NEW YORK, October 8, 2009—With equity values stabilizing and debt markets returning to life, companies face a rare window of opportunity to do mergers and acquisitions that will reshape industries and create new leaders, says a new report by The Boston Consulting Group (BCG).
For those with the financial wherewithal, current conditions offer a “once-in-a-lifetime opportunity,” say the authors of Be Daring When Others Are Fearful: Seizing M&A Opportunities While They Last.
“Time is of the essence. The capital markets are gradually reopening, and growth is returning in economies that had previously fallen into recession,” write the authors. “When the window of opportunity flies open, the prizes will go to those that have grasped their position and prepared themselves for the surge in M&A. With the clock ticking, there is no time to lose.”
Earlier BCG research established that the returns from M&A are much greater in downturns than they are in upturns. The firm’s latest research—based on an analysis of more than 5,200 M&A transactions since the start of the subprime crisis in the late summer of 2007—confirms that insight. Moreover, it shows that some of the best opportunities in the last two years have been acquisitions of fundamentally healthy but financially distressed companies. Returns from distressed M&A were higher for both acquirers and targets (2.4 percentage points higher and 30.1 percentage points higher, respectively) in 2008 than in downturns during the previous 15 years.
The authors also found, after analyzing more than half the companies in the S&P 500, that about 20 percent are “predators,” ready to take on the risks of a deal. Another 20 percent are “prey,” so weak and vulnerable that they must focus on surviving the downturn. The remaining 60 percent have the potential to become either predator or prey. These businesses must assess their financial and market positions as a matter of urgency to ensure that they make the right strategic moves.
“For the majority of companies that are neither predator nor prey, the good news is that up to one-quarter of them can transform themselves into predators before the M&A market surges,” says Alexander Roos, a BCG partner and coauthor of the report. “To do so, however, they will have to strengthen their finances and reshape their businesses—to seize M&A opportunities when they arise.”
Who Are the Predators and the Prey?
The most active acquirers now are financially sound companies with strong balance sheets, high profitability, and sufficient cash to capitalize on the weaknesses of competitors. They can take advantage of the current low valuation levels to transform their industry and improve their own position within it, according to BCG.
Transactions over the last year have often been in industries such as finance and automotive, which are on the ropes. But there are also opportunities for large-scale transactions that could transform the competitive landscape of other industries, including currently robust sectors such as pharmaceuticals and utilities.
Other potential predators include private-equity (PE) firms, which have around $500 billion at their disposal, and sovereign wealth funds, which were sitting on assets of more than $3 trillion before the crisis started.
Many of the targets for M&A in the current crisis have been in sectors hard hit by the credit crunch, such as financial services and the automotive industry. But there has also been M&A in relatively healthy sectors, such as pharma. Companies whose shares have fallen the most will be seen as potential prey. Other targets will be businesses divested by larger companies and PE-owned portfolio companies.
The Clock Is Ticking—Be Ready for Action
Since the start of the crisis, companies have tended to focus inward. Cost cutting and restructuring have been seen as the overwhelming priorities, necessary to maximize cash flow, strengthen the balance sheet, and ensure survival. But now conditions are beginning to turn.
“Investors appear to recognize that today’s extraordinary circumstances present once-in-a-lifetime M&A opportunities on which companies should capitalize,” says Roos, citing a recent BCG survey of investors and analysts. “They want companies to use the crisis to strengthen their competitive position—even if their stock price takes a short-term hit. Investors expect companies to do what is necessary to secure their financial viability, but they are concerned that potentially game-changing moves will be neglected for fear of missing quarterly earnings-per-share guidance.”
The report cautions, however, that conventional M&A strategies must be updated to deal with the heightened uncertainty in a downturn as severe as the current one.
“With earnings set to reach their lowest levels in the second half of 2009 or the first half of 2010, existing multiples may be too high,” notes Jeff Gell, a BCG partner and coauthor of the report. “Valuation of targets requires a good deal more than analysis of their financials and simple multiple calculations. Executives need to do real business planning and explore worst-case scenarios. But for the predators, after they’ve done their homework, they may see the best deals they will see in a generation.”
To receive a copy of the report or arrange an interview with one of the authors, please contact Eric Gregoire at +1 617 850 3783 or gregoire.eric@bcg.com.