MERGERS AND ACQUISITIONS PERFORMANCE

VALUE CREATION vs. WEALTH DESTRUCTION

Session 1

PGP 2014-16, IIM Indore

Group Activity

• Groups of 5

• Submit the group details by 22nd September, 2015

• Assume the role of an investment banker

• Identify a potential M&A dealI. Not yet under considerationII. Cannot include deals that have already happenedIII. Potential target(s) and potential bidder(s): Based on the understanding of

competitive landscape and industry analysisIV. Represent Buy-side or Sell-sideV. Valuation, other analysis, deal structure (payment), deal financingVI. Prepare a pitch book (more in session 13)

• Report – 1 page summary on points III and IV, and economic rationale for the deal• Submit before the start of session 13 (Deadline –to be announced)

• Pitch book presentation & Submission – After Session 15 (Date to be announced)

The Market for Corporate Control

• A market where alternative owners compete for the rights to manage companies• Shareholders can exercise their right to sell/ not sell - to the highest bidder

• Why are Takeovers needed?• Build or Buy: Enter new market, acquire new customers, build new

technology, etc. through internal investments or through purchase• Apple vs. Microsoft

• Firm value maximization

Surging M&A deal volumes

Sum of

Value of

Deals No of Deals

Sum of

Value of

Deals No of Deals

1991 30.642 7 0.65 4 0.65 1 0.65 1

1992 12.399 13 0 10 0 0 0 0

1993 972.495 12 229.56 9 229.56 4 208 1

1994 1040.324 31 148.234 10 148.234 4 17.673 2

1995 1393.298 90 1154.87 70 1154.427 29 127.503 8

1996 1291.358 32 1264.099 22 1263.939 8 12.929 3

1997 642.735 38 633.714 31 633.714 10 72.602 3

1998 252.497 55 195.769 43 195.649 21 14.141 3

1999 2296.235 180 2088.058 123 2087.707 63 17.046 5

2000 5474.729 397 5059.244 239 5057.666 91 2659.984 23

2001 2586.376 256 1662.417 184 1661.838 79 139.928 13

2002 5775.1 242 4238.507 164 4238.032 73 1641.511 14

2003 3160.42 325 2873.709 195 2873.192 99 831.786 30

2004 2843.381 360 2314.734 214 2314.01 75 966.092 31

2005 23071.72 591 6839.829 351 6839.079 136 1677.368 44

2006 21048.35 647 15912.88 402 15912.332 143 4894.745 64

2007 20933.29 738 13339.68 468 13338.551 198 8004.525 85

2008 20402.59 718 12548.14 457 12547.113 168 7716.865 62

2009 11813.88 629 8368.249 334 8367.685 118 832.989 29

2010 33695.68 619 22698.99 377 22697.238 141 17263.221 53

2011 12994.26 498 9290.498 303 9290.203 93 6357.782 32

2012 9954.258 443 5978.475 259 5977.866 85 3478.237 31

Table 1: M&A Activity in India from 1991 -2012

This table presents M&A activity in India from 1991 to 2012, based on different filtering criteria, i.e., a.

all deals, b. only deals by non-financial companies, and c. deals by non-financial companies above a

certain deal value. We have considered only the completed deals by Indian acquirers.

Year

No filter All Non-fin Non-fin>= $0.25mn

Sum of

Value of

Deals

No of

Deals

Sum of

Value of

Deals

No of

Deals

Domestic & Cross Border Cross Border

Metals,Mining,Auto,IT & ITES,M/c,Telecom,Chem,Textiles

Yet M&As don’t create value

• Or so says the popular wisdom

• The sobering reality is that only about 20 per cent of all mergers really succeed. Most mergers typically erode shareholder wealth…the cold, hard reality that most mergers fail to achieve any real financial returns…very high rate of merger failure…rampant merger failure…

~Grubb & Lamb (2000)

• On the contrary, M&As should constitute +ve NPV projects, improve shareholder wealth

Practioner Studies and Their Key findings

Source &Date Sample Size Sample Period

Findings

McKinsey & Co., 1987 (cited in Lajoux and Weston, 1998)

116 Firms 61% failed to earn back the cost of equity.

McKinsey & Co. (cited in Fisher, 1994)

NA A 10-year period

23% transactions recovered the cost incurred in the deal

David Mitchell of Economists IntelligenceUnit, 1996 (cited in Lajoux and Weston, 1998)

Survey of executives in 150 companies

1992-1996 30%- successful53%- satisfactory11%- unsatisfactory5%- disastrous

Ref. Bruner, R.F. Applied Mergers and Acquisitions. John Wiley and Sons, Inc.

