R



Be Daring When Others
     Are Fearful
 Seizing M&A Opportunities While They Last
The Boston Consulting Group (BCG) is a global manage-
ment consulting firm and the world’s leading advisor on
business stra...
Be Daring When Others
     Are Fearful
 Seizing M&A Opportunities While They Last




                  Jeff Gell
        ...
© The Boston Consulting Group, Inc. 2009. All rights reserved.

For information or permission to reprint, please contact B...
Contents
Preface                                                5

Executive Summary                                      ...
   T B C G
Preface




A
               s the world comes to terms with the aer-      of all companies will be “predators” that are ...
Executive Summary




T
             he global financial and economic crisis              by some of the world’s most promi...
◊ Sovereign wealth funds (SWFs) are unlikely to become       When the M&A market returns to growth, there will
  predators...
M&A
                                             Down but Not Out




T
                he financial-market turmoil that be...
Exhibit 1. The Financial Crisis Has Strongly Affected M&A Markets

                     Planned deals were still executed,...
Exhibit 2. The Credit Crunch Has Brought Private Equity Down to Earth

                    Overall PE deal value dropped  ...
Exhibit 3. On Average, Public-to-Public Deals in 2008 Brought Higher Target Returns and
 Lower Acquirer Returns Than in Pr...
Exhibit 5. In a Downturn, the Smaller the Target the Better in Public-to-Public Deals


                  For acquirers, s...
Exhibit 6. Corporate Debt Issuance Decreased Dramatically in 2008 but Picked Up Again
 in 2009

           Global investme...
and output remained weak—leading to mounting corpo-                  investors and analysts recently surveyed by BCG said ...
Exhibit 9. Investors Want Companies with Strong Financials to Seize Opportunities


              Potential uses of excess...
Current M&A Opportunities




T
              oday’s M&A opportunities vary according to      pear to be strengths can rap...
Exhibit 10. BCG’s Analysis Indicates That Roughly 20 Percent of the Surveyed S&P 500
 Companies Can Be Considered Predator...
steps companies need to take to move into an effective                  can gain market share profitably by consolidating th...
Exhibit 12. Public Investments by PE Firms Soared Alongside the General Trend


     $billions                            ...
Exhibit 13. Valuation Levels Have Come Down Significantly


            The aggregate price-to-earnings ratio of the      ...
A Guide to Distressed M&A




M
                  &A is more likely to create value in a     The first success factor for a...
Exhibit 14. Returns from Distressed M&A for Both Acquirers and Targets Were Higher in
     2008 Than in Previous Downturns...
The Clock Is Ticking—
                Be Ready for Action



T
              here are signs that the tide could be turning...
cash flows, their vulnerability, and how they can be im-   still time-consuming. From day one of the merger,
     proved. O...
Guidance in the Crisis for
            Predator CEOs



S
          uccess with M&A comes when preparation              • ...
2009 BCG Report (M&A)
2009 BCG Report (M&A)
2009 BCG Report (M&A)
2009 BCG Report (M&A)
2009 BCG Report (M&A)
2009 BCG Report (M&A)
2009 BCG Report (M&A)
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2009 BCG Report (M&A)

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2009 BCG Report (M&A)

