Emerging facts on Mergers and Acquisitions
Mergers and Acquisitions (M&As) are a fact of business life, and can often be a quicker, easier and cheaper way for businesses to grow than by organic expansion. However, now that the heyday of the 1980’s hostile takeover is over, new research in Continental Europe reveals some surprising results for what makes a company more likely to seek speedier acquired growth, over slower expansion.
M&As are still a popular means of growth for firms. Looking solely at 2007, almost 36,000 deals were announced worldwide, including over USD 3 billion’s worth just in Europe. While several studies have used various analysis techniques to examine the company features that likely make firms takeover targets very few analyse the characteristics of bidding companies.
So what makes a company look around for possible targets? Scholars have developed numerous arguments to explain why firms may choose to participate in M&As. First, acquisitions often allow faster growth, as the target is ‘ready-made’, with its own production capacity, distribution network, and clientele. Takeovers can also be cheaper than internal expansion, particularly where the replacement cost of target assets exceeds their market value, as M&As can be (partly) paid for with equity- shares in the acquiring company. This could be particularly attractive to firms with small cash reserves and/or limited debt capacity. It may be that the excessive self-confidence of management is another notable reason behind M&As.
So that is the theory, but what do the numbers show? Is it cash-strapped, impatient businesses that look for acquisition targets? Actually, no.
The results show that neither the firm’s cash position nor its cash-generating abilities influence its choice to grow externally. Neither those companies with higher earnings nor those with considerable cash reserves are particularly unlikely to enter into an M&A transaction, but neither are such firms tempted into M&As solely because of easy access to internal funds. However, where firms are constrained by existing bank financing- if the ratio of bank loans to total assets is high- this does have a negative effect on the likelihood of a business considering an M&A. While it is likely this indicates that the obligation to make interest payments and repay the loan principal restricts the possibility to finance M&As, the notion that financial constraints are binding in a sample that is dominated by private enterprises is not actually surprising at all.
So given that available cash does not seem to affect the decision to consider an M&A, but existing loans do, what other factors are there that may indicate a greater or lesser likelihood to consider this type of business growth?
Surprisingly, one of the strongest correlations found in the research was that companies with higher ratios of intangible assets, which include things like research and development expenditure and patents, were far more likely to look at acquisition as a route to expansion than organic growth.
But less surprisingly, companies that are owned by fewer individuals are less likely to enter into an M&A deal, given the potential for dilution of their ownership. If a deal involves an element of equity, as is common, large owners who care about preserving control would want to avoid issuing stock to pay for their M&As. While it is possible to have a cash-only deal - indeed the sampled companies falling into this category showed a higher incidence of this type of deal - the self-imposed restriction did show a negative effect on the number of M&As.
And, according to this latest research, those are the biggest influencing indicators on the probability of a company becoming an M&A bidder. Previous studies suggested that the most recent M&A wave, which started in the mid-1990s, was largely engendered by global competition, technological change, and deregulation. While competition and the rapidly-changing technological landscape were found to have some impact on the likelihood of a company entering into an M&A transaction, this new research shows that industry deregulation, industry growth, and financial market conditions have no influence, and these findings are largely comparable across listed and private firms.
In particular, this study refutes the idea that realising operating synergies from economies of scale is a key determinant underlying external growth, as the size of industry incumbents actually has a negative effect on the probability of an M&A. That is not to say that there are not advantages to be gained by a business increasing in size- attempting to secure market power is a major consideration in horizontal and domestic takeover decisions, and indeed industry sales concentration tends to increase the likelihood of such deals. However, M&As are not considered purely for operating synergy advantage, as previously thought.
In summary then, this latest research indicates that a bidding company is most likely to be one without large debts and concentrated shareholdings but instead a company with a large proportion of intangible assets. The company may be looking to increase market share or market power, but is positively uninterested in growing purely to make scale economy savings.
Related academic article
Huyghebaert N. Luypaert M. 2010. Antecedents of Growth through Mergers and Acquisitions. Empirical results from Belgium. Journal of Business Research. 63 : 392 - 403