Mergers and acquisitions — who really wins when companies merge

The boardroom table is long, the lawyers are expensive, and the investment bankers are very confident. There is a chart showing synergies. There is a presentation about strategic fit. There is a press release already written about the transformational nature of the deal. What there rarely is — at least not in the room — is a clear-eyed assessment of whether any of this will actually benefit ordinary shareholders.

The research on mergers and acquisitions is remarkably consistent, and remarkably damning. Study after study, across decades and across markets, comes to the same conclusion: the majority of M&A deals destroy value for the acquiring company’s shareholders. They either pay too much, fail to deliver the promised synergies, or simply find that two cultures, two IT systems, and two sets of middle managers do not blend together as cleanly as the PowerPoint suggested.

That does not stop deals from happening. Quite the opposite. M&A cycles through waves of activity, inflating and deflating with the credit cycle and the mood of the market. When money is cheap and confidence is high, chief executives go shopping. The question any private investor needs to ask is not whether the deal will happen, but who benefits when it does. The answer, more often than not, is not them.

When one company makes a bid for another, the target shareholders almost always do well. They receive a premium to the current market price — the bidder has to offer them something to persuade them to sell. Historically, takeover premia in the UK have averaged somewhere between twenty and thirty per cent above the undisturbed share price. If you hold the target, that is a very welcome outcome. For shareholders of the acquiring company, the picture is rather different. The share price of the bidder often falls on deal announcement. Sometimes sharply. Markets tend to read this as a signal that the acquiring company has overpaid, is taking on debt it does not need, or is pursuing a deal that suits the ambitions of management more than the interests of shareholders.

The most vivid example in UK corporate history was the acquisition of ABN Amro by a consortium led by Royal Bank of Scotland in 2007. At the time, it was the largest banking acquisition in history. It was also, by general consensus, one of the most catastrophic. RBS — now rebranded as NatWest — paid roughly 71 billion euros for a bank with substantial exposure to US subprime mortgages, at almost exactly the worst moment in financial history to be doing so. The deal was the product of hubris, competitive pressure, and a board that did not push back hard enough against a chief executive who wanted to win the auction. The subsequent collapse required one of the largest government bailouts in British history. Shareholders were effectively wiped out.

The RBS/ABN Amro deal is an extreme case, but the dynamics that produced it appear in almost every significant acquisition. The Kraft takeover of Cadbury in 2010 is a smaller but instructive example. Kraft made promises about keeping Cadbury’s operations in the UK, including a factory in Somerdale, that it broke almost immediately after the deal completed. The episode produced significant regulatory scrutiny and eventually contributed to changes in UK takeover rules. Cadbury shareholders received a premium. British employees and communities received considerably less.

The City operates on a straightforward principle: deals are good for deal-makers regardless of outcome. The investment bank advising the acquirer earns a fee. The investment bank advising the target earns a fee. The lawyers on both sides earn fees. The financial PR firms on both sides earn fees. The success of these advisers is not measured by whether the combined entity performs well in five years’ time. It is measured by whether the transaction completes. That structural incentive runs through every stage of the M&A process and shapes almost every piece of advice a chief executive receives.

This does not mean that all acquisitions fail. Some companies have been built through disciplined acquisition strategies that genuinely created value. The distinction usually comes down to the same few factors: price discipline, cultural fit, and the realism of the integration plan. Acquirers who overpay, who underestimate the difficulty of combining two businesses, or who assume that cost synergies will fall into place without disruption, tend to regret it. BHP’s repeated pursuit of Rio Tinto ultimately came to nothing partly because the price was never going to make sense. That restraint — however reluctant — protected BHP shareholders from a deal the market had already priced as too rich.

For private investors watching from the outside, M&A activity is worth reading carefully precisely because the market’s initial reaction is often right. A sharp fall in the acquiring company’s shares on announcement day is usually telling you something. A prolonged period of underperformance as integration drags on and synergy targets are quietly revised tells you more. The standard line in annual reports — that the integration is progressing well and synergies will be delivered in line with expectations — deserves the same scepticism you would bring to any corporate communication designed to reassure rather than inform.

When a company you hold as an investment makes a large acquisition, the most useful questions are not about the strategic rationale or the projected synergies. They are simpler and harder. How much are they paying, and why now? Is the price justifiable on any reasonable assumption about the target’s future cash flows, or is this a deal priced for a bull case that may never arrive? And is the person driving it someone who has a track record of disciplined capital allocation, or someone who wants to run a bigger company? The answers will not always be obvious. But they are worth looking for before the press release lands.

This post is drawn from The Street-Smart Trader by Ian Lyall. Republished with permission.

Street Smart is a series drawn from first-hand experience of the City of London, updated as each new chapter arrives.

Disclaimer: The value of investments can go down as well as up, and you may get back less than you invest. This article is for informational and educational purposes only and does not constitute financial advice. Always do your own research and consider seeking independent advice before making any investment decision.

This article is for informational purposes only and does not constitute financial advice. Investment values can go down as well as up. Always do your own research before making any financial decisions.