They touch of death Corporate America’s single largest M&A experiment sounded in November 2021 when General Electric announced its intention to split into three. Jack Welch, his notoriously enthusiastic boss, closed thousands of deals and ran the US financial and industrial giant from 1981 to 2001. The pace did not slow under his successor, Jeffrey Immelt. The result has been a monumental destruction of shareholder wealth. The company’s market value peaked at $594 billion in 2000. Today it’s a relatively measly $83 billion.
Despite this lesson, bosses just can’t shake the urge to shake hands. In 2021, the urgency reached a fever pitch: a record $5.9 trillion worth of deals were announced globally, $3.8 trillion by operating companies and the rest by private equity funds and acquisition companies with special purposes (see graph). Competition for assets was fierce and due diligence frantic. The cost of capital was historically low and buyers paid premium prices, with a record median valuation of 15.4 times earnings before interest, taxes, depreciation and amortization (ebitda), according to Bain, a consultancy. The number of deals for highly valued tech firms skyrocketed, accounting for a quarter of total volume.
If history is any judge, many of these transactions will destroy value. It’s easy to spot disastrous deals: large write-downs of goodwill or even bankruptcy are helpful signals. But measuring the performance of an average deal is difficult; Relative stock price performance is a quick but noisy measure and asking a hypothetical “what if” question is a crystal ball. A recent review of the academic literature by Geoff and J. Gay Meeks at the University of Cambridge estimates that only a fifth of studies conclude that the average deal produces higher combined earnings or increases the wealth of the acquirer’s shareholders. McKinsey, another consultancy, calculated that companies seeking big deals between 2010 and 2019 had only one chance to generate excess shareholder returns. Enough to deter average Joes from making deals, but not budding Neutron Jacks.
Those chances of success are further reduced by the circumstances in which the latest crop of deals was closed. Busy times like last year are particularly bad for finding suitable buyers and sellers. Negotiation tends to snowball when CEOs, eager to expand their domains (and compensation), watch others make their moves and cannot sit idly by while competitors win hay. Unprecedented competition from private equity funds only intensifies the need to move fast. To aggravate their zeal are the intermediaries. Investment bankers, who are paid by the deal rather than by the hour, convince them that anything is possible: Flattery is strong currency in the advice market.
There are few brakes on this train. Where activist investors can agitate on the sell side of a transaction for a higher price (often successfully), this type of scrutiny is less common on the buy side. Strong shareholder dissent in reaction to Unilever’s failed $66 billion bid for gskThe December 2021 consumer healthcare division is a very rare example of owners holding trigger-happy management accountable. Today the division, called Haleon, is listed on the London Stock Exchange, valued at around half of Unilever’s offering.
The result has been ambitious deals made at high prices. Lower asset values are already exposing the faulty logic of some beaten at the top of the market. In August, Just Eat Takeaway.com, a European food delivery company, announced a writedown of Grubhub, its distracting American misadventure, by $3.3 billion, just one year after completing the $7.3 billion deal. .
As stock markets fell this year, the forced weddings announced in 2021 were consummating. After the excitement of courtship begins the hard task of post-merger integration. This complex process is the domain of consultants, organization charts, and budgets, rather than backroom negotiations and forceful projections. It is being turned upside down by a combination of inflation and slowing growth. The bosses bet big that higher prices would be justified by higher profits. They are now running new businesses in a new world.
Buyers tend to overestimate the operating benefits of bringing two companies together (“synergies” in corporate parlance). Often promised but rarely fully delivered, these projections persuade bosses that the pin factory is better off in their hands than the financial wizards of private equity. The scale was fixed idea of deals during 2021. Such deals are generally anticipated in a sharp cost reduction, which is much more difficult as inflation rises. Add today’s supply chain chaos to yo-yo input costs, and managers will soon find their powers dwindle.
That difficulty is evident at Warner Bros Discovery, an American media giant formed in April 2022 through the merger of Discovery and WarnerMedia. In an industry that ranks among the worst for achieving such goals, came the promise of $3 billion in annual savings. Rising costs and cyclical pressures on ad revenue mean the integration will be more difficult than planned. expectations for ebitda in 2023 it is now $12 billion, up from $14 billion when the merger was announced. The response of David Zaslav, the head of the firm, has been to tighten the nuts even more.
Labor is often the first cost bosses turn to, even if many layoffs increase the chance of breakups among new bedfellows. Many of the most spectacular outbursts have involved rejection of the cultural transplant at the highest levels, although as in wow and Time Warner’s ill-fated $165 billion merger in 2001, this is often a symptom rather than a cause of a strategic mismatch. The real risks, however, occur further down the food chain, as labor markets continue to roil. The ability to retain good workers (“talent” in the integration dictionary) is critical. It ranks high on the list of reasons deals are successful in a recent Bain survey.
The war for talent has quickly turned into a big hiring freeze in the tech sector, but elsewhere labor shortages are the norm. The integration of the Canadian Pacific Railway and Kansas City Southern, a $31 billion deal announced in September 2021, has significant challenges ahead. their final regulatory stamps. The 1968 merger of the Pennsylvania and New York Central Railroad provides a warning from history. Shortly before the bankruptcy of the new entity in 1970, an internal report highlighted the role of high staff turnover in its failed integration: 61% of train masters, 81% of transport superintendents and the 44% of division superintendents had less than a year
The 2021 negotiators entered the current inflationary period with a high bar to clear to justify the top-tier deals they struck. For now, the mega-disasters of this wave of mega-operations are a matter of speculation, although no one doubts that they will emerge. Even this won’t be enough to convince bosses to kick their deal-making habit, at least as long as corporate balance sheets remain strong. Activity has been remarkably resilient in 2022. Until bosses can be persuaded of other uses for their profits, new challenges mean only new kinds of deals. At least this year there may be some bargains. ■
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