KPMG on Performance of Indian Companies

• KPMG study, 2013: Indian cos. that closed deals between 2005 & 2011• Benchmark – Nifty & Sensex, > Index (by 10%) – exceed value, <Index by 10% -

Destroy value• Synergies are more tangible with asset based deals (as compared to people

based deals – in case of Services sector)

Growth story vs. The sobering reality

• “In the 2007 and 2008 [economic] heyday they wanted to get [into] global markets and I don’t think many of their strategies made sense.

• A number were looking at acquisitions as a paradigm shift, with $100m-companies looking to acquire $200m- or $300m-companies.

• Some of these acquisition were more for the promoter [the controlling entrepreneur] to make a name – an ego boost.

• Plus a number of Indian companies got carried away with the press coverage on the India growth story and wanted to ride that wave.~Prashant Mara, co-chair of the India Group at Osborne Clarke, a law firm

Ref. http://blogs.ft.com/beyond-brics/2013/04/09/india-ma/

POSSIBLE OUTCOMES

• Value Conserved:• Investment return equals the required return.

• Investor earn “normal” return.

• Value Created:• Return on investment exceed the returns required.

• Value Destroyed:• Investment returns are less than required.

For buyer and seller of target company, and the combined entity

Measurement Of M&A Profitability: Better Than What?

Test Structure : M&A Pays If:

Description And comments

Weak Form P_After >

P_Before

Price improve from before to after the deal? Used by consultants & journalistsConfounding events & Market wide events

Semi strong Form

% R_M&A Firm >% R_Benchmark

Return exceed that of a benchmark? Used by Academic researchers.

Strong Form %R_Firm with

M&A > %R_Firmwithout M&A

Does the return on the firm’s share exceed what it would have been without the deal.

Ref. Applied Mergers and Acquisitions by ROBERT F. BRUNER, WILEY FINANCE.

Approaches:

1. Accounting Studies:• Focuses on net income, return on equity, EPS, leverage and

liquidity of the firm.• Best studies are structured as matched-sample comparisons• Weaknesses

• Backward looking data • Change in reporting practices can make data incomparable• Differences in accounting policies across firms adds noise• Cross border comparisons not possible (different accounting

principles)

2. Event Studies:• Examine abnormal returns to shareholders.• Compared to a Benchmark

Event Studies

• 𝐸(𝑅𝑖𝑡) = 𝛼 + 𝛽 𝑅𝑚𝑡• 𝐴𝑅𝑖𝑡 = 𝑅𝑖𝑡 − 𝐸(𝑅𝑖𝑡)

• 𝐶𝐴𝑅𝑖𝑇 = 𝑡=𝑡1

𝑡2 A𝑅𝑖𝑡

• Event, event date, first time when the information is disseminated

• Normal returns: Returns generated from a return generating model

• Excess Returns – Statistical test to test their significance

• If the event window studied starts from t-7, then the estimation period for the model starts prior to the t-7 day (if the estimation period is 200 days then: t-207 to t-8 day)

• Ref. Brown and Warner (1980, 1985), Mackinlay (1997), and Kothari & Warner (2007).

Event Studies (contd.)

