Acquisitions in line with capability strengths add by far the most value, research by Strategy& into the effectiveness of M&A finds. M&A’s where there is limited or no capability fit with the already existing function of a company generate for the most part significantly negative returns.
The study, titled ‘Deals that Win’, involved 540 deals, including the 60 biggest deals, over the period 2001 to 2012 across the industries of chemicals, consumer staples, electric and gas utilities, financial services, healthcare, industrials, information technology, media, and retailing. To identify the quality of the deals, Strategy& used the buyer’s total shareholder return (TSR) for a two year period after the announced deal and compared it with the TSR compound annual growth rate of the large-cap index in the buyer’s home territory. To identify the kind of deal, whether leveraged, enhancing or poor-fit, a qualitative approach was taken.
The three categories used to identify the fit of companies are broadly defined as: leverage, enhancement, and limited fit. A leverage deal sees the buyer’s capabilities leveraged to improve the situation of the acquisition through its own capabilities system, thereby generating considerable added value. As an example, a large medical player may, through an acquisition, gain access to the therapeutic area of a small competitor upon whose service line they can improve operations, thereby improving its market capabilities. Enhancement deals involve the acquisition extending the capabilities of a buyer into a closely related functional area that allow it to further intensify its capabilities system. Whereas a limited fit acquisition doesn’t see either the buyers’ core capabilities enhanced or deployed through the acquisition.
In the analysis of the different fit of buyers to their acquisitions, the consulting firm finds that on average leveraged deals create the best value for money in terms of TSR, with the TSR from leveraged deals at 5.4% over the period of two years. For enhancement deals the TSR stands at 2.6%. Limited fit deals on the other hand, often see significant decreases in TSR, down -9.8% annually.
The different kinds of intentions for M&A cited by companies also changes the way in which they are able to produce results in terms of their TSR related to their leveraged, enhancement or limited fit status. Of the deals, 31% were intended as consolidations, with consolidation in the capability area of an acquisition producing TSR of 7.9% and enhancement producing 12.1% return. If the intention involves a non-fitting acquisition, shareholders see a -13.1% return from such a deal. Diversification is the area in which leverage and enhancement see the least value, with 2.1% and -28.2% respectively, however, limited fit sees the smallest negative return from -4.6%.
The effect of betting on capabilities also shows significant variation across industries. Particularly retail and consumer staples show the most significant gains from the buyer’s capabilities being in line with activity of their acquisition. In retail, enhancement is also reflected particularly positively, while for consumer staples it generates a small loss. Chemicals, industrials and healthcare are also good fits for leverage and enhancement friendly acquisitions. For media, financials and IT leverage remains flat, with only enhancement seeing significant positive gain. In all industries besides utilities, limited fit generates negative TSR over the two subsequent years.