No surprise to learn that in the first quarter of this year, there was a reduced appetite amongst boardroom directors for M&A deals. Partly due to the banks resistance to lend money to fund takeovers whilst in the midst of a 'credit crunch'.
However, those funds (i.e. sovereign wealth) and businesses with considerable cash reserves would be well advised to increase their mergers and acquisitions focus.
Research recently undertaken by BCG (Boston Consulting Group) shows that M&A activity in the lower levels of the economic cycle delivers superior shareholder value for both sellers and buyers over the long term. The BCG report was based on an analysis of over 400,000 deals conducted over the last 27 years and placed a special emphasis on just over 5000 corporate divestments. To summarise, "downturn deals have a higher chance of creating shareholder value and delivering greater returns."
Downturn deals are those M&A deals transacted during periods of slow growth (that is, less than 3& per year) or recessions. They are "twice as likely to produce long-term returns in excess of 50 percent and, on average, create 14.5 percent more value for shareholders of the acquirer.
Company divestments have a higher probability of success for buyers than the purchase of whole companies and can also create substantial value for the vendors. Sellers’ overall returns for sellers from divestitures are on average 1.5%. This rose by 13% to 1.7% during periods of economic downturn, “suggesting that it is a good idea to clean up portfolios during downturns.”
On average, 58% of buyers of divested assets generate positive returns, compared with 42% of buyers of whole companies.
However, anyone thinking along residential property lines and hoping that by simply buying up businesses on the cheap when times are bad and selling them at a profit later on, is likely to be disappointed. The report found that the long-term advantage of downturn deals is due to more complex reasons. During tough times, businesses evaluate potential targets with a more critical and objective eye. They can more readily recognise businesses with unfulfilled potential. Downward cycles where there is ready cash available is a plus, and we are in one right now. In aggregate, businesses have approximately 60% more cash reserves than they had at the very peak of the last mergers and acquisitions boom of 2000.
The key to success for potential buyers is focusing on the right types of companies: typically those with strong finances and relatively weak profitability.
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