The Edge

Pursue game-changing mergers and acquisitions

For companies that are relatively strong strategically and financially, recessions present rare opportunities to improve their competitive position through mergers and acquisitions.

By Suvir Varma and David Harding

Published on July 27, 2009
min read


For many executives, doing a deal in a downturn seems risky and impractical. But for companies that are relatively strong strategically and financially, recessions present rare opportunities to improve their competitive position through mergers and acquisitions (M&A). Consider the decision by pharmaceutical firm GlaxoSmithKline to pay up to £2.5 billion (RM14.5 billion) for US skincare products maker Stiefel Laboratories in an acquisition intended to grow and diversify its business. Besides helping to execute a company's strategy, M&A also create strategic options that enable a company to emerge from the downturn both strong and flexible. Our analysis of more than 24,000 transactions between 1996 and 2006 shows that acquisitions completed during and right after the 2001–02 recession generated almost triple the excess returns of acquisitions made during the preceding boom years. For companies with resources and the will for deals, there are three necessary ingredients for success: an investment thesis tailored to a company's strategic priority, a well-prepared team ready to act quickly, and the right list of targets. 1) Investment thesis One key to avoiding disastrous acquisitions is to have a clear investment thesis—a statement that articulates why buying a business will make your company more valuable. Many companies fail to understand the importance of an investment thesis, even in good times. In one survey of acquirers, we found about 80% of successful transactions were based on a clear investment thesis. For failed deals, the proportion was about 40%. To boost the odds of success, each transaction needs to strengthen a company's basis of competition, which could be its cost position, brand strength or customer loyalty. These imperatives don't change whether the economy is booming or slumping. For example, Tata Consultancy Services Ltd, India's top software services exporter, has made a host of successful acquisitions in the past eight years, during strong and weak economic conditions, boosting the company's competitive position. For Lafarge SA, the world's largest cement company, the purchase of India's L&T Concrete last year pushed it into leadership position in India's ready-mix concrete market, which has strong long-term growth potential. The deal was also in sync with Lafarge's strategy of increasing its presence in emerging markets. 2) Preparation leads to success Instead of reacting to acquisition targets as they become available, seasoned deal makers, like US business services company Cintas Corp, know their basis of competition and are always thinking about the kind of deals they should be pursuing. Their M&A teams work with individuals close to the ground in line organisations to create a pipeline of priority targets, each with a customised investment thesis. They cultivate a relationship with each target so that they can quickly get to the table, sometimes before the "For sale" sign goes up. Because they know what they want to achieve through the acquisition, they are often willing to pay a premium or act faster than rivals. Acquisitions on this basis helped Cintas sustain sales growth for 39 consecutive years until May last year. But the acquisitions continue. Last month, as the downturn roiled the US and German economies, Cintas bought Aktenmühle GmbH, a German document destruction business. 3) Seek out the right targets Turbulence brings deal-making opportunities, but obstacles presented by a downturn can stall even a well-prepared company. Focusing on three practices can guide companies. First, ratchet up the diligence. Many deals may turn out to be less attractive than acquirers had initially believed. Corporate buyers seeking targets in the same industry may conduct inadequate diligence because executives believe they know the industry. They often conduct a cursory regulatory review without asking the big strategic questions—and then are unpleasantly surprised. Second, tailor your list of targets to the new valuations. Many companies are relatively cheap in a downturn because their shares are at low levels. But some companies are cheap for a good reason and the adage that "You get what you pay for" often applies. Third, update the target list to reflect the changing environment. The future business climate is likely to be less freewheeling, more tightly regulated, less leveraged and more risk-averse. Once-successful business models may no longer work. One-time market leaders may be permanently compromised. Yet you may want to add businesses that you think are likely to thrive in a different environment. A clear investment thesis reflecting the new reality is key. Can a company's portfolio emerge stronger from the current economic hurricane? In many cases, yes, as long as deals are based on a sound assessment of the new conditions. Don't assume things will return to normal. Don't assume conventional M&A are your only options; scarce capital is likely to make joint ventures and alliances increasingly popular. Above all, don't use deals to reshape your company's competitive foundation. Use them instead to strengthen it, to do what you do better. Acting on these principles is the first step. Suvir Varma is a partner with Bain & Company and leads the firm's Southeast Asia Private Equity practice. David Harding is a partner and co-head of Bain's Global M&A practice. This article is adapted from the forthcoming book, Winning in Turbulence, published by Harvard Business Press.

