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Recessions can present rare M&A opportunities

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

글 Sri Rajan and David Harding

First published on 4월 16, 2009
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For many executives, doing a deal in a downturn seems risky and impractical. Credit markets aren't functioning normally, so financing is difficult. Equity markets are depressed, so acquirers and targets alike are wary of stockbased transactions. That's why the number and value of deals tend to plummet during and immediately after a recession. For example, aggregate deal value in post-recession 2002 was less than half of what it was four years earlier. The current worldwide recession may cause a sharper fall. But for companies that are relatively strong strategically and financially, recessions present rare opportunities to improve their competitive position through acquisitions and partnerships. Our analysis of around 24,000 transactions between 1996 and 2006 shows that acquisitions completed during and right after the last recession (2001–02) generated almost triple the excess returns of acquisitions made during the preceding boom years. The most important objective of mergers and acquisitions (M&As) is to help execute a company's strategy that in a downturn will almost certainly focus on strengthening the core business. In a recession, M&A also serves another purpose: creating strategic options. The post-recession landscape will be very different and no one really knows how supply chains may change, what the financial system will look like, or to what degree consumers have changed their spending patterns. As companies ride out the storm, they need to position themselves to emerge from the downturn both strong and flexible. The right acquisitions can help. Some have the resources to expand their strategic options through acquisitions, despite the downturn. For example, Pfizer Inc.'s agreement to acquire Wyeth Ltd buys some time for Pfizer as patents expire on several of its leading medicines. For companies with resources and the will to undertake deals, there are three necessary ingredients for success: an investment thesis tailored to a company's strategic priority, the target list, and a well-prepared team ready to act quickly. 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. Those 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. Too often, an acquisition is inbound—when someone sends over an idea or a deal book. If the deal looks interesting after a preliminary review, a valuation model is constructed and financial and legal due diligence starts. This approach delivers mixed results at best. If an acquisition team is reacting rather than being proactive, it's likely to pursue deals with prices below the valuation model, deals with limited up side and big downside, and deals whose numbers can be massaged to meet corporate hurdle rates. The team may turn down transactions that appear too expensive but are really not in terms of their long-term strategic benefits. It will also fail to uncover opportunities it might have turned up on its own if it had followed a strategic road map. In contrast, seasoned deal makers like Cintas Corp., a business services company, know their basis of competition and are always thinking about the kinds of deals they should be pursuing. Their M&A teams work with individuals close to the ground in line organizations to create a pipeline of priority targets, each with a customized 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. Savvy acquirers are likely to have months or years invested in a prospective deal. Because they know what they want to achieve through the acquisition, they're often willing to pay a premium or act faster than rivals. Acquisitions on this basis helped Cintas sustain sales growth for 39 consecutive years till May 2008. The acquisitions continue. Last month, as the downturn roiled the US and German economies, Cintas bought Aktenmühle GmbH, a German document destruction business. 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 initially believe. 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 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 sound assessment of the new conditions. Don't assume things will return to normal. Don't assume conventional M&As 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 towards M&A success, in turbulence or calm weather. Sri Rajan is a partner with Bain and Co. and leads the M&A and Private Equity practices in India. David Harding is co-head of Bain's Global M&A practice. This is the fourth in a series adapted from the forthcoming book Winning in Turbulence by Bain and Co. Bain Book Winning in Turbulence Learn more about how companies can navigate through turbulent times and succeed as the economy improves.

For many executives, doing a deal in a downturn seems risky and impractical. Credit markets aren't functioning normally, so financing is difficult. Equity markets are depressed, so acquirers and targets alike are wary of stockbased transactions.

That's why the number and value of deals tend to plummet during and immediately after a recession. For example, aggregate deal value in post-recession 2002 was less than half of what it was four years earlier.

The current worldwide recession may cause a sharper fall.

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

Our analysis of around 24,000 transactions between 1996 and 2006 shows that acquisitions completed during and right after the last recession (2001–02) generated almost triple the excess returns of acquisitions made during the preceding boom years.

The most important objective of mergers and acquisitions (M&As) is to help execute a company's strategy that in a downturn will almost certainly focus on strengthening the core business.

In a recession, M&A also serves another purpose: creating strategic options. The post-recession landscape will be very different and no one really knows how supply chains may change, what the financial system will look like, or to what degree consumers have changed their spending patterns.

As companies ride out the storm, they need to position themselves to emerge from the downturn both strong and flexible. The right acquisitions can help.

Some have the resources to expand their strategic options through acquisitions, despite the downturn. For example, Pfizer Inc.'s agreement to acquire Wyeth Ltd buys some time for Pfizer as patents expire on several of its leading medicines.

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

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. Those 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.

Too often, an acquisition is inbound—when someone sends over an idea or a deal book. If the deal looks interesting after a preliminary review, a valuation model is constructed and financial and legal due diligence starts.

This approach delivers mixed results at best. If an acquisition team is reacting rather than being proactive, it's likely to pursue deals with prices below the valuation model, deals with limited up side and big downside, and deals whose numbers can be massaged to meet corporate hurdle rates.

The team may turn down transactions that appear too expensive but are really not in terms of their long-term strategic benefits. It will also fail to uncover opportunities it might have turned up on its own if it had followed a strategic road map.

In contrast, seasoned deal makers like Cintas Corp., a business services company, know their basis of competition and are always thinking about the kinds of deals they should be pursuing. Their M&A teams work with individuals close to the ground in line organizations to create a pipeline of priority targets, each with a customized 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.

Savvy acquirers are likely to have months or years invested in a prospective deal. Because they know what they want to achieve through the acquisition, they're often willing to pay a premium or act faster than rivals. Acquisitions on this basis helped Cintas sustain sales growth for 39 consecutive years till May 2008. The acquisitions continue. Last month, as the downturn roiled the US and German economies, Cintas bought Aktenmühle GmbH, a German document destruction business.

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 initially believe.

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 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 sound assessment of the new conditions.

Don't assume things will return to normal. Don't assume conventional M&As 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 towards M&A success, in turbulence or calm weather.

Sri Rajan is a partner with Bain and Co. and leads the M&A and Private Equity practices in India. David Harding is co-head of Bain's Global M&A practice. This is the fourth in a series adapted from the forthcoming book Winning in Turbulence by Bain and Co.