  1. 1. R Be Daring When Others Are Fearful Seizing M&A Opportunities While They Last
  2. 2. The Boston Consulting Group (BCG) is a global manage- ment consulting firm and the world’s leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep in- sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet- itive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 66 offices in 38 countries. For more infor- mation, please visit www.bcg.com.
  3. 3. Be Daring When Others Are Fearful Seizing M&A Opportunities While They Last Jeff Gell Jens Kengelbach Alexander Roos September 2009 bcg.com
  4. 4. © The Boston Consulting Group, Inc. 2009. All rights reserved. For information or permission to reprint, please contact BCG at: E-mail: bcg-info@bcg.com Fax: +1 617 850 3901, attention BCG/Permissions Mail: BCG/Permissions The Boston Consulting Group, Inc. One Beacon Street Boston, MA 02108 USA
  5. 5. Contents Preface 5 Executive Summary 6 M&A: Down but Not Out 8 A Changed M&A Environment 8 M&A Trends in 2008 9 The Capital Markets Started to Stabilize in 2009 10 Never Let a Crisis Go to Waste 14 Current M&A Opportunities 16 Are You Ready for M&A? 16 Who Are the Predators? 18 Who Are the Prey? 19 A Guide to Distressed M&A 21 Distressed M&A for Smart Predators 21 Smart Strategies for Distressed Targets 22 The Clock Is Ticking—Be Ready for Action 23 Successful Strategies for Predators in the Downturn 23 Integrate and Restructure Fast 24 Guidance in the Crisis for Predator CEOs 25 Appendix: Methodology 26 For Further Reading 28 Note to the Reader 29 B D W O A F 
  6. 6.  T B C G
  7. 7. Preface A s the world comes to terms with the aer- of all companies will be “predators” that are ready for ac- math of a financial crisis unprecedented in quisitions, while another one-fih will be “prey”—unless the lives of most executives, it can be they take radical steps to survive. Most companies, how- tempting to see mergers and acquisitions ever, will be in-between: many could become predators (M&A) as a distant prospect. The M&A by taking appropriate action now, while others could be- market seems frozen, it remains difficult to finance deals, come prey if they fail to make the right moves. and continuing insecurity about the future has kept risk aversion high. Yet the experience of past crises shows that But time is of the essence. The capital markets are gradu- companies can find M&A opportunities in downturns ally reopening, and growth is returning in economies that that give them the capacity to reshape their industries had previously fallen into recession. When the window of and take commanding leads within them. Indeed, our re- opportunity flies open, the prizes will go to those that cent survey of some of the world’s biggest investors found have grasped their position and prepared themselves for that they want companies to be ready to capitalize on the surge in M&A. With the clock ticking, there is no time M&A opportunities when they arise. This 2009 edition of to lose—for either predators or prey. The Boston Consulting Group’s annual M&A report high- lights that even in this most severe of downturns, buyers About the Authors and sellers can create significant value for their owners. Jeff Gell is a partner and managing director in the Chi- cago office of The Boston Consulting Group and a global Earlier BCG research has established that the returns sector coleader of M&A. Jens Kengelbach is a principal from M&A in downturns are much greater than those in in the firm’s Munich office and a member of the Euro- upturns. This year’s report, which is based on analyses— pean Corporate Finance Task Force. Alexander Roos is conducted by the BCG M&A Research Center—of more a partner and managing director in BCG’s Berlin office than 5,200 M&A transactions since the start of the sub- and a global sector coleader of M&A. If you would like prime crisis in the late summer of 2007 (with a special to discuss any of the observations and conclusions in focus on distressed M&A), confirms that insight. More- this report, please contact one of the authors. over, it shows that some of the best opportunities in the last two years have been acquisitions of fundamentally healthy but financially distressed companies in danger of finding themselves unable to refinance their ongoing business. Drawing on the M&A Research Center’s find- ings, we present the key ingredients of success for both buyers and sellers. Companies that want to take advantage of the opportuni- ties must analyze their position to ensure that they are prepared for the coming upturn in M&A. A good one-fih B D W O A F 
  8. 8. Executive Summary T he global financial and economic crisis by some of the world’s most prominent investors, has taken its toll on M&A, but there are who—in a recent BCG survey—said they want strong strong signs of stabilization in the capi- companies to use the crisis to reinforce their competi- tal markets. The crisis has created op- tive position through acquisitions. Almost two-thirds of portunities for acquisitive businesses to these investors said they are comfortable using equity reshape industries and create new leaders, as compa- when the acquirer has a relative valuation advantage. nies like IBM and Procter & Gamble did in the 1930s. BCG’s analysis of a sample of companies in the S&P ◊ The number of deals is down and their value has fall- 500 shows that about 20 percent are predators, ready en sharply—a trend that accelerated aer the bank- to take on the risks of a deal, while another 20 per- ruptcy of Lehman Brothers in September 2008 and has cent are prey—so weak and vulnerable that they continued into 2009. The number of deals in the first must focus on survival or be swallowed. The remain- half of the year was down 17 percent compared with ing 60 percent have the potential to be either preda- the first six months of 2008, and their value was down tor or prey—but up to one-quarter of these compa- 45 percent. nies could become predators by rigorously strengthening their finances and reshaping their ◊ On average, buyers in 2008 fared worse than in prior businesses. years, having moved too early in the downturn of M&A in, for example, financial services and manufacturing. ◊ Potential predators include large companies, many The acquisition of smaller companies produced far of which—with the cash reserves of the S&P 500 still better returns—as in previous years. at or close to record levels—have the firepower for M&A. Acquirers with strong balance sheets, high prof- ◊ The capital markets are gradually reopening, however. itability, and sufficient cash will be able to capitalize Corporate debt issuance has picked up in 2009 for in- on the weaknesses of competitors and transform their vestment-grade debt, although high-yield debt has industries. been slower to recover. ◊ Private-equity (PE) firms will certainly not play the ◊ Initial public offerings (IPOs) are still scarce, with just same role in M&A as in the years before the credit 119 in the first half of 2009, but secondary-equity issu- crunch. In the absence of debt financing, the value of ance has risen sharply—in June 2009 reaching the their M&A deals in 2008 was 60 percent down over highest level in two years. The cost of debt financing 2007. However, with dry powder—the undrawn capital fell steeply in the second quarter of 2009, aer reach- commitments of limited partners—of about $500 bil- ing a record peak in March. lion at their disposal, these firms can be a source of funds for corporate predators; indeed, they have made ◊ Our research has shown that downturns should be 552 public investments worth more than $56 billion in seen as opportunities for acquisitions, a view shared the last two years.  T B C G
