South China Morning Post

Downturn deals pay bigger rewards

Given the continuing fallout from the subprime mortgage crisis, as well as the Shanghai Composite Index's dive to a 17-month low and looming slowdowns in several regions, is it really wise to be acquiring now? The answer is yes.

글 Ted Rouse, Nick Palmer and Michael Thorneman

First published on 7월 14, 2008
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Shenzhen-based China Merchants Bank's bid of 3.1 times book value for Wing Lung Bank turned quite a few heads when it was announced last month. Sure, Merchants Bank was the only Hong Kong-listed mainland bank without a presence in Hong Kong, and there were precious few banks available to acquire in the city. And yes, the move gives Merchants Bank access to Wing Lung's branch network—a solid base from which to expand outside the mainland. But given the continuing fallout from the subprime mortgage crisis, as well as the Shanghai Composite Index's dive to a 17-month low and looming slowdowns in several regions, is it really wise to be acquiring now? The answer is yes. With the right combination of readiness, prudence and guts, economic uncertainty actually presents some of the best opportunities to fill capability gaps, gain market share and change a company's competitive position. Making 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 boom years. Among industries, the largest increases in excess returns occurred in health care and consumer products; the smallest gains were posted in the utilities and telecommunications 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. 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 even in the US, the epicentre of the subprime crisis, corporate balance sheets are generally strong. With last year's 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 global private equity deal volume down almost 80 per cent in the first quarter of the year, even the big private equity funds are less likely to bid up prices. Indeed, global merger and acquisition deal volume was down 17 per cent year on year in the first quarter and value off by some 44 per cent. Amid widespread retrenchment, it is hard for most executives to be contrarian. Funding constraints and the lack of operational and financial leverage can turn aggressive chief executives wary. Yet, as Novartis showed with its instalment purchase of Alcon, 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 analysed 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 Dynegy'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. Consider the value of Wing Lung's 35-branch network in Hong Kong, and the market in the city for the private banking business that Merchants Bank is building. Similarly, globally recognised brands like General Dynamics and Johnson & Johnson have also built strong competitive positions by buying throughout the business cycle. More than impeccable timing, these firms 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. Ted Rouse is co-leader of Bain & Co's global mergers and acquisitions practice and is based in Boston. Nick Palmer is a partner based in Hong Kong, where he leads the financial services practice. Michael Thorneman is a partner in Shanghai and head of the Greater China mergers and acquisitions practice

Shenzhen-based China Merchants Bank's bid of 3.1 times book value for Wing Lung Bank turned quite a few heads when it was announced last month.

Sure, Merchants Bank was the only Hong Kong-listed mainland bank without a presence in Hong Kong, and there were precious few banks available to acquire in the city. And yes, the move gives Merchants Bank access to Wing Lung's branch network—a solid base from which to expand outside the mainland.

But given the continuing fallout from the subprime mortgage crisis, as well as the Shanghai Composite Index's dive to a 17-month low and looming slowdowns in several regions, is it really wise to be acquiring now? The answer is yes. With the right combination of readiness, prudence and guts, economic uncertainty actually presents some of the best opportunities to fill capability gaps, gain market share and change a company's competitive position.

Making 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 boom years.

Among industries, the largest increases in excess returns occurred in health care and consumer products; the smallest gains were posted in the utilities and telecommunications 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.

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 even in the US, the epicentre of the subprime crisis, corporate balance sheets are generally strong. With last year's 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 global private equity deal volume down almost 80 per cent in the first quarter of the year, even the big private equity funds are less likely to bid up prices. Indeed, global merger and acquisition deal volume was down 17 per cent year on year in the first quarter and value off by some 44 per cent.

Amid widespread retrenchment, it is hard for most executives to be contrarian. Funding constraints and the lack of operational and financial leverage can turn aggressive chief executives wary. Yet, as Novartis showed with its instalment purchase of Alcon, 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 analysed 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 Dynegy'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. Consider the value of Wing Lung's 35-branch network in Hong Kong, and the market in the city for the private banking business that Merchants Bank is building.

Similarly, globally recognised brands like General Dynamics and Johnson & Johnson have also built strong competitive positions by buying throughout the business cycle.

More than impeccable timing, these firms 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.

Ted Rouse is co-leader of Bain & Co's global mergers and acquisitions practice and is based in Boston. Nick Palmer is a partner based in Hong Kong, where he leads the financial services practice. Michael Thorneman is a partner in Shanghai and head of the Greater China mergers and acquisitions practice