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The Return of the Strategist

Creating Value with M&A in Downturns

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Jeff Gell

Jens Kengelbach

Alexander Roos

May 2008

© The Boston Consulting Group, Inc. 2008. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: [email protected]: +1 617 850 3901, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. Exchange Place Boston, MA 02109 USA

The Return of the Strategist 3

Contents

Note to the Reader 4

Preface 6

Executive Summary 7

The Return of the Corporate Buyer 9Power Is Shifting from Private-Equity Firms to Corporate Buyers 9Private Equity Is Down but Not Out 11Are Sovereign Wealth Funds the New Private Equity? 14Is Now a Good Time to Do a Deal? 14

The Advantages of Doing Deals in Downturns 16Harnessing the Power of Downturn M&A 16Picking Winners in Downturns 16

The Benefits of Divestitures for Buyers and Sellers 21Key Success Factors for Buyers 21Key Success Factors for Sellers 24

Appendix: Methodology 27

For Further Reading 30

4 The Boston Consulting Group

Note to the Reader

About the AuthorsJeff Gell is a partner and managing director in the Chicago office of The Boston Consulting Group and global sector coleader of M&A. Jens Kengelbach is a principal in the firm’s Munich office and a member of the European corporate-finance task force. Alexander Roos is a partner and managing director in BCG’s Berlin office and global sector coleader of M&A.

AcknowledgmentsThis report is the product of the Corporate Development practice of The Boston Consulting Group. The authors would like to acknowledge the contributions of their colleagues:

Gerry Hansell, senior partner and managing director in the firm’s Chicago office and leader of the Corporate Development practice in the Americas

Jérôme Hervé, partner and manag-ing director in BCG’s Paris office and leader of the Corporate Develop-ment practice in Europe

Heino Meerkatt, senior partner and managing director in the firm’s Munich office and global private-equity sector leader

Daniel Stelter, senior partner and managing director in BCG’s Berlin office and global leader of the Corporate Development practice

The authors would also like to thank Philipp Jostarndt and Kerstin Hobelsberger for their scientific and research support.

Finally, the authors would like to acknowledge Keith Conlon for helping to write this report, and Katherine Andrews, Gary Callahan, Elyse Friedman, and Kim Friedman for their contributions to the editing, design, and production of this report.

For Further ContactBCG’s Corporate Development practice is a global network of experts helping clients design, implement, and maintain superior strategies for long-term value creation. The practice works in close cooperation with the firm’s industry experts and employs a variety of state-of-the-art methodologies in portfolio management, value management, mergers and acquisi-tions, and postmerger integration.

For more information, please contact one of the following leaders of the practice.

The AmericasJeff GellBCG Chicago+1 312 993 [email protected]

Ed Busby BCG New York+1 212 446 [email protected]

Daniel FriedmanBCG Los Angeles+1 213 621 [email protected]

Gerry HansellBCG Chicago+1 312 993 [email protected]

Jeffrey KotzenBCG New York+1 212 446 [email protected]

Eric OlsenBCG Chicago+1 312 993 [email protected]

Walter PiacsekBCG São Paulo+55 11 3046 [email protected]

John RoseBCG New York+1 212 446 [email protected]

Peter StangerBCG Toronto+1 416 955 [email protected]

Alan WiseBCG Atlanta+1 404 877 [email protected]


EuropeJens KengelbachBCG Munich+49 89 23 17 [email protected]

Alexander RoosBCG Berlin+49 30 28 87 [email protected]

Kees CoolsBCG Amsterdam+31 20 548 [email protected]

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Preface

The recent cooling of the mergers and acqui-sitions (M&A) market in the wake of the credit crunch has sparked media specula-tion that the market is about to enter a deep freeze. Commentators’ main concern is that

the midyear contraction of the debt market, which ini-tially affected only highly leveraged private-equity (PE) transactions, will turn into a widespread liquidity shock, making funding scarce for moderately financed deals as well. But for the players who matter the most—the buy-ers and sellers—the key question is not whether deal vol-umes and values will rise or fall but whether it is still possible to generate value from transactions. As we dem-onstrate in this, our fourth annual report on M&A, buyers and sellers can create significant value under all econom-ic conditions—including economic downturns.1

In addition to discussing the latest M&A developments and how to create value in downturns, we have placed a special emphasis in this year’s report on corporate dives-titures. We have done so for two reasons. First, divesti-tures have received relatively little attention. Second, there is a possibility that divestitures will increase if there is a global economic downturn.

