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    Are You Paying Too Much for That Acquisition?

     
    10/12/1999
    Despite 30 years of evidence demonstrating that most acquisitions don't create value for the acquiring company, executives continue to make more deals, and bigger deals, every year. In this excerpt from the Harvard Business Review, three M&A specialists look at the costs of pricing an acqusition incorrectly.

    by Robert G. Eccles, Kersten L. Lanes, and Thomas C. Wilson

    More Deals, More Failures
    Pricing an acquisition correctly is extraordinarily important given how many deals there are — and how many fail. During the past decade, merger and acquisition activity has steadily increased, as measured both by the total number of deals and by the value of those deals. In 1998 alone, 20,448 deals were completed worth a total of $2 trillion.

    The prognosis for most of those deals is not good. Several studies covering MSA activity in the past 75 years have concluded that well over half of mergers and acquisitions failed to create their expected value. In many cases, value was destroyed, and the company's performance after the deal was significantly below what it had been before the deal. The success rate is not much better today than it was 75 years ago, despite numerous, well-publicized studies illuminating the high failure rates.1

    The executives who continue to make bad deals don't appear to have learned much. The equity markets, by contrast, have learned from experience. Building on research done by Mark Sirower, we studied 131 deals, each valued at $500 million or more, that took place between1994and 1997 in the United States, Europe, and Asia. Our analysis, consistent with Sirower's earlier study of U.S. companies, shows that in 59% of the deals, the total market-adjusted return of the acquiring company went down on announcement.2 That means the market thought the deal would destroy rather than create value for the shareholders of the acquiring or merged company. Returns for 71% of those deals were negative over the next 12 months. By contrast, of the 41% of deals where the total return went up on announcement—in other words, where the market expected value to be created—55% still had positive returns in the ensuing year. This analysis demonstrates both that most deals do not create value and that the market is fairly good at predicting which ones will and which ones won't.

    1. For a good summary of these studies, see Dennis C. Mueller, "Mergers: Theory and Evidence," in Mergers, Markets and Public Policy, ed. G. Mussati (Kluwer Academic Publishers, 1995 ).
    2. Mark Sirower, The Synergy Trap (The Free Press, I997)

    · · · ·

    Excerpted from the article "Are You Paying Too Much for That Acquisition?" in the Harvard Business Review, July-August 1999.

    [ Order the full article ]

    Deals with Low Premiums Often Fail
    The Impact of Different Option Plans on Compensation
          Stock Price Increase Stock Price Decrease
      Stock Price Year 1
    $100
    Year 2
    $150
    Year 3
    $200
    Year2
    $65
    Year 3
    $30
    Fixed value plan

    Options granted
    Value of Options
    Cumulative Value

    28,128
    1 million
    18,752
    1 million
    14,0641 million
    5.4 million
    43,2731 million 93,7591 million
    1.3 million
    Fixed number plan

    Options granted
    Value of Options
    Cumulative Value

    28,128
    1 million
    28,128
    1.5 million
    28,128
    2 million
    7.2 million
    28,128
    $650,000
    28,128
    $300,000
    $510,000
    Megagrant plan

    Options granted
    Value of Options
    Cumulative Value

    79,697
    2.8 million
    0
    0
    0
    0
    8.1 million
    0
    0
    0
    0
    $211,000
    Option Values are derived using the Black-Scholes model and reflect the characteristics of a typical but hypothetical Fortune 500 company; the annual standard deviation of the stock price is assumed to be 32%, the risk-free rate of return is 6%, the dividend rate is 3%, and the maturity period is ten years.
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