reported a spread of premiums paid to shareholders of target firms for a sample of deals during the second quarter of 2013. Of these, 49 deals had premiums between 0 to 10 percent, 54 had premiums between 10 and 25 percent, 52 carried premiums between 25 and 50 percent, and 19 enjoyed premiums of 50 to 100 percent. Finally, 13 had hyper-premiums of greater than 100 percent.13
Also, the trend for premiums paid can be increasing or decreasing. In 2013, U.S. companies were paying on average a premium of only 19 percent above their target's trading price one week before the deal was announced.14 This reflected the lowest takeover premium since at least 1995, according to Dealogic. Given the uncertainty of macroeconomic conditions, executives and corporate boards were being cautious.
Nevertheless as suggested earlier, wide variance across deals in premiums typically occur, especially when the premiums paid to rapidly growing private high-tech companies are included. (Private company premiums are harder to measure than those associated with public companies, but are often based on the most recent private valuation.) Using another metric, WhatsApp's $19 billion price tag implied a multiple of approximately 100 times revenue and a huge premium over previous valuations.
It's not always possible to know the premium paid for an acquisition, For example, we'll see in Chapter 9 that Google discloses the valuation and terms for only a small number of its deals. Third parties provide estimates for a larger set of Google acquisitions.
The bottom line? M&A pays for almost all targets across industries. But in hot technology areas, the payoff can be off-the-charts.
Acquirer Financial Performance
As we've seen, classic research findings suggest that acquirers on average do not have much room for optimism, given that the distribution of announcement returns has a mean close to zero. Thus, a pressing question facing an acquirer is: How can my company do better than average?
More recent research involving large-scale samples provides a little more room for optimism. Abnormal returns to acquirer shareholders are modestly positive (about 1 percent) if large public company deals and deals involving stock-for-stock exchanges are filtered out.15
Post-merger returns typically analyze cash flow or operating profit over a period of time (typically three-to-five years) after an acquisition. However, there's a major problem with these analyses. The longer the period of study, the greater the likelihood that confounding factors (extraneous to the deal) impact financial performance.
In addition, it is not possible to analyze how the company would have performed had it passed up the acquisition. In an attempt to address this problem, some studies compare the performance of two similar companies, only one of which made an acquisition. But here again, confounding variables swamping the M&A dimension can enter into play.
Complexity in the M&A performance analysis is taken to an even higher level when a company is a serial acquirer or focuses on smaller acquisitions that are rounding errors in its market capitalization. Google is a prime example of such a company.
The bottom line is that research studies on acquirer performance face substantial methodological hurdles. With this caveat in mind, one study of studies analyzed 26 studies of post-merger performance, 14 of which showed a decline of operating returns, 7 showed positive (but not significant) returns, and 5 showed positive (statistically significant) returns.16 This is hardly a confident, conclusive picture of M&A performance results.
Numerous studies show acquirers of privately owned firms realize positive returns of 1.5 to 2.6 percent.17 Such higher returns are generally attributed to factors such as a limited number of bidders and the relative illiquidity of private companies, resulting in an associated liquidity discount. But such discounts may not apply to venture-backed companies that Google attempts to acquire – ventures where other deep-pocketed bidders may also be in pursuit. For example, reportedly both Apple and Facebook were interested in Waze's crowd-sourced traffic technology.
Some evidence exists that high-tech firms realize positive value by acquiring small, but related ventures to fill in gaps in their product offerings.18 This is one likely reason why successful high-tech companies persist in being very active deal makers. There will be more about this in our next chapter.
Several studies have shown that publicly traded acquirers using cash for transactions tend to do better long term than those that use stock.19 One rationale for this observation is that executives tend to use stock when they believe their shares are overvalued.20 Hence, it's not surprising that the acquirer's share price drops after the acquisition. (AOL's stock-for-stock merger with Time Warner is often cited as a classic example of this phenomenon.)
On the other hand, a company may genuinely believe its stock is an attractive currency (certainly not overvalued) and use the appeal of its shares to woo a target and close a deal. Consider Google's stock-for-stock acquisition of YouTube, where Google's shares were likely to have been regarded by both acquirer and target as a very desirable currency.
Acquisitions such as the Google purchase of YouTube argue against the superior acquirer performance when doing cash deals. Herd and McManus21 further support this argument in stating, “Historically, acquirer may have been keen to use equity to finance a deal when they've believed their equity was overvalued. But during the last decade, they've come to realize that equity is often more dear than cash in an era of plentiful and cheap credit.”
Given all of this, we can conclude that the motives for using equity in an M&A transaction vary across acquirers. Equity can be used when the purchaser feels its currency is Weimar-Republic hyperinflated. However, the use of equity may also signal a deal's importance if the acquirer is demonstrating to the target a willingness to use a tender that both believe has significant potential to appreciate.
When Berkshire Hathaway uses it stock, the company signals that it views the acquisition as having special value. As Warren Buffett quipped at a shareholders meeting about issuing stock in a transaction: “Charlie [Munger] and I like using stock about as much as preparing for a colonoscopy.”
Perhaps here's the key takeaway regarding M&A financial performance for acquirers. Average returns across all companies may not be all that exciting. But the real issue is, how does a company outperform these averages? How does a company move into the top quartile of performers? How does a company build a core strategic advantage via M&A? Throughout this book, we'll explore what we can learn about these questions from Google.
Reasons for M&A Failure
In other to provide context for understanding M&A success, let's highlight three major reasons for M&A failure. Not surprisingly, these reasons closely connect to the broad areas of M&A activity discussed earlier.
Flawed Strategy
The strategic rationale for an acquisition must be soundly based on a company's core competencies. Growth opportunities should be centered in areas where a firm has some distinctive advantage, not on areas of overt weakness. The chances that M&A will solve a company's problems have about the same likelihood of success as a marriage resolving the difficulties of two troubled people.
Consider an example. If a product or service is unable to obtain distribution by clearly providing value, acquiring distribution is unlikely to be the solution.22 In 1987, during the early days of personal computing, Atari was struggling to convince retailers to sell its PCs. In an attempt to solve the problem, Jack Tramiel, then chairman of Atari, bought the Federated Group chain of consumer electronics stores for $67.3 million. Tramiel reasoned that the network of 65 Federated stores in California, Arizona, Texas, and Kansas would successfully move his computers.
Other