Mergers and acquisitions (M&A) have unsurprisingly fallen in the last few months as listed companies tighten the purse strings in a bid to see out coronavirus.
Some prospective deals have been put on ice, especially where completion has been conditional on regulatory approvals. But when the dust settles on a confusing time for financial markets, consolidation is likely to pick up as opportunistic buyers savour the prospect distressed asset sales and overvalued companies desperately seek out their next phase of growth.
Evidence from history suggests that it is just as unwise for companies to enter the buyers’ circle simply because the economy is at a low ebb as it is for them to display irrational exuberance at the top of the market.
In the case of the latter impulse, there are numerous examples at the height of the commodities boom, when resource companies acquired productive assets, or those in development, on the basis of flawed assumptions on prices and/or future demand levels for the underlying commodity.
One of the best (or worst) examples of this over-exuberance centres on Rio Tinto’s (RIO) deal to buy Canada’s Alcan Inc for $38.1bn (£30.9bn) in 2007. The mining group’s newly appointed chief executive Tom Albanese got into a bidding war over the aluminium producer, eventually closing out the deal with an offer representing a one-third premium to the final bid by rival Alcoa Inc. The timing was perhaps unfortunate given what was to transpire during the following year, but Rio’s management team either underestimated, or simply chose to disregard, the growing prevalence of low-cost Chinese production in the market.
At the time, it was largest mining deal of all-time, but it was struck at the top of the cycle for aluminium prices. Rio was forced to take asset write-downs to the tune of $25bn through to the beginning of 2013, by which time Mr Albanese had fallen on this sword.
Maybe this was simply a case of a new chief executive wanting to make his mark, but there are innumerable examples of how ill-judged M&A deals – or inadequate due diligence – have destroyed shareholder value. One point worth considering is the critical role played by nominated advisers and senior management in the M&A process, particularly regarding the issue of financial incentives and its potential impact on critical thinking.
That is not to say that the pursuit of M&A strategies is inimical to value creation, but there needs to be specific criteria beyond building scale or diversifying for the sake of it. Investors will often read about the sharing of central costs between combined entities, but that should be considered an ancillary benefit of any proposed merger. A strategic rationale should be a central consideration whenever a deal is subject to shareholder approval.
The potential benefits can range from accessing a wider customer base to building productive capacity (plant and/or distribution facilities are often less costly to buy than to build). It may also be that a deal will be undertaken to rapidly increase market share, but there are inherent risks in allocating big volumes of capital to deliver growth in one fell swoop, as opposed to a gradual, measured response to incremental demand.
In the digital economy, ever more deals are being conducted to secure proprietary technology or intellectual property, hence the relatively high preponderance of intangible assets on many modern-day balance sheets. Amazon (US: AMZN) – a company known for re-investing all its profits back into its own business – is prolific on the M&A front. It has made over 100 acquisitions since its inception in its quest to expand into ever more markets. And anyone who has studied the rise of the Silicon Valley tech giants will know that some acquisitions are undertaken to effectively reduce competition by swallowing-up potential rivals – Facebook’s (US: FB) purchase of Instagram and Google’s acquisition of YouTube, for example – though that can result in friction with antitrust regulators.
There is always an element of risk in any given corporate action, but in terms of M&A, it is impossible to overstate the importance of having a clearly defined strategic imperative. The recently announced tie-up between Carlsberg (CPH: CARL-B) and Marston’s (MAR) provides a case in point, as it will enable the UK cask ale firm to access a wider global market through Carlsberg’s distribution channels, while the Danish brewing heavyweight will able to feed its beer range into Marston’s estate of roughly 1,400 UK pubs. Unfortunately, for investors, a focussed tie-up like this is the exception, rather than the rule.