  9. 9. ◊ Sovereign wealth funds (SWFs) are unlikely to become When the M&A market returns to growth, there will predators, but they have become a significant force in be a three- to six-month window of opportunity for the capital markets. They have also shown themselves the best-prepared companies to act before the rest of ready to take stakes in high-profile institutions in par- the world catches up. With the clock ticking, smart ticular instances. predators must be prepared for action and ensure that they have brought investors on board. ◊ The primary driver of deal volume in this period is likely to be distressed companies with further financ- ◊ Successful M&A in the current environment requires ing needs. They include businesses divested by larger meticulous planning to deal with the uncertainties of distressed groups and PE portfolio companies unable the times. Smart predators must be prepared to go be- to refinance their debt, which in many cases is trading yond traditional acquisition procedures and act quick- at distressed levels. ly when potential targets emerge—even when those targets are not ones that would normally be seen as ◊ M&A will also occur in relatively healthy sectors such ideal acquisitions. as pharmaceuticals, where those companies whose shares have fallen the most will—under consolidation ◊ Funding arrangements must include backup alterna- pressures—become downturn targets for competitors tives in case of further turbulence in the financial mar- with higher valuations. kets. PE firms and SWFs could both provide financing in particular circumstances. BCG’s research on previous economic crises has shown that M&A in downturns is more likely to cre- ◊ Predators should ensure that they are ready to take on ate value than deals done in upturns. Our latest re- the risks of M&A by screening their businesses through search shows that this is even truer for deals involv- a downturn lens and stress-testing them against sud- ing distressed target companies—but there are den and fundamental changes in the business and fi- ingredients that make success more likely. nancial environment. Then they should do the same for potential targets and for the new company that ◊ Predators can help maximize the returns from dis- would be created by any deal. tressed M&A by fixing their own problems before launching an acquisition in the current environment. ◊ Due diligence must be thorough and rigorous to pre- vent undisclosed problems from coming to light aer ◊ Acquisitions of distressed targets are more likely to be a deal is completed. successful when the predator is above average in prof- itability and more profitable than the target. Other ◊ Postmerger integration planning must be rigorous, measures that increase the chances of success include with cash generation the top priority. The strategic and choosing targets that have financial problems but tactical choices made before a deal is closed ultimate- have not yet run into operating difficulties, and acquir- ly determine its success—and never more so than in a ing smaller companies. downturn. ◊ Distressed companies that have identified themselves as prey can command the highest price by courting larger predators with sound financials. Deals involving companies from different sectors tend to produce bet- ter returns for both sides than transactions within the same sector. B D W O A F 
  10. 10. M&A Down but Not Out T he financial-market turmoil that began with with some well-known names disappearing from the the subprime crisis in the late summer of leaderboard. 2007 is reshaping the global economy—and with it the business landscape. The upheav- Superficially, the impact on M&A appears muted. For ex- al is unprecedented in the working lives of ample, the number of deals executed in 2008—almost today’s executives, presenting challenges that require 30,800—was just 2.4 percent less than in 2007. Moreover, constant reassessment of their strategies for managing there were 6.6 percent more deals in 2008 than in 2006— and developing their companies. A natural response is to and more even than in 2000, at the peak of the dot-com hunker down in order to survive the storm and emerge boom. The value of M&A deals plummeted along with as- from the downturn intact. Yet the crisis has created a win- set prices, however: at just over $2.5 trillion, the total last dow of opportunity for transformational M&A deals that year was almost one-third less than the total for 2007. some companies are already seizing. As the storm begins Even so, the 2008 figure was only 11.7 percent less than to moderate, now is the time to be daring—when others the total for 2006, and still the fourth highest for M&A are still fearful. transactions in the last decade. A Changed M&A Environment If we break the numbers down into monthly figures, however, it is clear that the bankruptcy of Lehman Broth- The last two years have seen the biggest jolt to the global ers in September 2008 strongly affected M&A markets economy since the crash of 1929, which ushered in the and that a significant decline in activity occurred in the Great Depression of the 1930s. Although government final quarter of that year. Deals already in the pipeline measures appear to have succeeded in halting the melt- still tended to go ahead, but since then, the number and down in the markets, the financial system remains a long value of transactions have fallen sharply. The number of way from normal functioning.1 The economic impact of deals in June 2009 was 25 percent down over December the current crisis continues to be felt, overturning old cer- 2008, and the monthly value of deals dropped to very tainties. low levels in the first half of this year. (See Exhibit 1.) The speed and scale of the crisis have been reflected in The ultimate outcome for 2009 is still unclear. In the first the stock markets, with leading share indexes falling half of the year, the number of transactions was just over much more sharply than in previous postwar recessions. 12,700, a drop of 17 percent compared with the first six Despite the rally in the equity markets in the spring of months of 2008. The value of those deals, at $681 billion, 2009, by the end of June the indexes were still about 40 was 45 percent less than the value of M&A deals in the percent below where they had been two years before. first half of 2008. If the number of transactions for all of Some industries have been particularly hard-hit by the 2009 turns out to be double the figure for the first six credit crunch—construction and automotive, for exam- ple. The banking industry has been turned upside down 1. See Collateral Damage Quick-o-Nomics Update—Leading-Indicator by both the financial turmoil and the political response, Edition: Searching for Green Shoots, BCG White Paper, July 2009.  T B C G
  11. 11. Exhibit 1. The Financial Crisis Has Strongly Affected M&A Markets Planned deals were still executed, with the full impact materializing in 2009 Number $billions of deals Lehman 3,500 bankruptcy 700 3,000 600 –25 % 2,500 500 2,000 400 1,500 300 200 1,000 100 500 0 0 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May 2007 2007 2007 2007 2007 2007 2008 2008 2008 2008 2008 2008 2009 2009 2009 Value of deals Number of deals Sources: BCG M&A Research Center; Thomson Reuters SDC Platinum. Note: Figures are based on a total of 76,958 completed M&A transactions, excluding repurchases, exchange offers, recapitalizations, and spinoffs. Enterprise values include the net debt of the target. months, that would produce a drop of almost 18 percent ing mergers in the sector, financial services accounted for compared with 2008—bringing the number of deals back 44 percent of total M&A value in 2008, compared with its down to 2004 levels. Similarly, if the value of transactions long-term average of 39 percent. Energy came in second for all of 2009 is double the value of those in the first six at 12 percent of total M&A value, followed by basic mate- months, total M&A value for the year would be almost 46 rials at 7 percent—both above the long-term average for percent less than in 2008—and down to levels last seen these industries. in the mid-1990s. The credit crunch brought PE down to earth in 2008, as But even if the outcome for the rest of 2009 does prove the leveraged financing intrinsic to its business model to be more of the same, the M&A environment would still dried up. The number of PE deals fell below 1,000— be more buoyant than the upheaval in the markets might down almost one-third over the previous year and ap- suggest. The especially sharp decline in the value of trans- proaching levels last seen in 2004. (See Exhibit 2.) The actions at least partly reflects lower asset prices, which value of those PE deals fell even more precipitously: the make deals easier to close for both buyers and sellers. total was 60 percent down, from $958 billion in 2007 to M&A is definitely down, but it is not out. $385 billion last year. Again, the biggest drops were in the second half of the year, and they continued into M&A Trends in 2008 2009. Given the turmoil in the capital markets, it is hardly sur- Acquirers in public-to-public deals fared worse than in prising that M&A activity in 2008 was dominated by fi- previous years, as shown by an event study analysis of re- nancial services. With governments aggressively promot- turns calculated over a seven-day window centered B D W O A F 
