NBR, 24 October 2008, Table Talk by Nicki Crauford

M&A in a down market

As the credit crunch becomes a global downturn, corporate leaders have a choice: pull in their horns and ride out the storm; or look for opportunities to pick up bargain-basement assets that will help them grow and create future value for shareholders. If past is prologue, more will follow the first course - which is a mistake, US researchers Mehrdad Baghai, Sven Smit, and S Patrick Viguerie say.

Acting on it

They say that although most executives know and pay lip service to the maxim “invest in a downturn,” few act on it. The researchers created a database of roughly 200 global companies and computed the most important sources of growth (market momentum, mergers, and share gains) not just for each company, but also for market segments. Then they identified segments that had experienced significant upturns or downturns and looked at the strategies companies adopted during those periods. Finally they computed each company’s total returns to shareholders to compare performance across growth sources, segments and strategies.

Counter-productive moves

Two sets of results emerged. First, of the potential strategic moves companies can take to grow in a downturn - divest, acquire, invest to gain share - an effective acquisition strategy (defined as growth through M&A at a rate higher than that of 75% of a company’s peers) created significant value for shareholders. During an upturn, on the other hand, divestments created slightly more value than acquisitions did. Second, companies often behave in counterproductive ways. Fewer than half as many companies made acquisitions in downturns rather than in periods of economic growth. Significantly more divested businesses in those market segments in downturns than in upturns.

Who Lost Wall Street?

Although pension funds stand to lose hugely from the financial crisis along with other share owners, they bear more responsibility for facilitating the problem in the first place. Why? Because they represent the single largest source of capital in many markets. Critics argue that many funds around the world have led the market into crisis with short-term trading strategies that ignore long-term risk controls. Help could come from draft guidelines for pension funds now being drawn up by the OECD, which has called for a range of governance reforms designed to apply to retirement schemes around the world, such as a governing body accountable to beneficiaries and risk-based internal controls.

Rules for trustees

There are further cutting-edge ideas in comments sent to the OECD by the Network for Sustainable Financial Markets (NSFM), a global group of star investment practitioners and academics formed this year. Their agenda urges fund trustee certification, with the OECD publishing an annual training plan; expansion of fund fiduciary duty to include extra-financial risks; fixing portfolio manager pay so that long-term performance triggers bonuses; promotion of investor engagement with portfolio companies; requirement that fund trustees report annually on their own governance and more creativity in designing plans best fit for members.

Seizing opportunity

All of this is understandable, McKinsey Quarterly says. As revenues slow and margins are squeezed, management naturally switches its focus to cutting costs and maintaining earnings. The company protects its balance sheet - leading to the deferral of growth and of low-priority investments, the shelving of large acquisitions and the sale of assets. Many companies simply freeze. The best growth companies take a different approach. They view a downturn as a time to increase their leads and make acquisitions. They pounce on opportunities with an alacrity that is the stuff of legends: think of GE’s speedy dispatch of an army of deal makers to Asia after the financial markets took a downturn in 1998.