Making these kinds of bold investments when markets are in dire
straits might seem reckless to many managers. But our analysis of
more than 24,000 deals between 1996 and 2006 reveals that companies
that acquired through the last downturn (2001 to 2002) generated
almost triple the excess returns of companies that made
acquisitions during prior boom years.
The successful acquisitions ranged from $10 billion mega-deals
to relatively small transactions under $100 million. Among
industries, the largest increases in excess returns occurred in
health care and consumer products; the smallest gains were posted
in the utilities and telecoms sectors. But, significantly, the
finding of good deals in bad times—higher excess returns on deals
completed during the downturn—held true across all industry
segments.
Nor was this simple market timing. We also found that executives
who buy during good times and bad significantly outperform the
opportunists. Think of it as 'corporate-dollar cost averaging.'
As a staging ground for improving competitive position through
mergers and acquisitions, the current wave of economic volatility
has several things going for it. True, credit markets are tight,
but corporate balance sheets are generally strong. With the 2007
S&P 500 cash-to-sales ratio almost three times what it was 20
years ago, corporate cash balances are flush and equity is a viable
deal currency.
Moreover, with private equity deal volume down almost 80% last
quarter, even the big private equity funds are less likely to bid
up prices. Indeed, there's a lull in deal activity, with M&A
deal volume down roughly 20% last quarter vs. the first quarter of
2007, and value off by some 25%.
Amid widespread retrenchment, it is hard for most executives to
be contrarian. Funding constraints and the lack of operational and
financial leverage can make aggressive CEOs turn wary. Yet, as
Novartis demonstrated with its installment purchase of Alcon,
announced April 8, creative financing can enable a strategic
acquisition—especially when there is no immediate need for
cash.
The necessary precondition to a successful deal in periods of
turbulence is a well-calibrated compass that shows the long-term
direction of the company and a thoroughly analyzed set of options
to get you there.
To do such transactions, managers need equal measures of
confidence and thoughtfulness. Spectacular failures occur when
companies attempt to buy false bargains. Think of Dynergy's
proposed acquisition of Enron. In late 2001, market turbulence and
fraud had brought Enron low. Dynegy thought it could buy a
distressed asset cheap. Fortunately for Dynegy, the deal never was
consummated.
The best turbulence deals allow companies to buy capabilities or
market positions that would take years and major investments to
create. General Dynamics, Johnson & Johnson, and Wells Fargo
have also built strong competitive positions by buying throughout
the business cycle.
More than impeccable timing, these companies have developed a
well-articulated corporate strategy, coupled with an in-house
capability covering the four major steps in the deal—strategy,
negotiation, diligence and integration.
More and more, companies are adopting this pattern to become
serial buyers: In the period from 1987 to 1991, only about 20% of
S&P 500 companies closed an average of 1.5 deals or more per
year. From 2002 to 2006, that number rose to almost 40% doing an
average of 1.5 deals each year.
At Danaher, another company with a systematic approach to
M&A, managers use a mix of 'new-platform investments' and
bolt-on acquisitions to drive growth. During the last recession,
Danaher made 10 significant acquisitions. The U.S. conglomerate,
best known for making Craftsman tools, closed two particularly
strategic transactions with London-based Marconi plc.
In December 2001, Danaher purchased Marconi Commerce Systems
(now known as Gilbarco), which strengthened its environmental
offerings for the petroleum industry. Today, environmental systems
amount to Danaher's second-most profitable business. Late that same
year, Danaher also bought Marconi's Videojet, establishing a whole
new platform in product coding and identification equipment.
This business has since grown to become Danaher's third-most
profitable line. The payoff came during the subsequent recovery, as
Danaher's stock outperformed the S&P 500 index by three-to-one.
Indeed, M&A has become a growth engine for Danaher. Over the
last five years, acquisitions contributed about two-thirds of
Danaher's average annual sales growth of 20%.
JPMorgan understands this disciplined approach to M&A
through market oscillations. The bank's executive team was able to
commit to acquiring an incremental $1 billion of earnings capacity,
even after meeting shareholder demands to raise the price once the
initial deal was signed, because they knew exactly what they
needed.
What's more, investors apparently believe in the Bear Stearns
deal, and have since bid up JPMorgan's stock price, even as it
reported a 50% decline in earnings April 16. By being in a similar
position to act, companies can actually take advantage of
turbulence.
David Harding and Ted Rouse are co-leaders of Bain &
Company's Global Mergers & Acquisitions Practice. Bart Vogel is
a Bain & Company partner based in Sydney.