  12. 12. Exhibit 2. The Credit Crunch Has Brought Private Equity Down to Earth Overall PE deal value dropped ... mainly driven by precipitous declines in the by 60 percent in 2008 ... second half of the year, and 2009 looks similar –60% Number Number $billions of deals $billions of deals 100 150 1,000 940 958 1,500 –73% 89 800 80 1,000 100 600 563 60 Ø 807 44 45 385 40 400 352 40 500 30 28 50 24 24 18 19 200 162 179 157 182 20 13 116 124 11 11 11 13 73 6 5 4 0 0 0 0 1997 1999 2001 2003 2005 2007 Jan Mar May Jul Sep Nov Jan Mar May 1998 2000 2002 2004 2006 2008 2008 2008 2008 2008 2008 2008 2009 2009 2009 Feb Apr Jun Aug Oct Dec Feb Apr Jun 2008 2008 2008 2008 2008 2008 2009 2009 2009 Number of deals Value of deals Sources: BCG M&A Research Center; Thomson Reuters SDC Platinum. Note: Figures are based on announced deal value, including the net debt of the target (rank value >$25 million), buyouts, or financial-sponsor involvement. around announcement day.2 The cumulative abnormal cumulative abnormal return for both was substantially return for buyers in 2008 was −1.5 percent, below the higher than in cases where the acquirer’s sales were less long-term average. (See Exhibit 3.) As so oen in M&A, than double the target’s. The markets see small deals as overpayment was the culprit, with acquirers jumping in less cash intensive and easier to implement for the ac- too early in the downturn, particularly in financial ser- quirer, and investors recognize the “safe harbor” effect vices and manufacturing. for smaller companies of acquisition by a larger one. (See Exhibit 5.) However, BCG’s research has shown that acquisitions during downturns have a higher probability of success The Capital Markets Started to Stabilize than those that occur when the economy is more buoy- in 2009 ant. Our analysis of thousands of deals indicates that, in the two years following the announcement year, such ac- Funding M&A transactions has been difficult since the quisitions produce returns 14.5 percentage points higher, summer of 2007, with the capital markets grinding almost on average. (See Exhibit 4.) It also shows that it is nor- to a halt aer the start of the subprime crisis. Funds for mal for downturn acquisitions to suffer an adverse mar- deals have been scarce and the cost of financing has oen ket reaction during the announcement window been high. However, there was evidence of a revival in period, before going on to generate positive returns. It is global capital markets in the second quarter of 2009, too soon to judge the long-term returns from many of which began to increase the availability of financing and the deals executed in 2008. reduce its cost. Finally, acquisitions of smaller companies in the current 2. A standard event-study analysis measures cumulative abnormal crisis are likely to produce better returns for both acquir- returns net of market returns in the period between the three days before and the three days after the day of the initial deal announce- er and target—as in the past. In 2008, in cases where the ment. For a more detailed description of the event study approach, acquirer’s sales were more than double the target’s, the see the Appendix: Methodology.  T B C G
  13. 13. Exhibit 3. On Average, Public-to-Public Deals in 2008 Brought Higher Target Returns and Lower Acquirer Returns Than in Previous Years For acquirers, takeovers created For targets, cumulative abnormal less value because of the returns exceeded those of tendency to overpay the late 1990s CAR1 (%) CAR1 (%) 2008: 30% (N = 132) 2 2008: 30 –1.5% (N = 142) 1 0 20 Ø 19.5 –1 Ø –1.22 –2 10 –3 –4 0 1996 1998 2000 2002 2004 2006 2008 1996 1998 2000 2002 2004 2006 2008 Escape into safe harbors was positively rewarded by the capital markets Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis. Note: The difference in sample size is the result of limitations in the targets’ return data. 1 Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/–3). Exhibit 4. Downturn Mergers Systematically Outperform Upturn Deals Cumulative relative-total- shareholder-return performance (T – 5 = 100) 110 108.3 Downturn mergers create value 105 104.5 101.4 100 97.8 5.9 10.4 14.5 percentage percentage percentage points points points 97.4 95 95.5 94.1 93.8 Upturn mergers destroy value 90 T–5 T+5 End of Year 1 Year 2 announcement year Event window Sources: Thomson Financial/SDC Platinum; BCG analysis. Note: T – 5 is the five days before the announcement date; T + 5 is the five days after the announcement date. The entire period is considered to be the event window. This analysis is taken from Winning Through Mergers in Lean Times: The Hidden Power of Mergers and Acquisitions in Periods of Below-Average Economic Growth, BCG report, July 2003. B D W O A F 
  14. 14. Exhibit 5. In a Downturn, the Smaller the Target the Better in Public-to-Public Deals For acquirers, small deals are less cash intensive and easier to implement Targets benefit from the safe-harbor effect CAR1 (%) 40 CAR1 (%) 33.5 0 30 26.6 –1 N = 92 N = 11 N = 17 20 –1.3 –2 14.6 –2.7 10 –3 –3.2 N = 92 N = 11 N = 17 –4 0 ≤50 >50 >100 ≤50 >50 >100 ≤100 ≤100 Target’s sales as a percentage of acquirer’s sales Target’s sales as a percentage of acquirer’s sales Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis. Note: Results based on a sample of 120 public-to-public M&A deals announced in 2008. 1 Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/–3). For example, it has become easier for companies to bor- Raising equity through IPOs remained difficult in the first row money by issuing corporate debt. (See Exhibit 6.) half of 2009, with just 119 offerings, compared with 783 Last year, levels of debt issuance plummeted. Globally in in the first half of 2007, before the markets seized up. (See October 2008, there were only 137 issues of investment- Exhibit 8.) The average value of IPOs was almost halved grade debt worth just $57 billion, compared with 604 is- in the first six months of 2009, as the total value fell from sues worth $351 billion in May. But activity picked up in $189 billion in the first half of 2007 to $15.7 billion. Hav- 2009, with the number of investment-grade debt issues ing flatlined over the winter months, the number and to- topping 400 in both May and June, to raise more than tal value of IPOs rose slightly beginning in April—but $200 billion a month. High-yield debt issuance has taken they were still at very low levels, with the value in June longer to recover, but May and June saw 85 issues worth 2009 down 44 percent over the previous June. $41 billion across the two months, restoring levels similar to those seen before the subprime crisis. The picture was more encouraging for corporate fund- raising through the issuance of secondary equity. The Debt financing remained expensive well into 2009, with number of secondary issues rose from 94 in January 2009 the cost of insuring against the risk of corporate default to 384 in June—the highest level since the start of the having increased dramatically in three waves since the credit crunch. Their total value also climbed steeply in start of the credit crunch. (See Exhibit 7.) The cost of cred- the first half of 2009, reaching $131 billion in June, com- it default insurance, as measured by the iTraxx index, pared with $26 billion in January. reached a record peak in March 2009 of more than five times the cost in the summer of 2007. In the months that Yet this partial revival in the capital markets came too followed, credit spreads over Treasury bills fell sharply late to prevent a further deepening of the recession aer the central banks pumped liquidity into the finan- in the advanced economies, as the financial crisis spilled cial system. But at the end of June 2009, they were still at over into the real economy. The corporate credit crunch more than three times their pre-credit-crunch levels. was still reducing investment in the summer of 2009,  T B C G
  15. 15. Exhibit 6. Corporate Debt Issuance Decreased Dramatically in 2008 but Picked Up Again in 2009 Global investment-grade debt issuance Global high-yield debt issuance Number Number $billions of issues $billions of issues 400 800 40 60 300 600 30 40 200 400 20 20 100 200 10 0 0 0 0 Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun 2005 2006 2006 2007 2007 2008 2008 2009 2005 2006 2006 2007 2007 2008 2008 2009 Number of issues Issuance volume Sources: Thomson One Banker; BCG analysis. Exhibit 7. The Costs of Default Insurance and Debt Refinancing Are Falling Following Sharp Increases The price of insuring against the risk of credit defaults The cost of debt financing iTraxx Europe Crossover index Credit spreads over T-bills (%) 1,250 20 18 1,000 16 185 percent increase 14 750 75 percent in second 12 increase wave in first 10 500 wave 400 percent 8 increase 6 in third 250 wave 4 2 0 0 May 1, Sep 1, Jan 1, May 1, Sep 1, Jan 1, May 1, 1997 1999 2001 2003 2005 2007 2009 2007 2007 2008 2008 2008 2009 2009 1998 2000 2002 2004 2006 2008 Jul 1, Nov 1, Mar 1, Jul 1, Nov 1, Mar 1, First quarter 2007 2007 2008 2008 2008 2009 High-yield Treasury AA-rated Treasury Investment-grade Treasury AAA-rated Treasury A-rated Treasury Sources: Thomson Reuters Datastream; BCG analysis. Note: Composition of series 7 to 11 of the iTraxx Europe Crossover five-year (midfixing) indexes; credit spread analysis based on Barclay’s bond indexes. B D W O A F 
