CEO Forum

Bad times and good deals

Times of economic turbulence can present some of the best opportunities to improve a company's...

By Bart Vogel, David Harding and Ted Rouse

First published on Ιουνίου 01, 2008
min read


The markets recently took note of JPMorgan Chase's better-than-expected earnings, but they may have overlooked a telling point: Acquiring Bear Stearns was more than just a price coup for JPMorgan Chase; it also neatly filled in valuable pieces for its long-term strategy. Only last February, JPMorgan told investors it needed investment-banking capabilities—like those of Bear Stearns—to meet its growth goals. Of course, JPMorgan Chase's quick action benefited from a unique set of circumstances. But it underscores that—for executives with the right combination of readiness, prudence, and guts—economic turbulence actually presents some of the best opportunities to fill capability gaps, gain market share and change a company's competitive position. 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.

The markets recently took note of JPMorgan Chase's better-than-expected earnings, but they may have overlooked a telling point: Acquiring Bear Stearns was more than just a price coup for JPMorgan Chase; it also neatly filled in valuable pieces for its long-term strategy. Only last February, JPMorgan told investors it needed investment-banking capabilities—like those of Bear Stearns—to meet its growth goals.

Of course, JPMorgan Chase's quick action benefited from a unique set of circumstances. But it underscores that—for executives with the right combination of readiness, prudence, and guts—economic turbulence actually presents some of the best opportunities to fill capability gaps, gain market share and change a company's competitive position.

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.