Business Day

Cash-rich companies go hunting for acquisitions

With such large cash reserves, South African firms have been on the hunt for merger and acquisition (M&A) opportunities.

By Athol Williams and John Sequeira

Published on August 19, 2010
min read


Deals made during turbulent times are often top performers. Many domestic companies are emerging from the economic downturn in a strong competitive position: they are cash-rich. Even at the height of the global financial crisis last year, the top companies on the JSE were sitting on a cash stockpile that totalled R397bn. With such large cash reserves, South African firms have been on the hunt for merger and acquisition (M&A) opportunities. In fact, M&A deals in SA more than doubled in the first half of this year from the same period last year. One of the largest deals is the proposed merger of FirstRand's Momentum with Metropolitan Holdings to create a large new South African insurance group. The deal, worth an estimated R30bn, would be a strategic win-win. Momentum, a high-end player, would tap into the faster-growing lower to middle market served by Metropolitan. For its part, Metropolitan will gain access to the more complex products it needs to better serve black South Africans who are amassing new wealth. Together, they can more effectively go up against their two largest competitors that offer life insurance across the spectrum. Deals made during turbulent periods are often top performers. A Bain analysis of more than 24000 deals executed from 1995 to 2005 shows that acquisitions completed during or just after the 2001-02 recession generated almost triple the excess returns of acquisitions made during the preceding boom years. The term "excess returns" refers to shareholder returns from four weeks before to four weeks after the deal, compared with peers. This was true regardless of industry or deal size. Meanwhile, many companies are also getting better at M&As. In 1995, about 50% of US mergers underperformed their industry index. Ten years later the figure was about 30%. This may be due to more experienced frequent acquirers and the increasing use of cash, rather than stock, to finance deals, which seems to encourage better due diligence and more realistic prices. But even in the best of times, many strategically sound deals fail to live up to expectations. Often, the fault lies in post-merger integration missteps. Many acquirers forfeit large amounts of value because of three big stumbles: missed targets; loss of key people; and poor performance in the core business. The failure to define a deal's payoffs—and risks—in clear terms shows there are no clear integration priorities, which leads to missed targets. Understanding whether deals are to boost "scope" or "scale" is vital. Scope deals require fostering some capabilities of the acquired company and integrating where it matters most. For example, computer hardware maker Dell's acquisition of Perot Systems was a move aimed at moving up into more profitable lines of business. In contrast, scale deals focus on combining two similar firms for maximum efficiency. Thus, merging companies such as Momentum and Metropolitan requires a skilful integration plan to deliver the full benefits of the deal's scope (new markets and product offerings) and scale (combining back-office operations). The key is less integration on the front end to preserve brand quality and client relationships while looking for ways to cut costs on the back end by consolidating IT, customer service call centres and clerical work. When it comes to people issues, many companies delay organisational and leadership decisions. In the interim, key personnel are at risk of being hired away by rivals. Experienced acquirers earn a reputation for retaining the best people—and creating opportunities for them. They go the extra mile to build confidence among employees of the acquired business. Poor performance in the core business occurs when integration soaks up too much energy or drags on, distracting managers from the core business. Ideally, at least 90% of the organisation should be focused on its core, with clear targets and incentives to keep those businesses humming. Veteran acquirers have the best record for avoiding these missteps. Consider US-based Danaher Corporation, once a tiny industrial tool-maker that has grown into a conglomerate. Using a repeatable M&A model, Danaher purchased diverse industrial businesses at reasonable prices and consistently boosted earnings and cash flow. Even before closing the deal, Danaher's M&A model maps all the processes based on key financial metrics. Despite the downturn last year, Danaher continued to make acquisitions totalling $1,1bn. Bain studies show that frequent acquirers such as Danaher consistently outperform infrequent acquirers by getting the integration process right and making it a core competency. If you had invested $1 in each group, the returns from the frequent-acquirer group would be 25% greater than the infrequent group over 20 years. Meanwhile, Bain research has found that as cross-border deals increase, their rate of success is similar to domestic deals, but integration typically is more complex. Among the unique challenges are: tailoring the integration thesis to each region's circumstances; quickly tackling actual and perceived cultural differences; and accounting for geographically dispersed operations and stakeholders as well as complex legal and regulatory frameworks that can derail integration. As cash-flush companies in SA pursue M&A opportunities, winning acquirers will work to prevent post-merger integration missteps. That is the best way to ensure that promising acquisitions deliver on their potential. Failure to define a deal's payoffs and risks in clear terms shows there are no clear integration priorities Athol Williams is a Bain & Company partner based in Johannesburg. John Sequeira, head of Bain's Mergers & Acquisitions practice in Asia, is based in Hong Kong.

