Are there common characteristics shares by acquiring firms and especially by successful acquiring firms? If you look at a small sample of acquisitions or even all the acquisitions done during the course of a year, you will be hard pressed to find any commonalities across acquirers. Researchers, however, have looked at hundreds of acquisitions over long periods and they have identified some common features shared by successful acquirers over time:
Firms that acquire firms of similar size (often called mergers of equals) seem to have a lower probability of succeeding than firms that focus on acquiring much smaller firms.20 Thus the odds of success would be greater for GE, which acquired dozens of small companies each year during the 1990s, than with the merger of AOL and Time Warner, two companies with very large market capitalizations.
Firms that are motivated by cost savings when doing acquisitions seem to have a better chance of succeeding that firms are motivated by growth hopes or expectations. This is especially so when the cost savings are concrete and planned for at the time of the
19 Kaplan, S. and M.S. Weisbach, 1992, The Success of Acquisitions: The Evidence from Divestitures, Journal of Finance, v47, 107-138.
20 This might well reflect the fact that failures of mergers of equal are much more visible than failures of the small firm/large firm combinations.
acquisition. Some of the most successful mergers of the 1990s involved banks that merged to save money and gain economies of scale.
Acquisition programs that focus on buying small private businesses for consolidations have had more success than acquisition programs that concentrate on acquiring publicly traded firms. Firms like Service Industries (funeral homes), Blockbuster Video (video rental stores) and Browning Ferris (waste disposal businesses) all grew by acquiring small private firms.
On the issue of synergy, the KPMG evaluation21 of the 700 largest deals from 1996 to 1998 concludes the following:
□ Firms that evaluate synergy carefully before an acquisition are 28% more likely to succeed than firms that do not.
□ Cost-saving synergies associated with reducing the number of employees are more likely to be accomplished than new product development or R&D synergies. For instance, only a quarter to a third of firms succeeded on the latter, whereas 66% of firms were able to reduce headcount after mergers.
Some research finds improvements in operating efficiency after mergers, especially hostile ones22. An examination in 1992 concluded that the median post-acquisition cash flow returns improve for firms involved in mergers, though 25% of merged firms lag industry averages after transactions.23 In 1999, another studyexamined 197 transactions between 1982 and 1987 and categorized the firms based upon whether the management is replaced (123 firms) at the time of the transaction, and the motive for the transaction. 24 The conclusions are that:
On average, in the five years after the transaction, merged firms earned 2.1% more than the industry average.
Almost all this excess return occurred in cases where the CEO of the target firm is replaced within one year of the merger. These firms earned 3.1% more than the
21 KPMG, 1999, Unlocking Shareholder Value: The Keys to Success, KPMG Global Research Report.
22A study by Healy, Palepu and Ruback (1989) looked at the post-merger performance of 50 large mergers from 1979 to 1983 and concluded that merged firms improved their operating performance (defined as EBITDA/Sales) relative to their industries.
23 Healy, P.M., K.G. Palepu and R.S. Ruback, 1992, Does Corporate Performance improve after Mergers?, Journal of Financial Economics, v31, 135-176.
24 Parrino, J.D. and R.S. Harris, Takeovers, Management Replacement and Post-Acquisition Operating Performance: Some Evidence from the 1980s, Journal of Applied Corporate Finance, v11, 88-97.
industry average, whereas firms, whereas when the CEO of the target firm continued in place the merged firm did not do better than the industry In addition, a few studies examine whether acquiring related businesses (i.e., synergy-driven acquisitions) provides better returns than acquiring unrelated business (i.e., conglomerate mergers) and come to conflicting conclusions with no consensus.25 An examination of 260 stock swap transactions and categorized the mergers as either a conglomerate or a 'same-industry" transactions.26 They found no evidence of wealth benefits for either stockholders or bondholders in conglomerate transactions. However, they did find significant net gains for both stockholders and bondholders in the case of mergers of related firms.
Looking at the stock price reaction of target firms both immediately prior to and immediately after the acquisition announcement, it is quite clear that the money to be made in acquisitions comes from investing in firms before they become targets rather than after. Absent inside information, is this doable? There may be a way, and the answer lies in looking at firms that typically become target firms. Since the motivations in hostile and friendly acquisitions are very different, it should come as no surprise that the typical target firm in a hostile acquisition is very different from the typical target firm in a friendly takeover. The typical target firm in a hostile takeover has the following characteristics:27
(1) It has under performed other stocks in its industry and the overall market, in terms of returns to its stockholders in the years preceding the takeover.
(2) It has been less profitable than firms in its industry in the years preceding the takeover.
(3) It has a much lower stock holding by insiders than do firms in its peer groups.
25 See Michel, A. and I. Shaked, 1984, Does Business Diversification affect Performance?, Financial Management, Vvol 13, 5-14 and Dubofsky, P. and P.R. Varadarajan, 1987, Diversification and Measures of Performance: Additional Empirical Evidence, Academy of Management Journal, 597-608. These studies find that diversification-driven mergers do better than synergy-driven mergers, in terms of risk-adjusted returns. Varadarajan, P.R., and V. Ramanujam, 1987, Diversification and Performance: A Reexamination using a new two-dimensional conceptualization of diversity in firms, Academy of Management Journal, Vol 30, 369-380. find evidence to the contrary.
26 Nail, L.A. , W.L. Megginson and C. Maquieira, 1998, Wealth Creation versus Wealth Redistributions in Pure Stock-for-Stock Mergers, Journal of Financial Economics, v48, 3-33.
27 Bhide, A., 1989, The Causes and Consequences of Hostile Takeovers, Journal of Applied Corporate Finance, v2, 36-59.
A comparison of target firms in hostile and friendly takeovers illustrates their differences. His findings are summarized in Figure 10.4.
Target Characteristics - Hostile vs. Friendly Takeovers
Target ROE -Industry ROE
Target 5-yr stock returns - Market Returns
% of Stock held by insiders
■ Hostile Takeovers □ Friendly Takeovers
Data from Bhide. This study compared the characteristics of target firms in friendly takeovers to those in hostile takeovers in the year of the takeover.
As you can see, target firms in hostile takeovers have earned a 2.2% lower return on equity, on average, than other firms in their industry; they have earned returns for their stockholders that are 4% lower than the market; and only 6.5% of their stock is held by insiders.
There is also evidence that these firms make significant changes in the way they operate after hostile takeovers. The study cited above examined the consequences of hostile takeovers and noted the following changes:
1. Many of the hostile takeovers were followed by an increase in debt, which resulted in a downgrading of the debt. The debt was quickly reduced with proceeds from the sale of assets, however.
2. There was no significant change in the amount of capital investment in these firms.
3. Almost 60% of the takeovers were followed by significant divestitures, in which half or more of the firm was divested. The overwhelming majority of the divestitures were units in business areas unrelated to the company's core business (i.e., they constituted reversal of corporate diversification done in earlier time periods).
4. There were significant management changes in 17 of the 19 hostile takeovers, with the replacement of the entire corporate management team in seven of the takeovers.
Thus, contrary to popular view28, most hostile takeovers are not followed by the acquirer stripping the assets of the target firm and leading it to ruin. Instead, target firms refocus on their core businesses and often improve their operating performance.
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