Based on an analysis of more than 5,100 divestiture deals—one of the largest studies of its kind—we present the key ingredients of success for buyers and sellers. Many of our insights are founded on new research. Other recommendations draw on previous studies from the BCG M&A Research Center that have stood the test of time.

However, we have not neglected the broader trends with-in the M&A market. Some of these trends have important implications for buyers and sellers. The partial retreat of

private equity—which is easing pressure on valuation multiples, making deals more attractive—is a case in point. This has created substantial opportunities for cor-porate—or so-called strategic—buyers, who have re-turned to reclaim an even greater share of deal value.

We hope that these and other insights in this report will enable both buyers and sellers to improve their share-holder returns, regardless of the economic climate.

1. In this report, we define an economic downturn as a period of be-low-average GDP growth (less than 3 percent).


Executive Summary

The rise and recent fall of the latest wave of M&A has been fueled largely by pri-vate equity’s excessive dependence on debt. Corporate buyers are now back in the driver’s seat and armed with the cash

and profitability to do deals.

As we showed in our 2007 M&A report, ◊ The Brave New World of M&A: How to Create Value from Mergers and Acquisitions, PE firms spearheaded the surge in deals between 2004 and 2007, accounting for a mount-ing share of transactions by value, aided by the low cost of debt and relatively weak covenants. The credit crunch has taken the wind out of PE firms’ sails— and has sent a few shivers through corporate board-rooms.

Although deal values rose by 19.3 percent between ◊ 2006 and 2007, they declined by 17.8 percent in the second half of 2007 compared with the first half of the year. However, a closer analysis of the deals reveals that this drop is less a sign of loss of confidence in M&A than a shift in power back to corporate buyers.

Transaction volumes, for example, remained relatively ◊ high and stable throughout the year (apart from a tem-porary dip in August 2007 in response to the subprime crisis in the United States), indicating that the market remains healthy—and that there is a trend toward smaller deals.

More significantly, private equity’s share of total deal ◊ value plunged from 27 percent to 13 percent between the first and second halves of 2007, while corporations’ share of deal value increased from 73 percent to 87 percent.

Moreover, corporate buyers have the cash and profit-◊ ability to continue to do deals. The average cash sur-plus of the S&P 500, for example, is 56 percent higher than it was in 2000, when M&A values and volumes reached record heights. The average profitability of these companies, measured by earnings per share, is also more than twice as high as it was in 2000.

Sovereign wealth funds (SWFs) could also step up their ◊ M&A activity. And private equity, with its $300 billion war chest of unallocated funds, could enjoy a resur-gence.

Is now the time to acquire a company? The retreat of private equity has eased pressure on valuation mul-tiples, making deals more attractive. An economic downturn will create greater opportunities for corpo-rate buyers to generate superior value.

Company valuations, measured by multiples such as ◊ price-to-earnings (P/E) ratios, are substantially lower than they were during the peak of the last M&A wave in 2000. Since 2001, the average P/E ratio for the S&P 500 has declined by 61 percent, from 46.5 to 18.1—close to the long-term S&P 500 average of 15.7.

An economic downturn—which was considered a dis-◊ tinct possibility at the time this report went to press because of the steep decline in the U.S. economy—would put further downward pressure on valuation multiples and, more crucially, provide an opportune moment to do a deal.

According to BCG research, downturn deals have a ◊ higher chance of creating value for buyers than upturn deals. In fact, downturn deals are twice as likely to


produce long-term returns in excess of 50 percent and, on average, create 14.5 percent more value for share-holders of the acquirer. This additional value is not generated purely from “buying low and selling high” but from acquirers unlocking hidden fundamental value through operational improvements.

