Monday, April 27, 2015

Here We Go Again?

The best of deals are made in the worst of times while the worst deals are made in the best of times. We may be seeing a replay of this mantra in the current M&A market. Coming off a deep post crash low, M&A activity has sharply rebounded. This reflects a recovering economy, booming capital markets and rising managerial and investor optimism. The activity is driven by strategic buyers instead of private equity. The number of large deals over $5B has also increased. Larger deals are froth with danger given the potential to over pay and heightened integration problems associated with larger deals. The buyer’s shareholders usually react negatively to the announcement of such deals-and for good reason. Their track record underlies this reaction; namely, 50% of targets are disposed of within 10 years of the closing.

Yet, such deals are now receiving a largely positive response from the buyer’s shareholders. Some possible explanations for this development include:

1)     Buyers are getting better at making acquisitions (AKA this time is different).I have seen no evidence to support this possibility.
2)     We are early in economic and M&A cycles. Thus as the cycle continues we will see mean reversion.
3)     Shareholders are confusing size and growth with value creation.

My concern is a toxic brew may be developing. This brew includes investor bias towards growth combined with managerial overconfidence. Board selection of CEOs favors over confident CEOs who are viewed as decisive optimists. The process favors the lucky risk taker with a “successful” track record -think of past Hewlett Packard CEOs Carly Fiorina and Leo Apotheker who both engineered disastrous acquisitions.
So what can boards do to prevent future over priced ill conceived acquisition disasters? It is unlikely subordinates will question CEO’s who want to do the deal. What is needed is a strong experienced lead independent director who can challenge-not second guess- large scale transactions by considering the following:

1)     Does due diligence support the deal’s thesis?
2)     Is there a detailed integration plan based on the strategic rationale of the deal?
3)     Have competitor responses been considered?
4)     How will changing economic and industry conditions impact deal economics?
5)     Are CEO incentives tied to the success of the acquisition?

The real key is to run alternative stress case projection scenarios reflecting what could go wrong not just what is expected. A useful approach is to consider what could cause your deal to fail financially in the next few years. If you cannot think of any - then think again - they are out there.


No comments:

Post a Comment