  16. 16. and output remained weak—leading to mounting corpo- investors and analysts recently surveyed by BCG said they rate defaults and job losses. With confidence anemic want companies to use the crisis to strengthen their com- among consumers and businesses, demand remained de- petitive position—even if their stock price falls as a short- pressed, creating a downward spiral in a wide range of term result.4 Investors expect companies to do what is industries. necessary to secure their financial viability, but they are concerned that potentially game-changing moves will be Never Let a Crisis Go to Waste neglected for fear of missing quarterly earnings-per-share guidance. “This is a unique time in history to gain share In the adverse economic and financial conditions that and keep it,” said one investor. “No one is pricing stocks have prevailed since the start of the credit crunch, com- on 2009 anyway.” panies have tended to focus inward. Cost cutting and re- structuring are seen as the overwhelming priorities, nec- The top priority for the investors in our survey was or- essary to maximize cash flow, strengthen the balance ganic investment in the business. (See Exhibit 9.) How- sheet, and ensure survival. Yet, as BCG has pointed out in ever, M&A came in a close second. As one respondent put previous research, recessions typically accelerate the forc- it, “Eight times out of ten, companies wait too long and es reshaping industries and create new winners and los- end up paying three times more than they would have ers. In the Great Depression, companies such as IBM and had they taken advantage of the situation when times Procter & Gamble placed aggressive bets on acquisitions were bad. Now is the time to step on the throat of the that helped them to strengthen their competitive posi- competition and pick something off.” tion in later years.3 3. See Collateral Damage, Part 7: Green Shoots, False Positives, and What Interestingly, investors appear to recognize that today’s Companies Can Learn from the Great Depression, BCG White Paper, June 2009. extraordinary circumstances will again throw up once-in- 4. See Collateral Damage: Function Focus—Valuation Advantage: How a-lifetime M&A opportunities on which companies should Investors Want Companies to Respond to the Downturn, BCG White capitalize. Contrary to what many executives might think, Paper, April 2009. Exhibit 8. Raising Equity Through IPOs Has Been a Challenge, but Secondary Offerings Are Picking Up Global IPO issuance Global secondary-equity issuance Number Number $billions of issues $billions of issues 100 300 200 400 80 150 403% 300 200 60 100 200 40 –44% 100 50 100 20 0 0 0 0 Jan Jun Dec Jun Dec Jun Jan Jun Dec Jun Dec Jun 2007 2007 2007 2008 2008 2009 2007 2007 2007 2008 2008 2009 Mar Sep Mar Sep Mar Mar Sep Mar Sep Mar 2007 2007 2008 2008 2009 2007 2007 2008 2008 2009 Number of issues Issuance volume Sources: Thomson One Banker; BCG analysis.  T B C G
  17. 17. Exhibit 9. Investors Want Companies with Strong Financials to Seize Opportunities Potential uses of excess cash Number of respondents who chose the option as a high priority Organic investment 71 in the business Strategic and accretive M&A 60 Retirement of bonds being 55 traded at a discount Accumulation of cash 30 on the balance sheet Significant stock repurchase 17 Dividend increase 14 0 20 40 60 80 Sources: BCG survey, “Investment Thesis for 2009 and Beyond”; Collateral Damage: Function Focus—Valuation Advantage: How Investors Want Companies to Respond to the Downturn, BCG White Paper, April 2009. Note: Respondents were asked, “If a company generates excess cash well beyond its committed debt payments and dividend, how would you rank the following options based on your preference for use of this excess cash?” The exhibit shows the number of times each option was selected first or second. The sample size was 135, but not all the surveyed investors responded to this question. Giving cash back to investors in the form of dividends or the math works in terms of relative valuation, I’m okay share repurchases was a much lower priority. Investors with that.” are prepared to see equity used in M&A transactions, with 63 percent of those surveyed saying they are com- Although it is difficult to predict when there will be a sig- fortable or very comfortable when the acquirer enjoys a nificant upturn in M&A, the investors surveyed by BCG relative valuation advantage. “Most managers look at suggested that it could come within the next 12 to 24 their stock as currency today and see its value cut in months. Our survey was conducted at the start of 2009, so half,” said one respondent. “They don’t understand the the clock is ticking. Investors are urging companies to be relative value of their equity currency.” Another said, “Us- ready to seize the opportunities while they last, and not ing stock is okay if what you are buying is cheaper. If to let the crisis go to waste. B D W O A F 
  18. 18. Current M&A Opportunities T oday’s M&A opportunities vary according to pear to be strengths can rapidly become major weakness- a company’s financial strength. BCG’s anal- es if trading conditions suddenly deteriorate, pushing ysis of more than half the S&P 500 compa- profitability and cash flow deep into the red. Each busi- nies showed that just one-fih have the fi- ness unit must be stress-tested against worst-case scenar- nancial muscle to take on the risks of a deal ios, such as a 25 percent drop in sales, a prolonged down- without putting themselves in play—they are classic pred- turn, or default by a major customer or supplier. ators. (See Exhibit 10.) A similar proportion are prey—so weak and vulnerable that they need to focus on surviving Even those companies that appear to be battle ready the downturn. But 60 percent are in the gray area in- overall may still find weaknesses that need to be correct- between, with the potential to become either predator or ed in order to further strengthen their firepower and al- prey—or simply to miss the boat. With the recovery not low them to focus on acquisitions. If there are value- yet as strong as hoped, these businesses must assess their destroying business units that cannot be fixed, they financial and market positions as a matter of urgency in should be sold to release resources for the value creators. order to ensure that they make the right strategic As BCG’s research has shown, divestments in a downturn moves. can create substantial value for the sellers when assets are sold to the right buyers.6 Are You Ready for M&A? For the majority of companies that are neither predator Despite the sharp downturn and continuing financial un- nor prey, the good news is that up to one-quarter of them certainty, a recent BCG survey found that 22 percent of can transform themselves into predators before the M&A European companies intend to step up their deal-making market surges. To do so, however, they will have to take activity, having increased their M&A plans during the cri- the actions that will allow them to strengthen their fi- sis.5 More than half the respondents (51 percent) said nances and reshape their businesses—in readiness to they are sticking to their M&A plans despite the deterio- seize M&A opportunities when they arrive. rating financial and economic climate. Nearly one-third (29 percent) of the companies surveyed—including half BCG’s predator-prey matrix can be used to clarify a com- of the largest companies—are likely to do a deal in the pany’s M&A strategy. (See Exhibit 11.) It maps operation- next 12 months involving a company with sales of more al stability against financial stability—taking into account than €250 million. But who will be the predators and who liquidity, the relative vulnerability of business units in a will be the prey in such transformational deals? recession, and other considerations—and indicates the To answer this question, every company should stress-test its business to evaluate the options. But this must be done 5. See M&A: Down but Not Out—A Survey of European Companies’ Merger and Acquisition Plans for 2009, BCG White Paper, December through a downturn lens because traditional indicators 2008. of financial health, such as free cash flow and relative val- 6. See The Return of the Strategist: Creating Value with M&A in Down- uation multiples, can no longer be relied upon. What ap- turns, BCG report, May 2008.  T B C G