Buyers can also increase their returns and likelihood ◊ of success by acquiring relatively small targets, paying lower valuation multiples, and paying in cash. Surpris-ingly, acquirers can also create value by paying above-average premiums—provided the underlying rationale for the deal makes sense. In fact, these insights hold true in all economic conditions.

Divestitures have a higher probability of success for acquirers, and they create substantial value for both buyers and sellers.

The retreat from big-ticket transactions, coupled with ◊ a bleaker economic outlook, is likely to lead to an in-crease in small “tuck-in” acquisitions and divestitures (such as asset sales and sales of business units and di-visions). As a result, our analytical work this year fo-cuses on divestitures.

On average, 57.5 percent of buyers of divested ◊ assets generate positive returns, compared with just 41.7 percent of buyers of entire companies (so-called public-to-public deals). Furthermore, the average di-vestiture creates substantially more value for the buy-er (a cumulative abnormal return, or CAR, of 2.2 per-cent) than the average public-to-public transaction (a cumulative abnormal return of –1.2 percent).2 Specifically, divestitures create value under all economic conditions for acquirers—including down-turns, when buyers produce an average return of 1.9 percent.

In addition, similar to public-to-public acquisitions, di-◊ vestitures produce positive (but smaller) returns for not just the buyer but the seller as well. The seller’s overall returns are 1.5 percent on average, rising to 1.7 percent during downturns—suggesting that it is a good idea to clean up portfolios during downturns.

But sellers need to sharpen their sales techniques—they are squandering value in the average divestiture.

Sellers earn significantly lower returns from divesti-◊ tures than from public-to-public deals, indicating that they need to improve their sales techniques. After ad-justing for the relative size of the deal, the difference in returns is 11.8 percentage points. This equates to $28 million of lost value for the average divestiture when matched against a comparable public-to-public transaction. Institutional differences between public-to-public deals and divestitures might explain part of this gap in returns. But the persistence of this differ-ence in returns throughout the deals in our sample indicates that companies that divest tend to undersell their assets.

To improve their returns, sellers need to target acquir-◊ ers who will gain the greatest shareholder returns from the divested asset—and consequently have the great-est leeway to pay a higher acquisition premium. Our research highlights how to match assets with the high-est potential bidders.

For example, we found that acquirers’ returns from ◊ divestitures are systematically higher when the rela-tive size of the asset is substantially higher for the buyer than for the seller. In deals where the divested unit represents more than 50 percent of the value of the buyer and less than 10 percent of the value of the seller, acquirer returns (6.5 percent) are almost three times higher than in deals where the relative sizes of acquirer and seller are similar (2.2 percent). Moreover, assets that are core to the acquirer’s business also pro-duce more than 23 percent higher returns than non-core assets.

Similarly, a seller’s choice between an IPO or a trade ◊ sale can also have a significant impact on its returns. On average, we found that sellers fare significantly bet-ter using the public divestiture route—even after con-trolling for size of the asset—which suggests that sell-ers should not prematurely jump at seemingly attractive offers from wholesale investors.

2. See the Appendix: Methodology for further details on cumulative abnormal returns.


After a prolonged surge of M&A that ap-proached the record heights of the previ-ous wave of deals at the turn of the cen-tury, the volume and value of transactions have started to drop. This isn’t surprising.

M&A activity goes in cycles, usually rising and falling with the ebb and flow of the economic tide. However, claims that the latest dip signals a natural long-term de-cline in the M&A market are premature.

The reality is that M&A activity, measured by the volume (or number) of transactions, has remained remarkably robust. What has changed is that private equity’s share of total deal value has dropped dramatically. This decline, which was triggered by the credit crunch, has created sub-stantial opportunities for corporate buyers, notably a re-duction in competition for deals and less inflated valua-tion multiples. Moreover, corporate buyers have more than enough firepower, including rich supplies of cash and high levels of profitability, to do deals.

