M&A In The Wake Of Corona

By Feng Gu and Baruch Lev

Mergers & acquisitions (M&A) activity came to a screeching halt early this year. Most acquisitions planned in the late 2019 (like Charles Schwab’s (SCHW) intention to acquire Ameritrade (AMTD), or Xerox’s (XRX) plan to acquire HP (HP)) were much delayed until market outlook improved or abandoned altogether, and new ones are rare. (United Technologies’ (RTX) acquisition of Raytheon for $74 billion, announced on April 3, 2020, was an exception.) However, active economies and capital markets are always characterized by a thriving M&A activity.

So it’s not surprising that, as the economy is recovering, we see M&As on the rise. The third quarter of 2020 saw deals worldwide surpass $1 trillion compared with $763 billion in the prior-year period, and transactions in the U.S. reached $531 billion, up from $140 billion in the second quarter 2020 (Dealogic Ltd.). But will this pace of M&A continue? And more important, what types of deals will be executed? Moreover, will investors benefit from those M&As? Historically, M&A deals often lead to shareholder value destruction.

Prior to COVID-19 we assembled, for research purposes, the largest and most detailed M&A sample available: 36,000 deals over the 1978-2018 period. We have used this sample to predict from past post-crises deals how will M&A activity look in the near future. Specifically we asked:

How were M&A deals in the wake of crisis periods different from deals in normal times? And how successful were post-crisis deals relative to normal-period M&As?

The crisis periods we focused on were the burst of the tech bubble (2000-2001) and the recent financial crisis (2007-2008). Both periods were characterized by sharp stock price volatility, multiple business failures, and serious economic dislocation, not unlike in the current COVID-19 period. Indeed, our data show that M&A activity collapsed during both past crisis periods.

We compared M&A deals during the previous post-crisis periods (2001-2003 and 2008-2009) with deals in normal years: 1991-2013, excluding the examined post-crisis period (we ended with 2013 because some of our measures required four to five years of data post acquisition). We used multivariate statistical analysis (logit regressions) to simultaneously identify attributes unique to previous post-crisis periods. In all, we examined 35 attributes of acquiring (bidders) and acquired (target) companies, as well as deal and market conditions. Here are our main findings:

Size matters.

M&As in the post-crisis years were significantly larger and executed by larger companies than in normal-year deals. Large companies have better access to capital markets to finance acquisitions. They also have more cash on hand. Indeed, the cash component (as opposed to equity) of post-crisis deals was substantially higher than in normal years. Large companies are also better positioned to use quickly the legal and accounting resources needed for acquisitions. The post-crisis deals were larger than normal because the preceding crisis weakened many medium and small businesses that are normally resistant to acquisitions. Post-crisis deals were also characterized by a larger proportion of shares acquired than normal, making the acquisition more potent.

Thus, economic crisis, like drought, famine, or diseases in nature, makes the surviving predators more dangerous and the prey more vulnerable. Take Salesforce.com’s (NYSE:CRM) current plan to buy Slack Technologies (NYSE:WORK) for $27.7 billion, a deal that would be Salesforce’s largest acquisition ever. This is an example of an industry leader (Salesforce is the world’s largest provider of software for customer relationship management) acquiring a smaller and weakened target with related businesses (Slack’s stock price this year was essentially flat until the plan of the deal was reported in late November).

Market power matters.

The acquisitions conducted in the post-crisis years were much more industry-related than in normal years – namely, in post-crisis years the target shared most business lines with the acquirer. The motive of increasing market power was thus much more pronounced during the post-crisis years. Regulators were apparently more lax about M&A market power in the post-crisis years and allowed the deals. Given the gradual increase in industry concentration and corporate size inequality in the U.S. in recent years, the prospects of enhanced dominance of large enterprises is indeed worrisome. The recently announced acquisition of IHS Markit (INFO) by S&P Global (SPGI) for $44 billion is an example of such a large and related deal with the potential to enhance the acquirer’s market dominance.

Employment – not so much.

Post-acquisition, the number of the acquirer’s employees usually increases, as many of the target employees are absorbed by the acquirer. Our data, however, show that the post-acquisition increase in the number of employees was substantially lower in the post-crisis years than in normal periods. This may be due either to fewer labor-intensive targets acquired in post-crisis years, and/or to more post-acquisition layoffs in past-crisis deals. Neither explanation bodes well for post-COVID employment.

Time is of the essence.

The amount of time spent to consummate acquisitions in the post-crisis years was substantially shorter than in normal years. Importantly, prices paid for targets were higher, as evidenced by the larger goodwill values (the difference between deal price and the fair value of the net assets acquired) in the post-crisis M&As. Post-crisis acquirers thus pounce hard and quickly. They also acquired more private enterprises than in normal years, which is good news for entrepreneurs looking for a buyout.

How successful were the post-crisis acquisitions relative to normal years’ deals? We measured acquisition success by a three-component index. Successful acquisitions are those characterized by:

1. above industry-average sales or gross-margin growth during 3-5 years post acquisitions,
2. positive stock returns in the post-acquisition period, and
3. no goodwill write-off.

By this composite success index, the larger and market-power enhancing acquisitions typical of previous post-crisis periods have contributed substantially to acquisition success, while the higher prices paid detracted from the success. Access to low-cost debt post-crisis further enhanced acquisition success. Overall, the post-crisis acquisitions, taking advantage of favorable conditions (weakened targets, low cost financing, etc.), were more successful relative to normal-years acquisitions. This is good news for investors.

So, if business history repeats itself (notwithstanding Henry Ford’s dictum that “history is more or less bunk”), we can expect in the foreseeable future a gradual return to normal years’ M&A activity. The deals we will see will be mainly conducted by the large companies that fared well during the covid crisis and will be larger than normal, on average. They will be mainly aimed at increasing market power and industry concentration, and will not contribute much to employment. Longstanding concerns about increasing market concentration and skewed size and success distribution of companies (“the big get bigger”) in the U.S. will likely not be alleviated by the forthcoming M&A activity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.