  19. 19. Exhibit 10. BCG’s Analysis Indicates That Roughly 20 Percent of the Surveyed S&P 500 Companies Can Be Considered Predators P/E ratio1 26 24 Predators ~20% 22 20 18 16 Gray area ~60% 14 Prey ~20% 12 Median P/E 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 12 Median Five-year CDS spread2 (%) CDS spread A company with a higher CDS spread is considered more likely to default by the market Sources: Bloomberg; Thomson Reuters; BCG analysis. Note: The sample consists of 281 companies in the S&P 500 with positive earnings forecast for 2010 and available data on CDS spread; data as of February 3, 2009. 1 Forward-looking price-to-earnings (P/E) ratio through 2010, based on consensus estimates. 2 CDS is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller and in return receives a payoff if the underlying financial instrument defaults. CDS spread reflects the default risk of a company as viewed by the market. A five-year CDS spread reflects the annual price premium as a percentage of nominal value to insure a five-year bond against default. (1 percent = 100 basis points.) Exhibit 11. BCG’s Predator-Prey Matrix Can Be Used to Clarify a Company’s M&A Strategy Prey Predators ◊ Preserve intrinsic value of businesses ◊ Enhance competitive advantages • Gain market share profitably ◊ Pay down debt • Invest wisely where returns are above High • Sell nonstrategic businesses to pay cost of equity off debt • Acquire prey when long-term value • Restructure debt schedule to reduce can be added risk of default • Acquire good pieces of business (that is, products that fit) and avoid toxic portions of liquidators Operational stability Liquidators Cyclical leaders ◊ Sell off assets to reduce debt ◊ Improve near-term EBIT as quickly as possible; reduce operational volatility in ◊ Improve profitability of remaining order to become less vulnerable in future Low businesses downturns ◊ Liquidate if unable to improve ◊ Avoid excessive debt that would turn the profitability above cost of capital company into a liquidator Low High Financial stability Source: BCG experience. B D W O A F 
  20. 20. steps companies need to take to move into an effective can gain market share profitably by consolidating their defensive or offensive position. weaker competitors and acquiring parts of others—and increase their long-term value. For example, potential predators should not just be think- ing about buying entire companies but also looking Transactions over the last year—in some cases promoted out for business unit divestitures that could allow them or at least supported by governments—have oen been to gain market share profitably. BCG’s research has in industries such as finance and automotive that are on shown that buyers can generate substan- the ropes. But there are also opportunities tially higher returns from acquiring good for large-scale transactions that could pieces of business than from wholesale ac- Acquirers must transform the competitive landscape of quisitions.7 act promptly—the other industries, including currently ro- bust sectors such as pharmaceuticals and Some companies will realize that they are bargains may not be utilities. vulnerable and must act quickly and deci- there for long. sively. They must cut costs and make their The PE firms whose acquisitions fueled cost structures as flexible as possible. For the M&A wave in the runup to the credit these companies, it will also be critical to maximize cash crunch still have dry powder—the undrawn capital com- generation, using both operational and financial levers, mitments of limited partners—of around $500 billion at such as working-capital reductions. Their aim must be to their disposal.8 While the amount of funds raised has fall- prevent a profit slump from turning into a liquidity crisis en 11 percent since 2006, the aggregate capital raised is that leads, in turn, to potentially life-threatening prob- up 7 percent since then. More than $550 billion was raised lems in refinancing. in 2008, significantly more than in the boom year of 2000, when the figure was $258 billion. While some limited Divestments should be contemplated not only to dispose partners with liquidity problems are trying to reduce their of weaker units but also to generate funds for the remain- committed investments to PE funds, BCG’s research sug- ing business. Companies that divest actively in a down- gests that this will result in a reduction of no more than turn show that they are committed to restructuring their 15 percent. businesses, and they are oen rewarded by investors. Yet, as noted in the previous section, the closure of the Who Are the Predators? debt markets has hit PE hard. For now, PE firms are fo- cused on “working and holding” their portfolio companies The most active acquirers right now are financially sound rather than acting as predators. But they continue to be a companies with strong balance sheets, high profitability, source of funds for other predators by buying distressed and sufficient cash to capitalize on the weaknesses of com- debt in target companies and taking minority stakes. petitors. They can take advantage of the current low valu- There were 552 public investments by PE firms worth ation levels to transform their industry and improve their more than $56 billion in the two years leading up to the own position within it. But they must be ready to act end of June 2009. (See Exhibit 12.) promptly given the incipient recovery in asset prices in the first half of 2009—the bargains may not be there for long. One other group of potential predators is sovereign wealth funds, which were sitting on assets of more than Many large companies certainly have the firepower for $3 trillion before the crisis started. Falling asset prices M&A. The cash reserves of the S&P 500 companies have hit SWFs just as they have other investors, but these reached nearly $1.5 trillion last year—higher than at any funds are still estimated to be worth around $2.3 trillion. time in history and 71 percent more than in 2000, the However, according to BCG’s research, SWFs have been peak of the dot-com boom. In spite of record first-quarter losses in 2009, financially sound strategic buyers are still 7. Ibid. able to fund acquisitions in an environment in which val- 8. See Driving the Shakeout in Private Equity: The Role of Investors in uation levels can offer attractive returns. With investors the Industry’s Renaissance, BCG and IESE Business School White keen for them to capitalize on these opportunities, they Paper, July 2009.  T B C G
  21. 21. Exhibit 12. Public Investments by PE Firms Soared Alongside the General Trend $billions Number of deals 30 200 150 20 100 10 50 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Number of deals Value of deals Sources: Thomson One Banker; BCG analysis. Note: Figures are based on announced acquisitions of minority stakes in public companies by financial sponsors. less likely than other investors to choose outright acquisi- survived by divesting businesses that were underper- tions to deploy their funds, instead taking minority forming, releasing much-needed capital. stakes—oen less than 5 percent. Rather than seeking a directing role, they prefer to interact with management at But there has also been M&A activity in relatively healthy a personal and confidential level. sectors such as pharmaceuticals. Even aer the stock mar- ket rebound in the first half of 2009, the S&P 500 compa- For now, SWFs are not driving M&A activity—not even nies were trading in June 2009 at price-to-earnings ratios when divestments become available. But since hitting the that were half those of 2001, with bigger declines in their headlines a few years ago, they have become a significant price-to-book ratios. (See Exhibit 13.) Companies whose force in the capital markets. In the early stages of the shares have fallen the most will be seen as potential tar- credit crunch, SWFs underpinned some leading financial gets by competitors, generating sporadic and unpredict- institutions and other companies in distress. And in par- able hostile-takeover bids in 2009 and beyond. ticular instances, they can play a decisive role—as recent developments in the German automotive industry have A third target for M&A activity is businesses divested by demonstrated. larger companies. Some will be spun off by healthy com- panies to pay down debt and strengthen their balance Who Are the Prey? sheets. Others will be put up for sale by less healthy com- panies that wish to improve their liquidity and focus on Many of the targets for M&A in the current financial cri- their value-creating business units. sis have been in sectors hard-hit by the credit crunch, such as financial services and the automotive industry. The M&A pipeline will also be fed by PE-owned portfolio Some distressed banks and carmakers were forced to find companies. In an analysis conducted in November 2008 refuge in wholesale acquisition by competitors. Others by BCG and IESE Business School (University of Navarra), B D W O A F 