Whether corporate buyers will be able to sustain their M&A momentum will ultimately depend on the econom-ic climate. And there are dark clouds gathering on the horizon. A global economic downturn will inevitably re-duce deal activity. Corporate buyers and sellers, however, can generate above-average returns in all environments—and are even more likely to generate good returns in bad times.

Power Is Shifting from Private-Equity Firms to Corporate Buyers

From 2006 to 2007, deal values and volumes increased by 19.3 percent and 54.7 percent, respectively. Once again, echoing the findings of last year’s M&A report, private

equity was the driving force behind these increases, ac-counting for a growing share of transactions by value and by volume. PE firms’ share of the total value of deals has leaped from 5 percent in 1998 to more than 40 percent in June 2007, an eightfold increase in less than ten years.

However, headline statistics can be deceptive. A closer analysis of deals during 2007 reveals not only a marked downward movement in the second half of the year but also a shift in power away from private equity toward corporate buyers. After the first half of 2007, deal values (measured in U.S. dollars) dropped by 17.8 percent, with the sharpest drop between July and August. During the same period, PE firms’ share of total deal value plunged from 27 percent to 13 percent, while corporate buyers’ share of deal value increased from 73 percent to 87 per-cent. (See Exhibit 1.) Not surprisingly, the turning point came in the summer of 2007 when the subprime crisis began, prompting the credit crunch and calling time on several major PE transactions.

Nevertheless, the appetite for deals remains relatively strong: although M&A volumes dipped by 11 percent be-tween July and August 2007, they swiftly rebounded. The average deal today might be smaller than it was a year ago, but confidence in M&A remains fairly strong.

One of the advantages of the credit crunch for corporate buyers is that it has reduced the competitive pressure for deals, especially from PE firms. Valuation multiples are now more reasonable, making transactions more attrac-tive and providing corporations with greater room to cre-ate value. (See Exhibit 2.) Corporate buyers also have the cash and profitability to capitalize on this opportunity. Last available data show that corporate cash reserves for the S&P 500 are currently around $1.3 trillion—56 per-

The Return of the Corporate Buyer


0Feb Mar Apr May Jun Jul Dec

Number of PE deals

0

400

500

600

700

800Number

Jan Aug Sep Oct Nov0

Corporate buyers’ deal value

Number of deals

–62%

160

Jan

339361

Mar

461

Apr

166

489

Feb

156

392

Jun

117

481

JulMay24

182

Aug28

169

Sep

266

Oct31

415

Nov31

297

Dec0

550

600

650

700

750

800

$billions $billions300

200

100

46

83 85 59

166 156–80%

117

24 28 3731 31

PE buyers’ deal value PE buyers’ deal value

59858346 37

600

500

400

300

200

100

PE deal value dropped by 80 percent... ...and PE share stayed at less than 15 percent, while corporate buyers’ deal value picked up

2007 2007

Number

Exhibit 1. The Midyear Meltdown of the Debt Market Was Spurred by a Strong Decline in PE Activity and Reduced PE Share of Deals

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum. Note: Figures are based on announced deal values and volumes.

7.3x

1997

8.2x

1998

7.7x

1999

7.3x

2000

7.1x

2001

7.0x

2002

6.8x

2003

7.6x8.3x

2005

10.0x

12.0x

2.0x

4.0x

6.0x

8.0x

8.8x

2006

9.6x

10.9x

2007(third

quarter)Other/EBITDA Equity/EBITDA Debt/EBITDA

2004 2007( Jan–Sep)

Transaction proceeds as a multiple of EBITDA

Exhibit 2. Transaction Multiples Were Higher in 2007 Than During the Internet Bubble

Source: Standard & Poor’s Leveraged Commentary & Data.Note: “Other” was not further specified by Standard & Poor’s.


cent higher than they were at the peak of the last M&A wave in 2000. In addition, the average corporate coverage ratio—a measure of a company’s ability to pay its ex-penses, including debt—is very healthy: it currently stands at around 8:1, compared with just over 4:1 in 2002. (See Exhibit 3.) And profitability is more than twice as high as it was in 2001. (See Exhibit 4.)

