Advice for avoiding a failed merger

The biggest factor in completing mergers and acquisitions is form of ownership — most failed M&A deals involved public targets rather than private ones.

That’s according to a report by the M&A Research Centre at London’s Cass Business School. The report analysed data from 25 years of deal-making. No matter the type of company, lessons can be learned from previous failures.

Private deals ‘inherently easier’

From 1992 to 2016, the global average failure rate was 11.1% for publicly traded targets, according to the survey. On the other hand, deals involving private targets had a 3.7% failure rate in that span. A target firm’s location also played a significant role in failed mergers (see the chart below). Regionally, Asia-Pacific targets had the highest failure rate (7.1%), followed by North America at 6.4%.

Company type can have a bigger impact on deal success rates than significant factors such as geography, company and deal size, liquidity, and political decisions like the UK’s vote to leave the European Union and the US presidential election, said the report commissioned by collaboration-software provider Intralinks.

Mark Borkowski, president of Toronto-based Mercantile Mergers and Acquisitions, said proposed acquisitions of public targets are more likely to fail because of high demand for public companies. Failures often result because public targets exploit their leverage in negotiations.

“They can always say no and be back at the table and trading with another suitor who will offer a better deal — and we’ve seen that here repeatedly,” he said.

Noting that he hears of failures every day, Borkowski predicted that scuttled deals will continue to rise.

Jonathan Simnett, director of London-based Hampleton Partners said, “It’s disappointing that the failure rate shows no long-term decline and continues to be cyclical, affected by a random assortment of reasons — rational and irrational — and indicates that little has been learned in general M&A practice and process.”

In 2016, global failed M&A deals reached an eight-year high of 7.2%, the highest level since the 2008 global financial crisis stemming from the Lehman Brothers collapse. Failures rose for the third straight year while exceeding the long-term average of 5.7%.

Simnett said the eight-year high resulted from high share prices and the need to acquire firms “for growth, margin, and future expansion to help ensure that company share prices remain high.”

“Rising stock markets also generally coincide with good trading conditions for successful companies, and large cash reserves are often built up, making acquisition possible along with high-value paper. In fact, the value of M&A in the tech market closely follows the Nasdaq index with more deals at higher value done in a rising market and less deals at much lower value — often fire sales — done in a falling market.”

Proposed deals involving public targets, he added, are hampered by the complexities of public-company listings, complex share ownership, and regulatory issues that can come into play while transactions face public exposure.

“It is the nature of private-target deals that they are inherently simpler and may often be ingredient deals to provide new technologies or market entry rather than deals to provide market share or leverage financial positions,” said Simnett, whose firm specialises in the tech sector. “They are also largely free of the glare of publicity and largely free of the vagaries of the financial markets.”

More private deals have succeeded because investors were often required to use their own capital, M&A advisers believe. According to the report, all-cash deals were less likely to fail.

“[With] the private mergers, there’s a lot more skin in the game,” said Jon Doukas, managing partner of Trends Mergers & Acquisitions in Fort Lauderdale, Florida. “Private-equity firms are very hands-on.”

Meanwhile, researchers determined that most deals involving large players failed. So did most of smaller companies’ attempts to take over big firms. Borkowski said proposed takeovers of large public companies by small players are undermined by weak covenants, acquirers’ financially stronger rivals, and the fact that most targets do not want to sell.

“That’s the problem,” he said. “It’s so different from the private transactions. You see lots of buyers, lots of money — no sellers.”

But the probability of a deal’s failure was reduced when a larger acquirer attempted to take over a smaller target. Still, a much larger prospective buyer may not find it worthwhile to spend the time and money on acquiring a small firm, Simnett said.

“However, in the technology marketplace, large technology companies will acquire small and, usually, young technology firms to access a strategically important technology or team, often at high multiples,” he said. For the acquiring company, “the deal remains compelling to close.”   

According to the report, deals involving public targets were more likely to fail when no target break fee was involved. A target break fee is a penalty, often between 1% and 3% of the transaction value, paid by the target to the acquirer if the deal does not close. When no target break fee was included in the deal, 13.4% of deals failed, compared with 4.7% deal failure when there was a target break fee.

The report said it was possible that target companies informed of the expectation that they pay a break fee if the deal fails to be completed were much more careful about agreeing to be acquired.

The report was based on a study of 78,565 announced deals involving 73,268 public and private targets and 35,049 public and private acquirers between 1992 and 2016. Each transaction had a minimum value of $50 million or involved targets or acquirers with revenues matching that amount.

Tips to fend off failure

The report offers tips for acquirers pursuing either public or private companies:

• Getting back to size: Consider strategic rather than transformational deals. Deals involving larger targets in absolute size, and in size relative to acquirers, were less likely to be completed.
• Remember that cash is king. Keep deal consideration simple to avoid shifting equity valuations. The report found that deals where only cash was offered were less likely to fail. But the report also said that “there may be deals where the buyer feels it is more appropriate — by choice or lack thereof — to “build an element of equity into the transaction structure.”
• Manage your workload and resources during the attempted deal. Larger acquirers tend to have better access to finance and more bargaining power, but smaller targets are nimble and can mitigate failure risks by spending more time on due diligence.

When pursuing public targets specifically:

• Don’t be hostile. Take the time to woo your target in an agreed or solicited transaction.
• Pay for the right advice. The report showed that acquirers increased the likelihood of completing deals when they had a higher number of financial and legal advisers. However, the report noted that some companies elect to keep the group of advisers small on purpose, to avoid miscommunication, for instance. On complex deals that may cross borders, having a wealth of knowledge can help the deal come to fruition.

Simnett offers these tips for potential targets:

• Ensure there is clear agreement amongst shareholders as to the expected and acceptable valuation for the company and establish a threshold below which the company will not proceed.
• Ensure that an auction process is in place with multiple potential buyers still in play past the letter-of-intent stage.
• Ensure there is a C-suite champion for the deal on the buyer team — preferably the CEO with the board chairman also supporting the transaction.
• Ensure there is clear alignment between the seller and buyer as to the financial and strategic advantage that their combination will deliver — and the integration process for the two companies.
• Ensure you are clear from the beginning as to what will be an acceptable structure for an exit package — cash versus equity, length of earnout, share reinvestment, potential role in the acquiring company, etc. But be prepared to be flexible.
• Ensure you have sufficient time to focus on the deal process and its documentation.

Deal failures by region, 1992-2016

Cass Business School’s report analysed more than 78,000 announced deals and found a total M&A failure rate of 5.7%. Here is the failure rate by region:

Asia Pacific, 7.1%

North America, 6.4%

Europe, Middle East and Africa, 4.2%

Latin America, 4.0%

Monte Stewart is a freelance writer based in Vancouver, British Columbia. To comment on this article or to suggest an idea for another article, contact Neil Amato, an FM magazine senior editor, at Neil.Amato@aicpa-cima.com.