  22. 22. Exhibit 13. Valuation Levels Have Come Down Significantly The aggregate price-to-earnings ratio of the ... while the aggregate price-to-book ratio has S&P 500 has dropped by 50 percent over 2001... dropped by approximately 60 percent P/E ratio –50% P/B ratio 30 6 –60% 25 5 Ø 20.3 4 20 Ø 3.2 3 15 2 10 0 0 Jan Jul Jan Aug Jun Jan Jul Jan Aug Jun 1995 1998 2002 2005 2009 1995 1998 2002 2005 2009 Low valuation levels High valuation levels create a potentially create a less attractive deal attractive deal environment environment Sources: Bloomberg; BCG analysis. half the PE portfolio companies studied were judged like- or can do so only by incurring unacceptably high costs. ly to default within the next three years.9 The partial re- In the next chapter, we will look at distressed M&A in covery in the debt markets in mid-2009 increased the more detail and present BCG’s findings on how to do availability of financing, but our latest White Paper on PE the right deal in ways that do not drag the acquirer into noted that maturing leveraged-buyout and high-yield distress. debt levels were rising sharply, with refinancing needs ex- pected to reach nearly $400 billion by 2014.10 9. See Get Ready for the Private-Equity Shakeout: Will This Be the Next Shock to the Global Economy? BCG and IESE Business School White Paper, December 2008. The largest driver of deal volume is likely to be divest- 10. See Driving the Shakeout in Private Equity: The Role of Investors in ments by distressed companies with immediate financ- the Industry’s Renaissance, BCG and IESE Business School White ing needs that either cannot borrow the funds they need Paper, July 2009.  T B C G
  23. 23. A Guide to Distressed M&A M &A is more likely to create value in a The first success factor for a predator is to be a healthy downturn than in an upturn—and this company—and, crucially, healthier than the target. The downturn effect is even more pro- acquisition of a distressed target is more likely to be suc- nounced when the deal involves a dis- cessful if the predator is above average in profitability tressed company. Interestingly, the se- and more profitable than the target. This is hardly sur- verity of the current crisis appears to have accentuated prising: capital markets are more likely to believe that a the distressed M&A effect, with even higher returns for healthy acquirer can turn around a distressed target, and both acquirers and targets in 2008 than in downturns they value the deal accordingly. It is also a reminder that during the previous 15 years. (See Exhibit 14.) postmerger integration (PMI) requires resources and management focus, and an acquisition is more likely to In such an adverse environment, it is more than ever im- create value if there are no weaknesses in the predator’s portant to identify the right deal. Recent research con- business to divert attention. The moral is to fix your own ducted by BCG has identified several factors that signifi- problems first to avoid parallel restructuring. cantly affect the chances that a distressed deal will succeed: A second success factor for a predator is to choose tar- gets that have financial problems but have not yet run ◊ The financial strength of the acquirer into operating problems—for example, a company that is breaking its debt covenants but remains profitable. ◊ The cause of distress in the target In such cases, recapitalization is oen enough to turn the target around relatively quickly. Even when the tar- ◊ The relative size of the acquirer and the target get does have operating problems, the returns from ac- quiring it will be higher if it also has problems with its ◊ The core sectors of the acquirer and the target capital structure, such as excessive leverage, which the predator can sort out. In such circumstances, market ex- Distressed M&A for Smart Predators pectations will be depressed, producing very low valua- tion levels and making the target more attractive. It It has long been known that M&A destroys value for ac- should also be easier to implement hard restructuring quirers in the majority of deals. But BCG’s research shows strategies with such a target, since the alternative— that the acquisition of deeply distressed companies in a bankruptcy—will be evident to government, labor downturn produces positive returns on average, with the unions, and regulators. cumulative abnormal return being 1 percent, compared with −1.1 percent in an upturn. However, these are aver- The third success factor for predators is to acquire smaller ages. Some distressed M&A transactions produce better distressed targets. More than 40 percent of deals in which results and some produce negative returns, so smart pred- the target’s sales are less than half those of the predator ators must adopt strategies that exploit the factors that are successful, compared with 32 percent in which the maximize value creation. target’s sales are more than half the predator’s. Acquiring B D W O A F 
  24. 24. Exhibit 14. Returns from Distressed M&A for Both Acquirers and Targets Were Higher in 2008 Than in Previous Downturns Acquirers Targets 1 CAR (%) 30.1 percentage points 4 CAR1 (%) 2.4 percentage points 60 2 50.4 0 –2.4 40 0 N = 30 N = 149 20.3 –2 20 Distressed M&A Distressed M&A N = 31 N = 157 –4 in 2008 in previous downturns, 0 1992–2007 Distressed M&A Distressed M&A in 2008 in previous downturns, 1992–2007 Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis. Note: A downturn year is defined as one in which worldwide GDP growth was below the average for the period 1990 to 2007. Distressed M&A is defined as a transaction whose target EBIT margin is below the sample median for targets. 1 Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/–3). smaller targets carries less risk and is easier to finance, The second success factor for a distressed target is to find which the market will recognize in its response to the an- a “big brother.” Being acquired by a significantly larger nouncement. company produces above-average returns, even if the tar- get company is not in distress. But when the target is a Finally, distressed acquisitions outside the predator’s core distressed company, acquisition by a company with more sector are marginally more successful than acquisitions than double its sales will produce substantially higher re- within the same sector. Because of overconfidence—the turns than when the acquirer’s sales are closer to those of assumption that nobody knows the business better than the target. Those higher returns reflect the market’s view they do—predators that make strategic acquisitions with- that a distressed M&A bid is more likely to be concluded in their own sector are more likely to overpay. As a result, when the predator is biting off something it can chew and they wind up paying high premiums that can turn the when the target is less able to bargain with the predator. deal into a failure for the predator’s shareholders. Smart Courting a predator of similar size therefore risks leaving predators screen for smaller distressed targets across in- shareholders’ money on the table. dustries. Finally, distressed target companies should seek to attract Smart Strategies for Distressed Targets bids from companies in a different sector. Shareholder re- turns are higher when a company in operating distress is For distressed companies that have identified themselves sold to a predator from outside its core sector. In some as prey, the objective must be to find a buyer that is pre- cases, this may be because an outsider can see opportu- pared to pay the highest price. Selling distressed assets is nities that insiders cannot spot, and therefore it is pre- rarely a straightforward process, but where possible, the pared to pay more. A smart target will not confine the first order of business should be to court predators with search for a buyer to its own sector but will cast its eye sound financials. The return for a distressed target is further afield—companies that are not direct competitors much higher when the acquirer is above median profit- could be attractive buyers. ability. And a bid from an acquirer in good financial shape is more likely to be completed, to the benefit of the target’s shareholders.  T B C G