Private Equity Is Down but Not Out

PE firms might have scaled back their M&A investments, especially in big-ticket transactions, but that doesn’t nec-essarily signal a long-term withdrawal. In fact, there are strong reasons to believe that private equity will remain a powerful and permanent force in the market.

As we highlighted in our recent report The Advantage of Persistence: How the Best Private-Equity Firms “Beat the Fade,” PE firms have massive war chests. At the end of 2007, PE firms in the United States and Europe had

nearly $300 billion of uninvested capital funds.3 In addi-tion, major pension funds and other investors are con-tinuing to invest in PE firms’ funds in the wake of the subprime crisis.

Confidence in private equity’s future has been further underlined by SWFs taking stakes in these firms. In- dependent research estimates that current SWF investments in the top 46 PE funds reached $120 billion to $150 billion in 2007.4

The credit crunch has also increased the price for insur-ing corporate default risk and pushed the refinancing cost for leveraged buyouts to record heights. (See Exhibit 5.) In fact, insurance for credit default risk, as measured by the iTraxx Index, more than doubled in the second quar-ter of 2007. But the impact of the credit crunch on PE

10

Cash on balance

%

5.3

5.8

5.05.5

6.05.85.55.35.14.95.0

0 0

2

4

6

8

10

Fixed-charge coverage ratio2

Fixed-charge coverage ratio

8.08.27.7

5.6

4.6

3.8

5.64.9

5.7

5

0

Cash on balance($billions)1

1,000

1,500

500561

628721

857

971

1,083

1,246

1,4361,346 1,339

2006 20061997 1998 1999 2000 2001 2002 2003 2004 2005 1997 1998 1999 2000 2001 2002 2003 2004 2005

S&P 500 companies have more cashnow than during the 2000 peak...

...and the coverage ratio is significantly healthier

M&Awave

M&Awave

Exhibit 3. Higher Cash on Balance Might Indicate a Financial Cushion for Corporate Buyers

Sources: Thomson Datastream; BCG analysis.Note: All analyses are based on current 2006 S&P 500 constituent companies tracked backward in identical composition until 1997.1Absolute cash on balance in S&P 500 companies, in real figures (2006 = 100).2Fixed-charge coverage ratio = earnings before interest and taxes ÷ (interest expense on debt + preferred dividends (cash)) ÷ (1 – (tax rate ÷ 100)).

3. See Private Equity News, January 28, 2008.4. See Preqin Sovereign Wealth Fund Review, 2008.


1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008a 2009a

0

5

1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006

0

5

0

5

M&Awave

Long-termaverage 15.7

18.1 (first quarter,

2008)

P/E ratio,S&P 500

Quarterly EPS (as reported) in S&P 500

P/E ratio of S&P 500

P/E ratio of S&P 500

M&Awave

10

15

20

25

10

15

20

25

30

35

40

45

50

10

15

20

25

30

35

40

45

50P/E ratio, S&P 500

Earnings per share, S&P 500

The market was overvalued in 2000, but today it is slightly above average...

...and corporate profits are significantly higher than they were in 2000

(fourth quarter)

(first quarter)

Exhibit 4. “Sounder” Corporate-Earnings Situations and Lower Stock Valuations Could Help Soften the Crisis

Sources: Thomson Datastream; S&P 500 Earnings and Estimate Report; BCG analysis. aS&P 500 forecasts.


Mar 21 2007

Apr 212007

May 212007

Jun 212007

Jul 212007

Aug 212007

Sep 212007

Oct 212007

Nov 212007

Dec 212007

Jan 212008

Feb 212008

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008(first

quarter)

0

2

4

6

8

Credit spreads over T-bills

129 percent increasein second wave

iTraxx EU crossover index1

150

200

250

300

350

400

450

500

M&A wave M&A wave

High yield—Treasury Investment grade—Treasury AAA—Treasury

12

10

The price of risk increased dramatically...

