We recently came across a piece which Michael Mauboussin (generally considered one of the more thoughtful and original analysts of financial topics) wrote while at Credit Suisse, entitled “To Buy or Not to Buy”. In it he reviewed the question of whether and how value is created in the course of mergers and acquisitions (M&A); how the “purpose” of an M&A transaction might affect the outcome; and factors to consider in evaluating M&A- all in the context of public markets, where the successor remained publicly-quoted.
What is interesting about the findings is that there are factors or reasons which make a demonstrable and empirical difference between whether a M&A transaction creates or destroys value; succeeds or fails, yet these are often ignored or overlooked.
For example, the management of the acquirer will often state that the transaction will be accretive to earnings per share, which sounds like a good thing. Unfortunately, this appears to have little to no bearing upon whether the transaction proves beneficial. As Mauboussin points out, value creation is based upon cashflows, cost of capital and true profitability, not some accounting construct, yet managements often obsess about EPS.
Anecdotally, it seems that many M&A deals do not create the expected positive value. This outcome is all the more likely if a buyer pays a premium for control which is too large, becomes vulnerable to competitors emulating its actions (but without M&A), or sees them taking advantage while it is distracted by integration. Of course, there is a relatively straightforward way of assessing whether or not a transaction should create value for the buyer (as suggested by Mark Sirower of Deloittes):
Net present value of deal to Buyer = present value of synergies – cost of premium
This simple formula highlights the fact that execution is the key to any successful M&A deal. This should be obvious, but management teams, unless they have demonstrable experience and a track record, can get caught up in the moment and excitement of a transaction, and lose sight of the fact that the real work begins once a deal has closed- “transformational” being a favourite term. Mauboussin groups the underlying premise of transactions into 4 categories:
– Opportunistic (e.g., a weaker competitor selling-out)- these have a high success rate
– Operational (bolt-ons, business extensions)- these have a better than even chance
– Transitional (to build market share)- these have mixed outcomes
– Transformational (large leap into new industry)- these tend not to end well
The way in which a transaction is financed also tends to matter. The use of cash and leverage helps focus minds better than the use of equity, as realizing synergies and operational improvements becomes an important factor in reducing the financial risks assumed.
Within the (re)insurance industry, the level of M&A transactions tends to be cyclical, with “soft” markets helping the stronger pick off the weaker, although one should always ask what the real purpose and benefit of any given transaction is. The industry still has great difficulty in using M&A to make significant cost reductions, or to improve operational efficiencies, while there is always the fear of paying up for expertise or client access which then melts away.
At Awbury, with our extensive and diversified panel of multi-line P&C partners, we naturally pay close attention to developments and trends in (re)insurance M&A, as ultimately one always needs to understand not just who can provide capacity, and is likely to continue to do so, but also exactly who we are dealing with. People matter as much as capital, and a badly-executed or misguided M&A transaction is disruptive, or can even materially damage an enterprise’s franchise.
The Awbury Team