M&A is back. Expect losers to outnumber winners

Green shoots in the M&A market are for real and a deal boom is imminent — at least, that’s what the spreadsheets predict. The question is whether a fresh crop of megadeals will yield another typically bad harvest, tracking the common wisdom that most takeovers end badly.

The thesis for more corporate activity is convincing. Chief executives paused dealmaking two years ago as the cheap money era ended and Russia’s invasion of Ukraine saw war return to Europe. Many publicly traded companies are now sitting on sizeable cash reserves and borrowing costs appear to be stable. Large firms’ financial strength has in turn helped the valuation of their shares, putting them in a commanding position as acquirers.

Buyout funds, too, are awash with cash and itching to deploy it. And many private equity and venture capital investments are past the time they would usually find a exit. Loss-making “unicorns” will struggle to realise $1 billion-plus valuations on the stock market, pushing them into the arms of buyers.

Gaps in corporate capability — relating to AI, the energy transition and supply-chain security — can be addressed faster through acquisition than organic investment.

Morgan Stanley analysts have crunched some arresting numbers: Between 2021 and 2023, there was as much as $11 trillion less M&A than macroeconomic fundamentals would suggest (although different assumptions show a less striking shortfall of $4 trillion); S&P 500 Index members have the financial capacity to acquire all 1,200+ unicorns.

The worry must be that financial firepower, frustration and a fear of missing out make for ill-disciplined acquisitions. Recent history backs the idea that buyers struggle to make megadeals pay. It may be too soon to pass judgement on the M&A wave accompanying the reopening of economies after the pandemic, but companies that have had three to five years to make a success of big-ticket acquisitions are ripe for scrutiny.

Among transactions worth more than $20 billion closing in 2018, there’s been one notable success – Linde Plc, the combination of two US and German industrial-gas giants. But the duds are more visible. They’re led by Bayer AG’s disastrous acquisition of genetically modified-seed-maker Monsanto. If only the German pharmaceutical firm had invested in its drug pipeline instead, as some investors wanted.

Then there’s AT&T Inc’s takeover of Time Warner, a bungled expansion
into entertainment whose principal legacy is a huge pile of borrowings and share underperformance. The same outcome afflicted mall owner Unibail-Rodamco following its acquisition of rival Westfield.

Comcast Corp took a writedown on its acquisition of UK satellite broadcaster Sky. Oil refiner Marathon Petroleum Corp appears to have performed well since buying rival Andeavor, yet the strongest gains only came after 2020, following moves to break itself up.

As for the 2019 vintage, the poor-performing acquirers dominate. Shares in payments firm Fiserv Inc. rallied following its acquisition of rival First Data Corp. But Hollywood studio Paramount Global and UK telecoms operator Vodafone Group Plc proved poor investments for shareholders in the wake of major purchases.

Fidelity National Information Service Inc, another payments firm, took a colossal writedown on its Worldpay purchase, while Walt Disney Co has had a rollercoaster ride since buying the bulk of 21st Century Fox Corp. In pharmaceuticals, returns at Takeda Pharmaceutical Co. and Bristol-Myers Squibb Co have lagged the sector following large acquisitions.

At least the 2020 vintage doesn’t look so bad – for shareholders at least. Drugmaker AbbVie Inc. has been a stellar performer since buying Allergan as has T-Mobile US Inc. since its deal for Sprint. The question remains whether it was good for consumers: Some are suing, saying it’s left them worse off.

Of course, we don’t know how companies would have fared absent their acquisitions. Maybe they would have returned cash to shareholders or invested profitably in their existing business. Or maybe they’d have wasted it in other ways.

Two factors suggest dealmaking could be more disciplined this time round. The cost of money is higher and increased antitrust scrutiny clouds the path to transactions closing. Acquirers should therefore weigh acquisitions more carefully today. But the forces driving CEOs to splurge remain strong and this market needs vigilant shareholders and activists to keep them in check. Unfortunately, management has huge freedom of movement in some jurisdictions – remember Bayer was able to buy Monsanto without polling its own shareholders.

Analysts screen the market for companies with a lot of cash (likely acquirers) and cheap valuations (likely targets). Identifying specific targets in the hope of bagging a takeover premium is nevertheless hard work. As Morgan Stanley analysts caution, the chances of those identified by its quantitative screening receiving an offer are still less than 5 percent: “We are trying to predict rare events.”

The indirect way of playing a deal boom is through the firms that earn fees on the back of it – the investment banks and the alternative asset managers like Goldman Sachs Group Inc. and Blackstone Inc. That ship may have sailed: Both sectors have enjoyed stunning rallies over the last five months.

But there’s one thing asset managers would do well to keep in mind: whether the bosses of their portfolio companies have a track record picking sensible acquisition opportunities and integrating them well. AbbVie’s past success explains why its stock rose with each of its two biotech buys last year. If investors can’t predict the next deal, they might at least stick with CEOs who know when to whip out the checkbook — and when not to.

Chris Hughes is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg