The Deal

Dealing with Turbulence

Dealing with Turbulence

Periods of turbulence can be opportune for making aggressive moves—but only for companies on solid financial footing, and only when a transaction strengthens the buyer's core business.

  • min read


Dealing with Turbulence

With the economy growing shakier, what business did GE Capital have to make a $5.3 billion buyout of Heller Financial late last year—GE's second biggest acquisition, after the $6.7 billion purchase of RCA in the mid-1980s? Did First Union's purchase of Wachovia make any sense, either? Should everyone postpone acquisitions until better times?

Not if they have the right fundamentals.

During economic turbulence, corporations such as General Electric that have strategic and financial power can snap up companies that further strengthen their position. Undiscouraged by its failed attempt to buy Honeywell, GE and its financial-services division, GE Capital, likely will remain hot on the takeover trail. In a typical year, good or bad, GE makes about 120 acquisitions—40 or so of which GE Capital initiates.

Periods of turbulence can be opportune for making aggressive moves—but only for companies on solid financial footing, and only when a transaction strengthens the buyer's core business. The GE-Heller deal meets both criteria. GE's history of successful deal integration—and the funding, customer acquisition and back-office benefits of the deal—suggest GE Capital will quickly justify the 50% premium it paid for Heller.

However, First Union's acquisition of Wachovia smacked of a desperation deal. We believe that, despite benefits from overlapping operations and access to new customers, it is destined for failure. In addition to the worst debt/equity ratio and second-worst loan-loss reserves among the top 10 banks, First Union has a pitifully low return on equity—even before a $2.8 billion charge driven by its bungled acquisition of The Money Store.

First Union's acquisitions often shed as many customers as employees. They rarely provide lasting synergies or expanded revenues. First Union would do better to prune peripheral businesses from its bewildering array of business lines: retail banking, securities trading, investment banking, commercial mortgages, asset management, trusts and sub-prime lending, and more than 60 distinct product and service categories.

In each category, First Union faces a bigger, stronger, more focused competitor. Its current path will likely further bleed First Union until it is forced to be acquired at a fire-sale price.

How can companies somewhere in the middle—in a position not as dire as First Union's or as strong as GE Capital's—strengthen themselves in today's climate?

Most companies are overly optimistic about their resiliency during downturns. About 79% of 377 Fortune 500 corporations that lived through downturns over the last two decades said in a study by our firm that they were better positioned to handle economic turbulence than other companies in their industry. However, only 34% of them actually outperformed their industries in the last recession.

Managers, many of whom were not in the driver's seat during prior recessions, tend to drive defensively when they hit economic potholes. They fail to pursue opportunities during downturns, when price tags tend to be lower and opportunities more abundant.

Our experience and studies about winning in turbulence suggest four smart moves for four types of companies:

Companies that are strong financially and strategically should acquire weaker players (GE Capital's forte). Companies in weak financial and strategic positions should dispose of anything not essential to survival and find a merger partner that can help shore up their core business (perhaps First Union should have followed this path).

Financially weak companies that are stronger strategically should divest noncore assets to raise cash, rebuild the balance sheet and focus on core competencies. Mellon Financial, for example, has had the second worst five-year revenue growth and worst long-term debt/total capital ratio among the top 20 banks. Its stock price has returned 3.1% in the past year versus its peer group average of 26.4%. By selling its retail and business banking units to Citizens Bank's parent, Royal Bank of Scotland, Mellon can concentrate on its stronger asset-management and financial-asset servicing businesses. Now more focused and financially healthier, Mellon can go on the hunt again soon.

Companies with good financial resources but a weaker strategic position should become smart underdogs and acquire selectively to dominate their most successful niches.

Fifth Third Bancorp's acquisition of Old Kent Financial strengthened its core Midwestern market. The Cincinnati-based retail and commercial bank is among the nation's 20 largest bank-holding companies, and among the top 10 in market capitalization. Despite revenue share of not more than 10% in any market, its ROE compares very favorably with the industry (19.3% versus 14.1%), and it boasts of 22 consecutive years of double-digit earnings growth.

In troubled economic times as in good times, the right deals help the strong get stronger faster. The wrong deals—or failing to shed noncritical businesses—help the weak become lunch. For companies somewhere in the middle, diverting resources from noncore areas to focus all efforts and resources on shoring up the core, including focused acquisitions at good prices, will help them emerge stronger and healthier.

Gerard du Toit is a vice president at Bain & Co. in Boston. Eric Aboaf is a Bain vice president in New York and co-leader of the firm's financial services practice.

Bain Book

Winning in Turbulence

Learn more about how companies can navigate through turbulent times and succeed as the economy improves.


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