...making deal refinancing more expensive

75 percent increase in first wave

Exhibit 5. The Credit Crunch Has Led to a Repricing of Risk and a Sharp Increase in Refinancing Costs

Sources: Thomson Datastream; Lehman Brothers; BCG analysis.1We show the “CMA iTraxx EU Crossover S7 Seniority 5Y - CDS PREM. MID.”


firms’ deal volumes might be less severe than expected. Indeed, there is evidence that PE firms are relying much less on debt arbitrage to generate value from deals and instead are focusing increasingly on fundamentals, nota-bly operational improvements and profitable growth.5

Are Sovereign Wealth Funds the New Private Equity?

The gorilla lurking in the corner—and capable of making a substantial impact on both M&A and debt markets, far beyond private equity—is SWFs. Since 2003, SWFs have nearly doubled in size, from $1.6 trillion to $3 trillion, largely as a result of rising demand for state-owned natu-ral resources, especially oil and gas. If SWFs continue to grow at their current rate of 18 percent per year—a rate that is unlikely to continue forever because of the close relationship between these funds and global economic growth—they could buy up 10 percent of the world’s eq-uity and debt markets by 2010. (See Exhibit 6.)

So far, SWFs such as Singapore’s Temasek Holdings have tended to take majority stakes in domestic targets and only minority stakes in overseas companies. Whether SWFs will be more ambitious on foreign soil is question-

able, especially from a political perspective. Concerned about the security implications of overseas, state-con-trolled funds’ owning shares of strategic assets such as utilities, some governments have already rebuffed bids from foreign SWFs. Germany, for example, prevented Russia’s conglomerate Sistema from taking a bite of Deutsche Telekom. The European Commission is also ex-ploring ways to regulate SWFs. The U.S. Department of the Treasury has voiced concerns about SWFs, too, while in the course of that discussion, U.S. Treasury Secretary Henry M. Paulson Jr. and officials from Abu Dhabi and Singapore have agreed to a basic code of conduct for SWFs and the countries they invest in. Until these largely political considerations are resolved, the long-term im-pact of SWFs on M&A is difficult to predict.

Is Now a Good Time to Do a Deal?

Mergers and acquisitions remain a risky pursuit. When looking at short-term stock-price reactions, we found that only 41.7 percent of the public-to-public transactions in

64

1

3

4

0 20 40 60 80

Bank assets

World GDP

Stock market capitalization

Private-debt securities

Public-debt securities

Investment funds

Pension funds

Insurance companies

Reserves, excluding gold

SWFs

Hedge funds

Value, 2007 ($trillions)

SWF value compared with other asset classes

45

42

36

23

21

18

16

7%

Exhibit 6. State-Owned Investment Funds Currently Own 7 Percent of Worldwide Stock-Market Capitalization, but They Are Growing Rapidly

Sources: Deutsche Bank research; BCG analysis.

5. See The Advantage of Persistence: How the Best Private-Equity Firms “Beat the Fade,” BCG report, published with the IESE Business School of the University of Navarra, February 2008.


our sample produced positive shareholder returns (ver-sus the market) for the acquirer on announcement of the deal. But this finding, which is consistent with numerous previous studies, conceals a vital fact: successful deals can generate substantial returns. For the top 20 acquirers in public-to-public transactions, the median market-adjust-ed abnormal return over the seven-day window around the announcement day was 39.2 percent. This finding un-derlines the strategic value of M&A, provided the deals are identified and executed properly.

These results apply to a period of sustained economic growth. But what if there is a global downturn, as many expect? M&A values and volumes are closely correlated to GDP, so the market will almost certainly drop. But re-turns are likely to increase.


Most companies pull away from the M&A deal table during downturns, but BCG research has found that it is often ideal to acquire a company during a weak economy, provided the strategic fit is

right. Downturn deals have a higher chance of creating shareholder value and delivering greater returns, on aver-age. Success during these periods depends in part on fo-cusing on the right types of companies, notably firms with strong finances and relatively weak profitability. But success also depends on a range of other guiding princi-ples of M&A that apply in all economic environments.

