M&A Is Heating Up in 2014
by Deborah Scally
Corporate Board Member
Third Quarter 2014
Corporate Board Member recently caught up with Patrick Ramsey, co-head of Americas M&A for Bank of America Merrill Lynch, to get a sense of his view of where strategic acquisition opportunities and challenges lie in the months ahead. Here’s what he had to say about the current state of the markets, along with his perspective on how to go about planning and executing a successful deal.
The M&A environment is absolutely on fire in 2014, particularly in the Americas. Dollar volume of activity was up nearly 60% in the first half versus last year, and it is running at a level higher than any year in the last decade other than 2007, which was the last peak. Megadeals ($10 billion plus) are a key factor, with twice as many announced this year compared with last— but overall deal activity is also up and accelerating.
The M&A uplift has been broad-based across nearly all sectors. However, health care and TMT (technology, media, telecom) have seen the steepest increase in activity this year. In fact, eight of the 10 largest deals have been in these sectors. Through the first half, TMT accounted for the largest share of global M&A activity at 24% (up from 22% last year), The number of deals announced greater than $500 million in size was up about 12% in the first quarter but nearly 40% in the second quarter over the respective quarters last year.
The key raw materials that have been in place over the last few years—receptive financing markets, historically low rates, relatively strong balance sheets, and high cash positions yielding little return—are still in place. Organic growth continues to be challenging amid a sluggish economic backdrop, driving increased emphasis on inorganic growth and consolidation opportunities.
What is most notable in the present environment is the strength of investor receptivity to smart, strategic deals. Stock price reaction of acquirers to announced deals in 2014 is on average positive, and higher than in any year over the past 20. That bolsters and reinforces confidence on the part of CEOs and directors and enhances their interest in pursuing strategic acquisition opportunities, including among those who are witnessing their peers successfully implement growth and expansion initiatives. with industrials following at 20% (up slightly from 19% last year) and health care at 18% (up from 10% last year).
Let’s talk about deal success and the factors that allow companies to make good decisions in this area. In a study we conducted earlier this year, nearly half of all responding directors told us they were not comfortable discussing M&A strategies with their shareholders, which was far less than with other topics, such as director qualifications and executive compensation issues. More than a third admitted they need better information and processes related to M&A to do their jobs effectively. In your experience, do you believe most board members are adequately prepared to react to M&A opportunities and make good strategic decisions related to M&A? Why is this a challenge for so many of them?
M&A strategy should be part of a broader, ongoing dialogue with shareholders on capital deployment. There should be a clear framework and discipline around how balance sheet capacity and free cash flow are deployed, whether toward organic investment, regular or special dividends, share repurchases, or M&A. Yet flexibility within this framework is also important, in particular as it relates to sizable M&A opportunities, which tend to be lumpy and less predictable or controllable from a timing standpoint. Best-in-class boards have a specific strategy/framework in place related to M&A, which necessarily evolves with time and in reaction to a changing landscape, so there should be periodic dialogue around it at the board level. Good directors make good strategic decisions when these practices are in place.
First, there are many, many more that are successful than unsuccessful. What varies, however, is the degree of success. For those that are less successful or truly unsuccessful, it usually comes down to one of three things: Bad strategy, poor integration, or unrealistic expectations. If the strategy behind the deal isn’t sound, shareholders are going to react negatively, and no matter how attractive the price or how strong the execution, a deal that isn’t strategically sound will never be a good deal. With regard to poor integration, it’s usually about not making the tough decisions quickly enough to achieve the cost or revenue synergies the deal economics are premised upon or not successfully retaining and motivating key talent, or both.
Finally, unrealistic expectations are just that—and this usually relates to the expected operating results for the business being acquired rather than the synergies.
I’d offer four points. First, be proactive, not reactive. Ensure there is a well-thought-out strategy/framework in place as it relates to M&A that is periodically discussed and refined at the board level. It should start with identifying areas of vulnerability and areas of opportunity, and it should follow with acquisition targets that offer the highest propensity to deliver in those areas. It’s important to keep in mind that those areas of vulnerability and opportunity will evolve with time as the industry structure evolves and based on M&A activity pursued by others. Months and years may pass before the right opportunity becomes available, but when it does, you want to be in a position to move quickly and decisively, so it shouldn’t be the first time the board is talking about the particular target.
Second, step back and ensure the strategic merits are sound. Apply the 30-second test: If you can’t clearly articulate the rationale for the deal in 30 seconds or less, the deal probably doesn’t make sense.
Third, ensure the “base case” forecast and synergy expectations that the valuation and pro forma consequences analyses are based on are reasonable—meaning a true 50/50 case, as likely to happen as not. For public company targets, equity research expectations can be a useful comparison and reference point when evaluating the base case forecast.
The fourth and final critical point relates to integration— making sure the top talent has been identified (and the right people pay attention to that top talent) and staying focused on the integration plan before and after close.