• Forward looking measure of value creation

• Weakness: Inferences drawn from it are always joint hypothesis• That the event earns abnormal returns

• That the benchmark used proves the right measure of normal returns

• Weakness: Vulnerable to confounding events

Returns: Sell-side

Returns to the Target Firm ShareholdersStudy CARs (%) N Sample

PeriodEvent Windows (Days)

Notes

Lang Stulz Walkling(1989)

+40.3%* 87 1968-1986 (-5,5) Tender offers only

Servaes (1991) +23.64%* 704 1972-1987 (-1,close) Mergers & tender offers

Healy, Palepu,Ruback(1992)

+45.6%* 50 1979-1984 (-5,5) Largest U.S merger during period

Eckbo, Thorburn (2000) +7.45%* 332 1964-1983 (-40,0) Canadian targets only

Renneboog,Goergen(2003)

+9.01%* 136 1993-2000 (-1,0) European transactions

Myth: Takeovers harm the shareholders of target companies.

Returns: Buy-side

Studies Reporting Negative Returns to Acquirers.

Study CARs Sample Sample Period

Event Window(Days)

Notes

Asquith, Bruner, Mullins (1987)

-0.85%* 343 1973-1983 (-1,0)

Servaes(1991) -1.07%* 384 1972-1987 (-1, close) Merger and tender offer

Healy, Palepu,Ruback (1992)

-2.2% 50 1979-1984 (-5,5) 50 largest U.S mergers during period

Kaplan, Weisbach(1992)

-1.49%* 271 1971-1982 (-5,5) Mergers and tender offers

Mitchell, Stafford(2000)

-0.14%* 366 1961-1993 (-1,0) Fama and French 3 factor model

Kuipers, Miller,Patel (2003)

-0.92%* 138 1982-1991 (-1,0) Foreign acquirers of U.S targets

Studies Reporting Positive Returns to Acquirers Study CARs Size Period Days Notes

Bradley, Desai, Kim (1982)

+2.35* successful 161 1962-1980

(-10, +10) Tender offers only

Asquith, Bruner, Mullins (1983)

+3.48%* successful+0.70%unsuccessful

170

41

1963-1979

(-20, +1) Mergers only

Renneboog, Goergen(2003)

+0.70%* 142 1993-2000

(-1, 0) European transactions

Summary of Studies of Financial Statement Data

Author, Sample Period and Sample Size

Major Findings

Meeks (1977)1964-1972233 mergers

ROA for acquiring firms in the United Kingdom consistently declined in post merger years

Healy, Palepu, Ruback (1997)1979-198450 mergers

Based on the 50 largest U.S mergers, operatingcash flow returns as a result of merger met, but did not exceed the premium paid for target.

Carline, Linn, Yadav (2001)1985-199486 mergers

Buyers & targets, underperformed their industry peers in 5 years before merger & outperformed in 5 years after.

Concern

• If bidders are more likely to lose or not create value• And Bidders are larger in size

• In a combined entity: Large gains by targets could be easily offset by small loss to bidder

• And the merger as a whole could destroy value

Returns to the Combined Entity

Combined Returns

Study CARs N Sample Period

Event Window

% Positive Returns

Notes

Servaes (1991) +3.66%* 384 1972-1987 (-1,close) NA Mergers & tender offer

Kaplan,Weisbach (1992)

+3.74%* 209 1971-1982 (-5,5) 66% Merger and tender offer

Mulherin, Boone(2000)

+3.56% 281 1990-1999 (-1,+1) NA

Returns to Rivals

• Rivals of acquisition targets earn significant positive abnormal returns

• Increased probability that they will become targets themselves• In case of terminated deals, targets lose whereas rivals gain

New Evidence on Value Creation

Cumulative Abnormal Returns to Acquiring Firms

Transaction Region Mean Median No.

1. All -0.91*** -0.80*** 4,577

2. US -1.34*** -1.11*** 3,171

3. UK -1.58*** -1.24*** 354

4. CAN -1.54*** -1.42*** 325

5. RofE 1.65*** 1.11*** 212

6. Japan 2.45*** 1.80*** 182

7. RofA 0.75 0.49 99

8. Oceania 1.04 0.64 181

9. S. Africa 0.64 0.75 36

10. S. America 2.32* 1.68 27

11.UUC -1.38*** -1.15 *** 3,850

12. RoW 1.56*** 1.10*** 727

Cumulative Abnormal Returns to Target

Transaction Region Mean Median No.

