The Edge

Turbulence can pave the way for better deals

글 Ted Rouse, Suvir Varma and Chng Hak-Peng

First published on 8월 15, 2008
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Abu Dhabi Commercial Bank (ADCB) recently bought a 25 percent stake in RHB Capital, Malaysia's fourth-largest lender, for RM 3.88 billion ($1.2 billion), paying a 36 percent premium on the bank's price at the time of purchase in May. The stake acquisition—the biggest by a Middle Eastern investor in the Malaysian financial sector—took place amid soaring inflation and the increased prospect of interest-rate hikes. ADCB is relying on robust growth in the Islamic banking market in Malaysia, as well stronger commercial ties between the Middle East and Malaysia, to make good its investment. Is it wise for companies to undertake large deals in a climate marked by increasing economic uncertainty? 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 amid economic uncertainty might seem reckless to many managers. But our analysis of more than 24,000 deals between 1996 and 2006 in the US 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 (M&A), 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 value down 73 per cent in the first half of 2008 against the same period last year, even the big private equity funds are less likely to bid up prices. Indeed, the global M&A deal count was down 17 per cent year on year in the first half and value off by 37 per cent. Amid widespread retrenchment or economic uncertainty, 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 installment 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 worth of RHB Capital to Abu Dhabi's ADCB: it gives the third-largest bank in the emirate of Abu Dhabi a foothold in Malaysia, the world's most developed Islamic banking market. ADCB will be able to capitalise on the experience of RHB's Islamic banking subsidiary, which is the sixth largest Islamic bank in Asia. Before the deal, ADCB operated only in Abu Dhabi and India. So there was an added incentive for the acquiring bank: RHB's branches in Singapore, Brunei and Thailand. Similarly, globally recognised companies 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, partner, is co-leader of Bain & Company's global Mergers and Acquisitions Practice. Suvir Varma, partner, is the leader of the firm's SE Asia Private Equity Practice. Chng Hak-Peng is a manager with Bain SE Asia.

Abu Dhabi Commercial Bank (ADCB) recently bought a 25 percent stake in RHB Capital, Malaysia's fourth-largest lender, for RM 3.88 billion ($1.2 billion), paying a 36 percent premium on the bank's price at the time of purchase in May.

The stake acquisition—the biggest by a Middle Eastern investor in the Malaysian financial sector—took place amid soaring inflation and the increased prospect of interest-rate hikes.

ADCB is relying on robust growth in the Islamic banking market in Malaysia, as well stronger commercial ties between the Middle East and Malaysia, to make good its investment.

Is it wise for companies to undertake large deals in a climate marked by increasing economic uncertainty? 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 amid economic uncertainty might seem reckless to many managers. But our analysis of more than 24,000 deals between 1996 and 2006 in the US 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 (M&A), 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 value down 73 per cent in the first half of 2008 against the same period last year, even the big private equity funds are less likely to bid up prices. Indeed, the global M&A deal count was down 17 per cent year on year in the first half and value off by 37 per cent.

Amid widespread retrenchment or economic uncertainty, 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 installment 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 worth of RHB Capital to Abu Dhabi's ADCB: it gives the third-largest bank in the emirate of Abu Dhabi a foothold in Malaysia, the world's most developed Islamic banking market. ADCB will be able to capitalise on the experience of RHB's Islamic banking subsidiary, which is the sixth largest Islamic bank in Asia.

Before the deal, ADCB operated only in Abu Dhabi and India. So there was an added incentive for the acquiring bank: RHB's branches in Singapore, Brunei and Thailand.

Similarly, globally recognised companies 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, partner, is co-leader of Bain & Company's global Mergers and Acquisitions Practice. Suvir Varma, partner, is the leader of the firm's SE Asia Private Equity Practice. Chng Hak-Peng is a manager with Bain SE Asia.