) The Pringles Business seller was Procter & Gamble (3) The Mosaic Company seller was Cargill, Inc. (4) The T-Mobile USA seller is Deutsche Telekom AG
As noted earlier, many large corporations and businesses are flush with cash after their remarkable recovery from the Great Recession. Due to tight cost controls and limited hiring of new employees, their operating and profit margins have rebounded dramatically. And because (at least here in the U.S.), aggregate demand and capacity utilization have not fully recovered from the recession, they have limited the amount of operating and free cash flow spent on capital investment and expansion. The result (as the chart below illustrates) is that U.S. nonfarm, nonfinancial businesses have seen their short-term liquid assets grow to over $1.8 trillion by the end of the fourth quarter last year. If we normalize this value as a percent of total balance sheet assets, it reached 7% in the fourth quarter, which is its highest level in 49 years.
There are a number of reasons why this high level of short-term investments on the balance sheets of businesses has led to a substantial uptick in M&A activity. One reason is financial markets do not reward businesses (in terms of stock price appreciation) for sitting on unused and uninvested capital. In some valuation models, idle short-term investments can even be valued at a discount (e.g. $0.80-0.90 contribution to the share price of every dollar of these investments per share on the balance sheet). That provides management with a motive to do something with this money.
Of course, one use could be to increase dividend payments. But there are tax consequences to many shareholders for higher dividend payments. And there are tax consequences to companies as well. U.S. multinational corporations earn income in a wide variety of countries. While these earnings are taxed at the local (country) level, they face an additional level of taxation if they are repatriated back into the U.S. The consequence of this double taxation is that U.S. corporations will often seek to employ the cash generated by international operations as part of overseas business investment or international M&A activity. Company management is also reluctant to increase dividends beyond what they project is their long-term sustainable growth rate. In many cases it turns out that paying out today's hoards of cash (in terms of a dividend increase"”not a one-time special dividend payout) is well beyond what many companies believe are their long-term sustainable dividend growth rates.
Another reason for the uptick in M&A activity is that many companies are still reasonably priced based on historical ranges for common valuation multiples (such as price to earnings or price to book value) despite the substantial increase in most stock market indices since early 2009. A final reason why unused cash can lead to M&A activity is simply management believing its job is to do something"”and more specifically, something big. In many cases, this can be justified strategically by the drive to consolidate and strengthen competitive position or expand into higher margin and higher growth business areas.
But history is replete with case studies where management either overpaid for what they acquired or had no idea how to capture the synergies a major acquisition was supposed to deliver. (Business synergies occur when the combination of two entities yields more than the sum of their respective values). Classic examples include Quaker Oats paying $1.7 billion to acquire Snapple in 1994 (Quaker sold it 27 months later for only $300 million), Sprint acquiring a majority stake in Nextel for $35 billion in 2005 (three years later the company took a $30 billion write-off due to the acquisition), and"”perhaps the granddaddy of them all"”the 2001 megamerger of AOL and Time Warner for $165 billion that was going to dominate the internet for years to come (but reported a $99 billion loss one year later).
While mega-deals by major multinational corporations capture the headlines and attention of the public, the great majority of M&A activity is much smaller in terms of deal size and is increasingly focused outside the U.S. The chart below illustrates a rolling four-quarter plot for the value of M&A deals for the Americas (primarily the U.S.) and the world. In the year 2000, the Americas accounted for approximately 60% of worldwide deal value and 40% of the number of transactions. Today, those figures have declined to 45% of worldwide value and 30% of total number.
One country responsible for this trend is China. Earlier this year, JPMorgan forecast that China would account for 8-9% of global M&A activity in 2011, up from the 2-4% it averaged between the years of 2003 and 2007. Industry consolidation among domestic competitors is likely to account for much of this activity. In fact, the Chinese government is behind much of this planned activity as it has emphasized consolidation in basic industries such as mining, chemicals, steel and power. And with the beginning of the country's new (12th) five-year plan starting next year, the pace of consolidation (intended to create fewer, larger and globally competitive companies in key industries) is expected to accelerate. (To wit, the country currently has over 1,000 coal mining companies; the goal of the next five-year plan is to consolidate this number down to 10 large companies each with a production capacity of 100 million tons annually.)
Worldwide, the level of M&A activity in the first quarter of 2011 well exceeded first quarter 2010 levels for all the industries and sectors shown in the chart below. Basic industries such as energy and power, materials, and industrials have seen substantial increases in activity primarily in developing regions and countries, while consolidation in the financials sector has been more focused on developed countries as a result of the banking and financial crisis that began in 2008.
Even when a merger or acquisition makes sense strategically (and is well integrated and managed after the deal), its ultimate success in creating shareholder value hinges on how much was paid. The chart below plots average premiums paid for M&A activity both in the U.S. and worldwide from 2000 to the first quarter of this year. (The premium paid is the amount the acquiring company pays over the market value of the target acquisition prior to the bid to purchase.) Historically, premiums in the U.S. have been higher partly because the deals have been larger and shareholders of the acquired company have demanded adequate premiums as incentive to agree to the deal. However, in recent years this gap has narrowed and disappeared as M&A activity outside the U.S. has become more prevalent, more competitive and involved larger target entities.
The other trend worth noting in the chart above is how the average premiums paid for deals has been on an upward trend since 2008 and are nearing the highs we saw back in 2000 and into 2001. That is a cautionary sign for investors since there is a herd-like tendency for company management (generally) to engage in M&A activity and pay higher premiums when they observe their peers and competitors doing so. One recent deal which turned heads and suggested this type of behavior was Microsoft's recent bid to acquire Skype for $8.5 billion in cash. With revenues of $860 million, operating profit of $264 million and net loss of -$7 million last year, the offer was clearly a "rich" one for Skype by Microsoft. In addition, eBay had bought the company in 2005 for $3.1 billion and later sold a majority of its interest in 2009 to private investors for $1.9 billion.
Perhaps there are substantial synergies to be leveraged through the combination of Skype and Microsoft. But more generally, investors should pay heed to how both the number and value of deals being done, and premiums paid are all on the rise"”suggesting (if history repeats itself) that some of these current deals may become future case studies in how and why M&A activity can reduce shareholder value too. Today's availability of record levels of short-term investments on the balance sheets of U.S. corporations is both an opportunity and risk for company management and their shareholders.
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