1. All 17.65*** 15.39*** 2,996

2. UUC 19.65*** 17.42*** 2,430

3. RoW 9.04*** 7.81*** 566

(3)- (2) -10.61*** -9.61***

Cumulative Abnormal Returns to Combined Firms

Transaction Region Mean Median No.

1. All 1.45*** 1.27*** 2,995

2. UUC 1.19*** 1.06*** 2,429

3. RoW 2.57*** 2.15*** 566

(3)-(2) 1.38*** 1.09***

Cumulative Abnormal returns – Indian Acquirers

Event Study Analysis - Summary of Abnormal Returns

TYPE OF DEAL N Day 0Day -1 to 0

Day -3 to 0

Day -5 to 0

Day 0 to 1

Day -1 to 1

Day -2 to 0

Day -2 to +1

Day -3 to -1

CAR1 CAR2 CAR3 CAR4 CAR6 CAR10 CAR14 CAR15 CAR17

CASH 286 Mean 0.0079 0.0122 0.0106 0.0094 0.0098 0.0141 0.0088 0.0107 0.0026

P-value 0.0005 0.0001 0.007 0.0328 0.0018 0.0001 0.0111 0.0081 0.3846

Deals with Negative CARs % 45% 44% 46% 46% 42% 42% 43% 44% 52%

STOCK 49 Mean 0.0047 0.0031 0.0201 0.0190 -0.0040 -0.0056 0.0140 0.0054 0.0154

P-value 0.2700 0.6721 0.0509 0.1483 0.5994 0.6023 0.0629 0.6249 0.0825

Deals with Negative CARs % 47% 51% 43% 49% 55% 61% 49% 51% 45%

The Performance Implications Of Participating In An Acquisition Wave

• Acquisition performance is higher for early movers • Lower for acquirers that participate at the height of the acquisition wave.

• Both industry and acquirer characteristics influence the degree to which firms seize early mover advantages or fall pray to bandwagon pressures.

Value Creation/Destruction during Merger Waves

Mcnamara, G.M., Haleblian, J., & Dykes, B.J. 2008. ‘The performance implications of participating in an acquisition wave: Early mover advantages, bandwagon effects & moderating influence of industry characteristics and acquirer tactics’. The Academy of Management Journal, 51(1), pp. 113-130.

Early Mover Advantages

Bandwagon effect

Wealth Destruction on Massive Scale

Yearly Aggregate Dollar Return of Acquiring-firm shareholders (1980-2001)

Moeller, S.B., Schlingemann, F.P., and Stulz, R.M., 2005. ‘Wealth destruction on a Massive Scale? A study of Acquiring-firm returns in the recent merger wave’. The Journal of Finance, 60(2), pp. 757-782

Value Creation during Indian Merger Waves

Early Movers versus Late Entrants in a Merger Wave -The Difference of Means test

Panel I: Year 2004 vs. 2011

Event

windows Day 0

Day -1

to 0

Day 0 to

1

Day 0 to

3

Day 0 to

5

Day 0 to

7

Day -1

to 1

Day -5

to 5

Day -7

to 7

Day -2

to 0

Day -2 to

+1

Diff. of

Mean (N:

19,20 ) 0.0097 0.0280 0.0278 0.0307 0.0460 0.0514 0.0461 0.0647 0.0773 0.0169 0.0349

p-value 0.3822 0.0559 0.0789 0.1991 0.0628 0.0698 0.0164 0.0840 0.0606 0.2751 0.0991

Panel II: Year 2004-5 vs. 2010-11

Diff. of

Mean (N:

43, 56) 0.0125 0.0203 0.0183 0.0267 0.0353 0.0442 0.0262 0.0424 0.0490 0.0142 0.0200

p-value 0.0659 0.0144 0.0406 0.0226 0.0046 0.0028 0.0111 0.0178 0.0164 0.1396 0.0828

Panel III: Year 2004-5-6 vs. 2009-10-11

Diff. of

Mean (N:

74, 90) 0.0055 0.0161 0.0094 0.0124 0.0192 0.0203 0.0200 0.0141 0.0119 0.0100 0.0139

p-value 0.3157 0.0288 0.2236 0.1746 0.0525 0.0822 0.0296 0.3297 0.4734 0.2253 0.1645