Harnessing the Power of Downturn M&A

It’s widely known that more than half of mergers destroy value for acquirers’ shareholders. However, when deals are analyzed by economic cycle, a different story unfolds. In our 2003 report Winning Through Mergers in Lean Times: The Hidden Power of Mergers and Acquisitions in Periods of Below-Average Economic Growth, we found that the aver-age downturn merger created value (8.3 percent) two years after the transaction, whereas the average upturn merger destroyed value (–6.2 percent) over the same pe-riod—a 14.5 percentage-point difference. (See Exhibit 7.)

Interestingly, both upturn and downturn acquisitions tend to trigger negative market reactions when the deals are announced. However, downturn transactions go on to create greater value in the long run, on average, than deals executed in more favorable economic climates. The long-term advantage of downturn deals cannot be ex-plained by the traditional, short-term “buy low, sell high” rationale. Instead, it suggests that acquirers in difficult economic conditions are better at identifying targets with unrealized potential—possibly because of the disciplin-

ing power of downturns, when every cent counts. So how do the top value creators in downturns pick the most fruitful targets?

Picking Winners in Downturns

Acquirers create superior value in weak economies by selecting targets that have low profitability and sound fi-nances.

The Value of Targets with Low Profitability. In success-ful downturn mergers, the difference in profitability be-tween the acquirer and the target, measured by cash flow return on investment (CFROI), is five times higher than the difference in profitability between acquirer and target in successful upturn mergers. (See Exhibit 8.) Also, when companies in our sample bought targets in downturns with higher returns than their own, their value creation was comparable to the stock market average. But when they acquired targets with lower returns than their own, they outperformed the market by 14 percent. This finding casts doubt on the widespread belief that immediate gains in earnings are critical to the success of acquisitions.

This difference in profitability enables weak-economy buyers to create value through operational improve-ments, which in turn increase profitability. Two years af-ter the successful weak-economy acquirers in our sample had announced their deals, they had increased their CFROI more than three times as much as their successful strong-economy counterparts (1.3 percent versus 0.4 per-cent). In addition, they had achieved average profitability of 10.4 percent, compared with 7.8 percent for successful upturn acquirers. Successful downturn acquirers secured these gains by improving both cash-flow margins and as-set productivity.

The Advantages of Doing Deals in Downturns


This is not to say, of course, that merely picking underper-formers will do the job for the acquirers. Instead, it is es-sential to combine the acquisition with a sound and ready-to-install business plan for turning the target into an economic success. The challenge is selecting an acqui-sition target that is both unprofitable and financially sound. Quite often, low profitability is mirrored in poor financials.

The Importance of Financially Healthy Targets. One of the fears of prospective acquirers in economic down-turns is that an M&A deal will drag down their financial performance. This is true if the target has weak financials, but BCG research has found that if the target is finan-cially healthy, with minimal indebtedness, the deal im-proves its position.

Using Altman Z-scores to categorize the relative financial health of the targets in our sample, we found that healthy targets were far more likely than distressed targets to have a positive impact on the acquirer’s share price dur-ing a period of below-average economic growth. Two years after the deal, 56.8 percent of healthy targets cre-ated value, compared with 39.3 percent of distressed tar-gets. (See Exhibit 9.)

T–5

Downturn mergers create value

Upturn mergers destroy value

T+5 Year 1 Year 2

10.4percentagepoints

Cumulative RTSR performance (announcement date = 100)

Announcement window

End ofannouncement

year

94.193.8

108.3

104.5

5.9percentagepoints

95.5

97.4

97.8

110

105

100

95

90

101.4

14.5percentagepoints

Exhibit 7. Downturn Mergers Outperform Upturn Ones in Terms of Relative Total Shareholder Return in the Long Term

Sources: Thomson Financial/SDC Platinum; BCG analysis.Note: 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, June 2003.

