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M&A – what’s the big deal for investors?

Headline-hitting deals when one company merges with or acquires another can leave investors wondering what it all means for them. 

Mega-mergers almost had another ‘wow’ moment in February. US titan Kraft Heinz was poised to take over Anglo-Dutch consumer goods giant Unilever until the proposed £115 billion deal unravelled two days later. But do mergers and acquisitions (M&A) always work out well for shareholders – and should investors be worried by hostile takeovers?
The history of M&A activity is strewn with high-profile unions – both global and involving UK companies. In the UK, among those that have grabbed the most attention (not just for scale, but for emotional wallop) was the takeover in 2000 by Vodafone of the German carrier Mannesmann – the biggest yet at £112 billion (€190 billion). The same year, Glaxo Wellcome merged with SmithKline Beecham to create a £130 billion colossus, while Kraft gobbled up Cadbury for £11.5 billion in 2010. (And changed the recipe of the much-loved Creme Eggs to great fury.)

But perhaps the best-known global mega-merger – for both its size and torrid aftermath – was the collision of new and old when AOL merged with Time Warner in 2000. The internet provider, riding high on dot-com hubris, had soared to a prodigious valuation. When AOL’s Steve Case initiated the fusion with Time Warner’s traditional media mix, the deal was widely applauded as a vanguard of future business deals. The value of the combined companies, according to Bloomberg, was $350 billion.

And then it all went sour. The dot-com bubble popped a few months later and the US economy went into recession. Very few in the tech or financial industries could have predicted the level of carnage. AOL was forced to take a goodwill write-off of nearly $99 billion in 2002 and its shares plummeted. Amid the turmoil, and after years of sniping and treacherous blood between the two camps, the companies announced a split in 2009. Now they are separate entities again, with Time Warner recovering much of its chutzpah.

In a New York Times interview in 2010, Case was reflective on the merger’s merits. “It was a good idea, but the execution of it wasn’t what it needed to be,” he said. “And I accept responsibility for that. Everybody involved, I think, needs to accept responsibility for that, but that doesn’t take away from the core strategic value of the idea.”

However, CNN founder Ted Turner – a major shareholder in the new entity – was more frank: “It’s one of the biggest disasters that has occurred to our country.”

Investors need to be wary

The Kraft Heinz and Unilever deal, if it hadn’t collapsed, would probably have been quite a catch for Kraft Heinz (which may explain why Unilever thought it fell short). The weak pound meant that Unilever shares were good value, the company has a great track record in emerging markets and it has a reputation for being an ethical brand.
But would it have been a good deal for shareholders? “For the shareholders of Unilever, initially at least,” says Professor Meziane Lasfer from the CASS Business School, City University of London. “Over the long term, maybe not so much.”
Lasfer cites research that states that a high percentage (around 75%) of M&A activity tends to fail. This doesn’t mean a calamity like bankruptcy – but a failure to deliver desired results when viewed through the lens of overall value created and savings made, particularly when orchestrated through stock-only deals.
“The best deals work when there are true synergies between companies,” he says, referring to costs that overlap and can therefore be cut. “Also, when you pay with cash you are much more likely to focus, which helps participants to be more choosy and not overpay.”
It’s true that inflated share price values can be a slapdash primer for a rash deal – companies that are not fundamentally strong or even profitable can buy up established firms because they are riding an ebullient tide. Just look at the AOL Time Warner fiasco.
But sometimes, pursuing an M&A strategy is a great way for even established, fast-growing companies to grow even quicker. Google is a thriving company, very profitable, and still growing healthily. Yet it accepts it doesn’t have all the answers in-house, so periodically it will take over a company like DeepMind (the British artificial intelligence firm it bagged in 2014) for specialist know-how that Google may not have been able to develop itself. The Facebook purchase of photo-sharing application Instagram in 2012 is another good example of a smart acquisition to gain a fast competitive advantage in a field.

A busy time for M&A

M-A.jpg“M&A activity is heightened once a cycle of share price prosperity is well-established, or even nearing its peak,” states Philip Smeaton, Sanlam’s Chief Investment Officer. This explains why mega-mergers have reached their zenith since the financial crash of 2008: the US stock market has enjoyed an eight-year bull run.

According to the UK’s Office for National Statistics, in 2016 the amount of successful inward and domestic M&A involving UK companies saw a notable increase, resulting in the highest levels of M&A activity since 2011. There were also major deals globally: chemical giants Bayer and Monsanto merged, British American Tobacco took over Reynolds American and Time Warner was back on the deal path as it announced a hook-up with US telecom giant AT&T. Brewing giants AB InBev and South African-founded SABMiller finally completed their more than $100 billion merger.
The trend is expected to continue; 75% of respondents to a Deloitte survey at the end of 2016 expect deal activity to increase. But, as ever, shareholders should be mindful of the implications of any proposed deal. When companies come together, the tests are not just about blending different cultures, how to divide up the board and whether value can be created.
“The challenge for shareholders is to find out what management wants out of a deal,” says Edmund-Philipp Schuster from the London School of Economics. “Therefore, it can be hard for shareholders to distinguish whether it is a good deal or not. Because of laws in the UK, directors may have information they cannot share.”  Referring to sensitive information about, say, new products or competitive innovation in the pipeline, he adds: “Sometimes the real value within a company is based on secrets you can’t disclose.”

A cautious, considered approach is best

Sanlam takes a considered approach to building portfolios, says Philip Smeaton, Chief Investment Officer at Sanlam, so that high-profile mergers or takeovers do not overly affect investors.
“When we invest in companies, we look at it from the point of view of the whole company – how much it is worth, and how much free cash flow the business can generate. We invest as if we were actually doing an M&A buyout,” he explains, referring to the level of inspection that building a robust portfolio demands.
Despite some takeovers and mergers capturing a lot of public attention, the effect on fund investors is usually small. “If you are well diversified, the effect of any single M&A transaction on a portfolio will be marginal. However, sometimes a deal can cause the value of companies in a whole sector to be reassessed.
“Of course, humans are optimistic by nature, so sometimes it can be very exciting for a company to do a deal – yet it always pays to be wary so you don’t miss any negative points of an offer or merger. When companies we own start making acquisitions, we carefully analyse the price paid and the execution risks associated with the deal.”
Caution underpins the construction of portfolios, he says, and never guesswork or the hope of a deal. “We would never invest in a company solely because it might get taken over. It is the fundamental value of a business compared to the market price that drives our decisions. Still, if we see a company’s value, it is possible that potential acquirers will also see the value in our investments.” 

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