Wave vs. Non-Wave period

Cumulative Abnormal Returns for Wave period and Non-wave period Deals

Panel I: Aggregate Wave Period Deals (2004-2011)

Event

windowsDay 0 Day -1 to 0 Day -3 to 0 Day -5 to 0 Day -7 to 0 Day 0 to 1 Day -1 to 1 Day -2 to 0

Day -2 to

+1

Day -3 to

+1

Mean

(N=247)0.0068 0.0097 0.0111 0.0091 0.0071 0.0057 0.0086 0.0084 0.0073 0.01

p-values 0.0027 0.0013 0.0043 0.0508 0.173 0.0749 0.0236 0.012 0.0696 0.0253

Panel II: Aggregate Non-Wave Period Deals (1995-2003)

Mean

(N=108)0.0077 0.0117 0.0136 0.0137 0.0187 0.0107 0.0146 0.0109 0.0138 0.0165

p-values 0.0481 0.0369 0.0658 0.0865 0.0541 0.0601 0.0341 0.0846 0.0725 0.0578

Panel III: Difference of Means Test (Non-Wave vs. Wave Period Deals)

Diff. of

Means

(108, 247)

0.0009 0.002 0.0025 0.0046 0.0116 0.005 0.0061 0.0024 0.0065 0.0065

p-values 0.8257 0.7308 0.7445 0.6029 0.2525 0.4111 0.4058 0.7093 0.4121 0.4596

Viewing The Whole Mosaic: Some Conclusions

• Does Pay: For targets, value is created.

• Doesn’t Pay: Buyers get at least what they deserve.

• It depends• Managers can make choices that materially influence the profitability of

M&A.

Factors Affecting Gains in M&A

Factors Affecting Gains in M&A

• Acquisition method: Merger or Tender Offer• Less scope for drastic restructuring and potential value creation after the

merger

• Method of Payment• Information asymmetries & overvaluation

• Risk Sharing (Private targets)

• Country• Developed countries have highly competitive market for corporate control

(high premium)

• Wave Period• Position in the wave

• No diff in non-wave period

Factors (contd.)

• Attitude of the Transaction• Hostile bidders lose

• Ownership: Toehold• Target gains decrease with the size of the initial bidder’s toehold.

• Less bargaining power

• Financial Synergies• When high growth and cash poor firm is acquired by a cash-rich bidder

• Bidder, target and total returns are highest for acquisitions that combine slack poor & free cash flow firms

• Negative returns for deals where bidders & targets are similarly classified

Factors (contd.)

• Diversification• Value destroying

• Managerial Holdings• Greater money at stake – value creating• LBOs are value creating

• Free Cash flow• Deals by firms with excess cash are value destroying

• Hubris• Glamour acquirers (w.r.t high M/B, past performance – stock price, earnings, &

cash flows) tend to fall prey to CEO hubris• Value creating in the short run• Reversal in the long run - destroys value

• Speed of Integration• Fast track integration – achieve over 80% of objectives• Go-slow integration – failure rate approaching 50%

Myths Surrounding M&A’s

• Takeovers harm the shareholders of target companies.• Evidence to the contrary

• Takeover expenditures are wasted. • Takeovers are solutions to the problems associated with free cash flows

• By merging competitors, takeovers create a monopoly that will raise product prices, produce less, and thereby harm consumers.

• Consolidating facilities after a takeover leads to plant closings, layoffs, and employee dismissals- all at great social cost.

• Managers act in their own interests and are in reality unanswerable to shareholders.

References

• Applied Mergers and Acquisitions by ROBERT F. BRUNER, WILEY FINANCE.

• Gains from Mergers and Acquisitions Around the World: New Evidence by G. Alexandridis, D. Petmezas, and N.G.Travlos, Financial Management.

• Takeovers: Folklore and Science by Michael C. Jensen.

• Mcnamara, G.M., Haleblian, J., & Dykes, B.J. 2008. ‘The performance implications of participating in an acquisition wave: Early mover advantages, bandwagon effects & moderating influence of industry characteristics and acquirer tactics’. The Academy of Management Journal, 51(1), pp. 113-130.