Executive Summary
The world has entered recession and newspapers are reporting daily on companies in trouble with their creditors or even going bankrupt. Forced acquisitions are common, with governments stepping in to engineer deals to save key companies in critical industries. In such a market when uncertainty is high, stock prices are volatile and overall share price levels are less than half what they were a year ago, it is important to try to understand whether now is a good time for a company to purchase a distressed target and whether, if you are a struggling company, now may be a good time to seek a stronger partner.
The M&A Research Centre (MARC) at Cass Business School (Dr Maria Carapeto, Professor Scott Moeller and Anna Faelten) has, in collaboration with Allen & Overy, Credit Suisse, Deloitte and FT/Mergermarket, conducted a comprehensive study of the M&A environment in distressed times. We have looked at the determinants of acquisitions of distressed and insolvent targets and measured differences in deal success. The study also incorporates research on relevant M&A activity and economic cycles to draw a clearer picture of the M&A environment today. Our global sample of 12,339 deals incorporates 2,652 acquisitions of distressed targets and 265 acquisitions of insolvent and bankrupt targets and spans a time period of 25 years from January 1984 to December 2008. The study includes all industries on a macro level except Financial Services and Government and Agencies which have been excluded in light of special regulatory environment and accounting issues. Note that we have defined a target as ‘distressed’ if its interest cover ratio (ICR) is less than one and at the same time it belongs to the bottom 25% of the industry in the year prior to the announcement of the deal. Also note that the terms ‘insolvent’ and ‘bankrupt’ are used interchangeably in this document. In light of differences in deal drivers and structure, this study focuses on ‘trade’ deals as opposed to so-called financial sponsor deals (such as private equity-backed acquisitions) which have been excluded throughout.
Key findings emerge from this analysis:
‘Buying cheap’ does not guarantee higher returns to shareholders; post-merger integration emerges as a key factor to deal success
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Acquisitions of distressed targets create value for the acquirer in terms of short-term stock market performance but generally struggle to realise longer-term value. This is a seemingly contradictory result which can perhaps be explained by the timing issues surrounding the deals. The time required to complete a deal is significantly shorter when acquiring distressed or insolvent targets, which puts pressure on planning and execution strategies. It seems as if the rationale behind making these acquisitions may be sound but the planning, execution and integration suffer.
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Acquirers of distressed and insolvent targets enjoy positive share returns on the days surrounding the announcement, an indication that the market views the acquisition as value enhancing for the acquirer. This does not hold true for acquirers of healthy targets.
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However, the analysis of long-term performance in terms of return on equity between one year before the acquisition to three years after shows that acquirers of distressed and insolvent targets fail to improve shareholder returns as the ROE deteriorates as a result of the acquisition. The acquirers of distressed and insolvent targets underperform when compared to acquirers of healthy targets. We conclude that even though acquisitions of distressed firms are viewed as value enhancing by the market—no doubt driven by low valuations—the integration process of a distressed target proves challenging for many acquirers. Integration strategies as well as execution planning emerge as even more important factors for deal success.
Post-acquisition synergies are generally better realised in acquisitions of distressed targets
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Viewing the results from a more economic point of view when looking at both companies combined (that is, not just from the acquirer’s perspective), we find evidence that newly-combined firms where the target is either distressed or bankrupt generally benefit from an overall improvement in performance (EBITDA/sales) over the long-term compared to their combined pre-bid performance. This is evidence of synergy realisation. As seen below, acquirers of distressed targets are more likely to be in the same industry as the target compared to acquirers of healthy targets. This can be seen as an explanation for the better realisation of synergies in these types of acquisitions.
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In comparing distressed and insolvent targets, the former suffer more from financial distress (when the company cannot meet its obligation with current cash-flow), whereas the latter suffer more from balance sheet types of distress (when the company’s liabilities are greater than its assets). We conclude that firms with immediate cash-flow problems are more likely to be ‘rescued’ (acquired) before entering formal insolvency procedures.
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If the target is distressed, it is more likely that the acquirer is in the same industry when compared to acquirers of healthy targets, who are more likely to acquire a company outside their industry, an indication that distressed investors want to play it safe and acquire core assets.
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When comparing relative size of target to acquirer, we see that distressed targets are much smaller than insolvent or healthy targets and that they are in worse financial condition. The same holds true when comparing acquirers of the three sub-sample groups and we conclude that distressed acquisitions tend to involve smaller (and more distressed) firms.
Industry and regional analysis shows that the US market views distressed acquisitions with more optimism and acquiring a bankrupt target gives positive short-term returns just after a major crisis
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Preferred industries for acquirers: industry level analysis shows that the market favours acquisitions of distressed targets in the Consumer Products & Services and Consumer Staples industries, whereas acquisitions of insolvent targets provide positive stock market returns when the target is in other selected industries, including Healthcare and High Technology.
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Differences between the US and UK: the UK and US stock markets react differently to acquisitions of distressed targets. There is insignificant or even negative reaction for the acquirer if the distressed or insolvent target is listed in the UK but the opposite is true if listed in the US. There is evidence of both the acquirer and the target enjoying short-term gains in terms of stock market returns if the target is in distress and acquired during a long-term market increase, i.e., an economic boom. Interestingly, it seems as though the best time to strike a deal for a bankrupt target is just after a major crisis when the market starts to recover, as analysis shows evidence of both acquirer and target gains in these types of acquisitions.
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Selected industries emerge as more likely to acquire distressed targets outside their own industry: some industries such as Materials, Telecommunications and Retail are short-term net distressed acquirers, meaning that these industries have higher levels of acquirers of distressed targets than actual distressed targets in 2008. This implies that they are acquiring distressed targets from outside their industry, which could be because they are opportunistically purchasing distressed or insolvent companies from other industries to add to their businesses. However, over the longer term, net distressed acquirers are the Healthcare, Materials and Media & Entertainment industries.
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