  25. 25. The Clock Is Ticking— Be Ready for Action T here are signs that the tide could be turning ◊ Returns may be higher from the acquisition of busi- for M&A. Equity values have stabilized and nesses that are not the obviously perfect strategic fit debt markets are returning to life—improv- oen sought in less turbulent times. Predators should ing liquidity and reducing the cost of credit take a fresh look at their industry and beyond. The from the exceptionally high levels reached rules of the game are changing, and the most lucrative in the 18 months following the start of the credit crunch. opportunities may be businesses that would not nor- It is impossible to say when the M&A market will return mally be seen as potential targets. to growth. But when it does, there will be a three- to six- month window of opportunity in which those companies ◊ Funding is still difficult, and arrangements can fall that have prepared themselves for action can take advan- apart as banks respond to developments in the finan- tage of it—before the rest of the world catches up. With cial markets and beyond. Predators should always investors willing to sanction M&A in the coming months, have a plan B ready and should consider alternative now is the time to prepare for the rare chance to launch sources, such as PE firms that have funds but lack the transformational deals. debt financing needed to be predators themselves. SWFs, while less likely to provide majority funding and Successful Strategies for Predators in managerial leadership, may be interested in a strategic the Downturn long-term investment. The factors that make for successful M&A—a coherent ◊ Valuation methods may prove inadequate in the current strategy, flawless planning, and rigorous PMI—do not extreme circumstances, as varying pressures on differ- change with the economic cycle. In a downturn as severe ent stock markets make peer group comparisons diffi- as the current one, however, predators cannot simply ap- cult. With earnings set to reach their lowest levels in proach potential acquisitions as if nothing has changed. the second half of 2009 or the first half of 2010, exist- Conventional M&A strategies and tactics must be updat- ing multiples may be too high. Valuation of targets re- ed to deal with much more uncertainty. quires a good deal more than analysis of their finan- cials and simple multiple calculations—real business ◊ Targets may become available overnight, requiring fast- planning and exploration of worst-case scenarios are er responses than those typical of the search processes necessary. traditionally used by business development teams. Target searches should scour the markets for attractive ◊ Forecasts must factor in sudden and fundamental prospects that may not be up for sale now but could changes in a business and financial environment that become available in the near future. Potential targets remains volatile. BCG’s proprietary marketplace- to scrutinize include companies with refinancing is- research techniques probe revenue streams against ad- sues, struggling PE portfolio companies, and seriously verse developments, such as a deepening downturn— undervalued competitors that are ripe for hostile or even a lasting, L-shaped one. The results help takeover. provide an understanding of the shape of baseline B D W O A F 
  26. 26. cash flows, their vulnerability, and how they can be im- still time-consuming. From day one of the merger, proved. Other elements in the BCG toolbox include measures to increase cash generation must be the top analysis of the competitive positioning of the target’s priority—and in tough credit markets, they may be essen- products and its vulnerability to consolidation among tial to funding the restructuring. its competitors. The quickest way to release large amounts of cash is to ◊ Execution should not skimp on due diligence if the ac- optimize the three key drivers of working capital: inven- quirer is to avoid being sucked down by tories, receivables, and payables. BCG’s ex- undiscovered problems in the target. perience shows that by doing this through- With less activity and fewer buyers in The downturn can out the entire value chain—from product the markets, there should be less pres- make the previously design to operations to sales—companies sure to complete transactions according can easily reduce their working capital by to a tight timetable. The target may impossible deal as much as 40 percent and cut their costs wish to impose such a timetable in a possible. by up to 10 percent, even when the busi- volatile environment, but completion ness is stable. Carve-out opportunities can of thorough due diligence is in its inter- also release cash to fund restructuring, as est as well. well as minimize PMI risks. Advance preparation is essential in responding to these Today’s severe downturn has one great advantage for new circumstances. Shareholders and other stakeholders predators: it can make the previously impossible deal should be prepared for the possibility of deals before they possible. Governments, for example, are more receptive emerge, and they should be briefed as soon as possible to consolidation of struggling businesses when the alter- aer bids are made to maintain their support. BCG’s sur- native may be corporate failures or state bailouts. Like- vey of investors showed the importance of managing ex- wise, regulators are more likely to approve M&A that pectations before initiating M&A transactions.11 When would previously have been seen as having adverse ef- asked to name the most important criteria for investing fects on competition—particularly in industries such as in a company today, investors cited management credibil- financial services, where collateral damage in the wider ity and a proven track record first. Moreover, they said economy could be severe. Employees have become more that the keys to establishing those attributes are transpar- open to flexible working arrangements, such as part-time ency, clear communication with investors, and a compel- work, shorter hours, and furloughs, making it easier to re- ling long-term plan for creating value. structure acquisitions and reduce fixed costs in parts of the world where such measures would be harder to im- Integrate and Restructure Fast plement in less difficult times. In the current financial environment, the focus during PMI must be on cash management. A well-planned and 11. See Collateral Damage: Function Focus—Valuation Advantage: How well-executed PMI strategy will release cost synergies as Investors Want Companies to Respond to the Downturn, BCG White rapidly as possible, but earnings-oriented restructuring is Paper, April 2009.  T B C G
  27. 27. Guidance in the Crisis for Predator CEOs S uccess with M&A comes when preparation • Think about how you will finance deals—and line meets opportunity. The following is a six-point up plan B plan to minimize vulnerabilities before capi- • Have due-diligence teams briefed and on call talizing on acquisitions. • Evaluate potential pitfalls and test worst-case scenarios, including a prolonged downturn 1. Check your home turf • Prepare shareholders and stakeholders for the pos- • Improve the operating performance of your company sibility of bids • Maximize and build up your cash 5. Execute quickly • Optimize your financial structure • Start due diligence on main issues immediately • Secure short-term liquidity • Use reps and warranties for minor issues 2. Optimize your company’s valuation • Consider offering payment in shares if the target’s • Manage investor relations to enhance your relative equity is cheaper, but... valuation • Finalize the deal structure fast—cash, shares, or a • Reassess your dividend policy—increasing divi- combination dends could raise your valuation • Capitalize on distressed targets and low valuations • Improve your debt rating 6. Integrate rigorously in a more forgiving M&A envi- 3. Examine the market thoroughly ronment • Understand industry trends • Cut fixed and variable costs vigorously • Search for targets not for sale now—their time might • Focus on cash come • Involve labor unions and employee representatives, • Look for smaller acquisitions stressing the need for urgent action • Don’t overlook good distressed targets from weaker • Harvest synergies and make quick wins companies or PE portfolios • Actively communicate rationales and achievements 4. Prepare for potential deals to improve your company’s valuation • Be ready to reassess value when the crisis distorts conventional methods B D W O A F 

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