Deals made during turbulent times are often top performers. Many domestic companies are emerging from the economic downturn in a strong competitive position: they are cash-rich.

Even at the height of the global financial crisis last year, the top companies on the JSE were sitting on a cash stockpile that totalled R397bn.

With such large cash reserves, South African firms have been on the hunt for merger and acquisition (M&A) opportunities. In fact, M&A deals in SA more than doubled in the first half of this year from the same period last year.

One of the largest deals is the proposed merger of FirstRand's Momentum with Metropolitan Holdings to create a large new South African insurance group. The deal, worth an estimated R30bn, would be a strategic win-win. Momentum, a high-end player, would tap into the faster-growing lower to middle market served by Metropolitan.

For its part, Metropolitan will gain access to the more complex products it needs to better serve black South Africans who are amassing new wealth. Together, they can more effectively go up against their two largest competitors that offer life insurance across the spectrum.

Deals made during turbulent periods are often top performers. A Bain analysis of more than 24000 deals executed from 1995 to 2005 shows that acquisitions completed during or just after the 2001-02 recession generated almost triple the excess returns of acquisitions made during the preceding boom years.

The term "excess returns" refers to shareholder returns from four weeks before to four weeks after the deal, compared with peers. This was true regardless of industry or deal size.

Meanwhile, many companies are also getting better at M&As. In 1995, about 50% of US mergers underperformed their industry index. Ten years later the figure was about 30%.

This may be due to more experienced frequent acquirers and the increasing use of cash, rather than stock, to finance deals, which seems to encourage better due diligence and more realistic prices.

But even in the best of times, many strategically sound deals fail to live up to expectations. Often, the fault lies in post-merger integration missteps.

Many acquirers forfeit large amounts of value because of three big stumbles: missed targets; loss of key people; and poor performance in the core business.

The failure to define a deal's payoffs—and risks—in clear terms shows there are no clear integration priorities, which leads to missed targets.

Understanding whether deals are to boost "scope" or "scale" is vital. Scope deals require fostering some capabilities of the acquired company and integrating where it matters most.

For example, computer hardware maker Dell's acquisition of Perot Systems was a move aimed at moving up into more profitable lines of business.

In contrast, scale deals focus on combining two similar firms for maximum efficiency.

Thus, merging companies such as Momentum and Metropolitan requires a skilful integration plan to deliver the full benefits of the deal's scope

(new markets and product offerings) and scale (combining back-office operations).

The key is less integration on the front end to preserve brand quality and client relationships while looking for ways to cut costs on the back end by consolidating IT, customer service call centres and clerical work.

When it comes to people issues, many companies delay organisational and leadership decisions. In the interim, key personnel are at risk of being hired away by rivals. Experienced acquirers earn a reputation for retaining the best people—and creating opportunities for them.

They go the extra mile to build confidence among employees of the acquired business.

Poor performance in the core business occurs when integration soaks up too much energy or drags on, distracting managers from the core business. Ideally, at least 90% of the organisation should be focused on its core, with clear targets and incentives to keep those businesses humming.

Veteran acquirers have the best record for avoiding these missteps. Consider US-based Danaher Corporation, once a tiny industrial tool-maker that has grown into a conglomerate.

Using a repeatable M&A model, Danaher purchased diverse industrial businesses at reasonable prices and consistently boosted earnings and cash flow. Even before closing the deal, Danaher's M&A model maps all the processes based on key financial metrics. Despite the downturn last year, Danaher continued to make acquisitions totalling $1,1bn.

Bain studies show that frequent acquirers such as Danaher consistently outperform infrequent acquirers by getting the integration process right and making it a core competency.

If you had invested $1 in each group, the returns from the frequent-acquirer group would be 25% greater than the infrequent group over 20 years.

Meanwhile, Bain research has found that as cross-border deals increase, their rate of success is similar to domestic deals, but integration typically is more complex. Among the unique challenges are: tailoring the integration thesis to each region's circumstances; quickly tackling actual and perceived cultural differences; and accounting for geographically dispersed operations and stakeholders as well as complex legal and regulatory frameworks that can derail integration.

As cash-flush companies in SA pursue M&A opportunities, winning acquirers will work to prevent post-merger integration missteps. That is the best way to ensure that promising acquisitions deliver on their potential.

Failure to define a deal's payoffs and risks in clear terms shows there are no clear integration priorities

Athol Williams is a Bain & Company partner based in Johannesburg. John Sequeira, head of Bain's Mergers & Acquisitions practice in Asia, is based in Hong Kong.