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Do Mergers and Acquisitions Create Value?

Written by Adrian L. 

Introduction

Companies have been engaging in mergers and acquisitions (M&A) for many decades. In fact, this has been one of the major modes of growth for companies operating in saturated markets. It is a simple way to boost a company’s sales, enter a new market or increase efficiency through synergy. However, M&A are not successful in each and every case. There have been many instances where a merger or an acquisition proved to be a value destructor rather than a value creator. Therefore, it is important to investigate whether M&A activity actually creates value or not (Zollo and Meier, 2008).

 

Value Creation

It is not a straightforward process to estimate the value addition of a merger or an acquisition. This is because there is a wide range of factors to be considered before it can be concluded that such a transaction has created any value. The most common technique that is used around the world for measuring the value creation is to look at the share prices of the companies involved in the transaction. According to this approach, if the share price of the acquirer and the target has managed to go up steadily after the transaction, then the merger or the acquisition has managed to create value for the firms involved. Swaminathan et al. (2008) used this approach to identify whether M&A activity resulted in value creation or destruction. The results of the research clearly indicated that the stock prices of the companies went up after the transaction in most cases. These results implied that M&A do indeed create value for the companies (Swaminathan et al., 2008).

The primary motivation behind any merger or acquisition in most cases is the potential to realise synergies in various forms. However, it is not given that every transaction will manage to do so in an effective manner. Nevertheless, many M&A around the world manage to have a positive impact on the share prices of the companies. Interestingly, the target companies are more likely to enjoy positive returns after M&A announcements because the shareholders of target companies often receive a premium. The bidding firm might experience a price drop in between the announcement and the completion period, but this is often a result of speculation in the market. In general, most M&A transactions around the world manage to create value for the parties involved, and this is the primary reason why M&A continue to be one of the most popular modes of growth according to Goergen and Renneboog (2003). However, there are also many cases of value destruction such as the case of the merger between AOL and Time Warner.

It is valid to argue that the described technique of measuring M&A results based on the share price performance is not foolproof. This is because the market price of shares is dependent on a range of internal and external factors not limited to the transaction. Therefore, a better approach would be to estimate abnormal returns that have been achieved by shareholders of the companies, according to Rehm et al. (2012). The scholars researched the world’s top 1000 companies, except the ones operating in the banking sector. The research found that more than half of the M&A transactions carried out by these companies over a decade managed to create value for them. This proves that M&A can result in value creation with proper management. Similar value creation success has been noted in the European banking sphere. Beitel et al. (2003) studied 98 major transactions in the field in order to assess if any value had been created. In most such transactions between 1985 and 2000, the result was a significant creation of value for the firms involved in the transaction. Excess returns were achieved by most of the shareholders post the transaction, which indicates that the M&A activity has been successful in this particular sphere.

 

Value Destruction

There are also numerous examples of M&A transactions that have eroded value for the firms involved. For instance, the $35 billion transaction between Sprint and Nextell in 2005 managed to destroy the firm value. This was due to multiple complications that took place in the deal. Firstly, the post-merger amalgamation between the two firms ran into problems due to some top executives leaving the merged entity. Secondly, the combined company failed to record the desired levels of customer growth, resulting in high customer churn. This resulted in a drop in share prices for both the firms involved. There are various other similar examples that are present across industries (Galpin and Herndon, 2008). Another finding was that, in the previous century, a significant number of transactions were unsuccessful, but now the companies have been getting better at M&A value creation as the years go by (Bruner, 2001; Cartwright and Schoenberg, 2006).

Additionally, for the value addition process to materialise, it is important to follow a few techniques. Firstly, M&A can only manage to create value if the entire process is treated as an integration rather than a transaction. If not, then transactions can lead to value destruction. This means that there is a need to understand cultural aspects as well as the complementarity aspects of a deal in order to ensure that it manages to create value in the long run (Bauer and Matzler, 2014). Secondly, the pace at which the two companies are amalgamated needs to be well planned. Integrating the target company too quickly or after too much of a delay can lead to a destruction of value for both the firms involved (Galpin, 2008).

 

Conclusion

To sum up, it is evident that M&A can create and destroy value. Value creation often happens due to potential synergies that can be realised if the other firm is the right fit. However, if the appropriate amount of time and resources are not allocated to the due diligence process, M&A can prove to be a value destruction exercise. Therefore, it is important to consider cultural factors, competition, costs of acquisition, and method of financing the deal in order to increase the chances of creating value through M&A.

 

References

Bauer, F. and Matzler, K. (2014) Antecedents of M&A success: The role of strategic complementarity, cultural fit, and degree and speed of integration, Strategic Management Journal, 35(2), pp.269-291.

Beitel, P., Schiereck, D. and Wahrenburg, M. (2003) Explaining the M&A success in European bank mergers and acquisitions, Witten/Herdecke Working Paper.

Bruner, R.F. (2002) Does M&A pay? A survey of evidence for the decision-maker, Journal of Applied Finance, 12(1), pp.48-68.

Cartwright, S. and Schoenberg, R. (2006) Thirty years of mergers and acquisitions research: Recent advances and future opportunities, British Journal of Management, 17(S1), pp.S1-S5.

Dobbs, R., Goedhart, M. and Suonio, H. (2007) Are companies getting better at M&A, McKinsey on Finance, 22(Winter), pp.7-11.

Galpin, T. (2008) From the deal world to the real world: maximizing M&A value after the deal is done, Business Strategy Series, 9(2), pp.57-64.

Galpin, T. and Herndon, M. (2008) Merger repair: when M&As go wrong, Journal of Business Strategy, 29(1), pp.4-12.

Goergen, M. and Renneboog, L. (2003) Value creation in large European mergers and acquisitions, Advances in Mergers and Acquisitions, 2, pp. 97-146.

Rehm, W., Uhlaner, R. and West, A. (2012) Taking a longer-term look at M&A value creation, McKinsey Quarterly, 2, pp.1-7.

Swaminathan, V., Murshed, F. and Hulland, J. (2008) Value creation following merger and acquisition announcements: The role of strategic emphasis alignment, Journal of Marketing Research, 45(1), pp.33-47.

Zollo, M. and Meier, D. (2008) What is M&A performance?, Academy of Management Perspectives, 22(3), pp.55-77.