For many executives, doing a deal in a downturn seems risky and impractical. But for companies that are relatively strong strategically and financially, recessions present rare opportunities to improve their competitive position through mergers and acquisitions (M&A).

Consider the decision by pharmaceutical firm GlaxoSmithKline to pay up to £2.5 billion (RM14.5 billion) for US skincare products maker Stiefel Laboratories in an acquisition intended to grow and diversify its business.

Besides helping to execute a company's strategy, M&A also create strategic options that enable a company to emerge from the downturn both strong and flexible. Our analysis of more than 24,000 transactions between 1996 and 2006 shows that acquisitions completed during and right after the 2001–02 recession generated almost triple the excess returns of acquisitions made during the preceding boom years.

For companies with resources and the will for deals, there are three necessary ingredients for success: an investment thesis tailored to a company's strategic priority, a well-prepared team ready to act quickly, and the right list of targets.

1) Investment thesis

One key to avoiding disastrous acquisitions is to have a clear investment thesis—a statement that articulates why buying a business will make your company more valuable.

Many companies fail to understand the importance of an investment thesis, even in good times. In one survey of acquirers, we found about 80% of successful transactions were based on a clear investment thesis. For failed deals, the proportion was about 40%.

To boost the odds of success, each transaction needs to strengthen a company's basis of competition, which could be its cost position, brand strength or customer loyalty. These imperatives don't change whether the economy is booming or slumping.

For example, Tata Consultancy Services Ltd, India's top software services exporter, has made a host of successful acquisitions in the past eight years, during strong and weak economic conditions, boosting the company's competitive position.

For Lafarge SA, the world's largest cement company, the purchase of India's L&T Concrete last year pushed it into leadership position in India's ready-mix concrete market, which has strong long-term growth potential. The deal was also in sync with Lafarge's strategy of increasing its presence in emerging markets.

2) Preparation leads to success

Instead of reacting to acquisition targets as they become available, seasoned deal makers, like US business services company Cintas Corp, know their basis of competition and are always thinking about the kind of deals they should be pursuing.

Their M&A teams work with individuals close to the ground in line organisations to create a pipeline of priority targets, each with a customised investment thesis. They cultivate a relationship with each target so that they can quickly get to the table, sometimes before the "For sale" sign goes up.

Because they know what they want to achieve through the acquisition, they are often willing to pay a premium or act faster than rivals.

Acquisitions on this basis helped Cintas sustain sales growth for 39 consecutive years until May last year. But the acquisitions continue. Last month, as the downturn roiled the US and German economies, Cintas bought Aktenmühle GmbH, a German document destruction business.

3) Seek out the right targets

Turbulence brings deal-making opportunities, but obstacles presented by a downturn can stall even a well-prepared company. Focusing on three practices can guide companies.

First, ratchet up the diligence. Many deals may turn out to be less attractive than acquirers had initially believed. Corporate buyers seeking targets in the same industry may conduct inadequate diligence because executives believe they know the industry. They often conduct a cursory regulatory review without asking the big strategic questions—and then are unpleasantly surprised.

Second, tailor your list of targets to the new valuations. Many companies are relatively cheap in a downturn because their shares are at low levels. But some companies are cheap for a good reason and the adage that "You get what you pay for" often applies.

Third, update the target list to reflect the changing environment. The future business climate is likely to be less freewheeling, more tightly regulated, less leveraged and more risk-averse. Once-successful business models may no longer work. One-time market leaders may be permanently compromised. Yet you may want to add businesses that you think are likely to thrive in a different environment. A clear investment thesis reflecting the new reality is key.

Can a company's portfolio emerge stronger from the current economic hurricane? In many cases, yes, as long as deals are based on a sound assessment of the new conditions.

Don't assume things will return to normal. Don't assume conventional M&A are your only options; scarce capital is likely to make joint ventures and alliances increasingly popular.

Above all, don't use deals to reshape your company's competitive foundation. Use them instead to strengthen it, to do what you do better.

Acting on these principles is the first step.

Suvir Varma is a partner with Bain & Company and leads the firm's Southeast Asia Private Equity practice. David Harding is a partner and co-head of Bain's Global M&A practice. This article is adapted from the forthcoming book, Winning in Turbulence, published by Harvard Business Press.