Sample size = 148 Sample size = 77

Upturn mergers Downturn mergers

0

1

2

3

4

5

1.1

4.4

0

1

2

3

4

5

Success2Success2

5.0

Failure1Failure1

2.2

Difference in CFROI betweenacquirer and target (%)

Difference in CFROI betweenacquirer and target (%)

Exhibit 8. Successful Downturn Mergers Have a Large CFROI Spread Between Acquirer and Target

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.Note: 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, June 2003. 1Relative total shareholder return from five days before the deal announcement to two years after the announcement year is less than 0. 2Relative total shareholder return from five days before the deal announcement to two years after the announcement year is greater than 0.


One of the key success factors is low leverage: the ratio of debt to assets for value-creating targets in downturns was 47 percent, on average, compared with 61 percent for value-destroying targets. By contrast, leverage and the general financial conditions of the target have relatively little impact on value in periods of above-average eco-nomic growth.

More important, companies that acquire healthy targets in downturns improve their interest coverage (measured as the ratio of earnings before interest and taxes, or EBIT, to interest expense) by substantially more than acquirers of healthy targets in upturns. In fact, interest coverage for healthy downturn mergers increased by about 16 per-cent (from 6 to 7), while interest coverage for healthy upturn deals declined by around 10 percent (from 5.9 to 5.3).

The Fundamental Principles of Picking Winners. There are principles that acquirers in all economic cli-mates should keep in mind when pursuing targets.

Choose relatively small targets. ◊ Public-to-public deals de-stroy progressively more value as the size of the target increases relative to the size of the acquirer. Targets worth more than 50 percent of the acquirer destroy nearly twice as much value as targets that are worth less than 10 percent of the acquirer. Furthermore, as our 2007 M&A report showed, absolute size matters: for example, deals worth more than $1 billion destroy nearly twice as much value as transactions worth less than $1 billion, reflecting the difficulties of integrating large targets.

Pay a premium for low valuation multiples. ◊ Acquirers are often obsessed with keeping acquisition premiums to a minimum. However, our 2007 M&A report found that value-creating deals had a 21.7 percent premium, compared with an 18.7 percent premium for non-val-ue-creating transactions. Typically, acquirers paying above-average premiums (14.7 percent) earned returns that were 1.5 percentage points higher, and their share of value-creating deals was almost 5 percentage points

Distressed target1Healthy target1

Announcement effect Two years aer the deal

39.8 40.0

56.8

39.3

0

39.8

34.3

43.2

25.0

113 35 46 28

Downturnmergers

Sample size Sample size 113 35 46 28

Successful deals (%)

Successful deals (%)

50

40

30

20

10

0

60

40

20

Upturnmergers

Downturnmergers

Upturnmergers

Exhibit 9. In Downturn Mergers, Deals with Financially Healthy Targets Are Far More Likely to Succeed

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum; Edward I. Altman, “Financial Ratios, Discriminant Analysis, and the Prediction of Corporate Bankruptcy,” The Journal of Finance, September 1968.Note: 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, June 2003. 1Altman Z-scores are a compound measure for financial distress, defined as the sum of 1.2 x (working capital ÷ total assets) + 1.4 x (retained earnings ÷ total assets) + 0.6 x (market value equity ÷ total debt) + 1.0 x (net sales ÷ total assets) + 3.3 x (EBIT ÷ total assets). To indicate financial distress, 2.8 is used as a barrier.


greater. The most value-creating combination was high premiums and low multiples. (See Exhibit 10.) This does not mean that high premiums necessarily trans-late into higher value, but it shows that paying above-average premiums can send positive signals to the market for having identified the right deal.

Cash is king. ◊ Cash-only payments in public-to-public transactions have a much more positive impact on value than deals that rely on stock, a mix of stock and cash, or other payment combinations. The most likely explanation for this is that cash investments signal to the market that the acquirer has carefully calculated that it will achieve a higher return than the cost of capital. However, with divestitures, cash plays a slight-ly different role in value creation.

Practice makes perfect. ◊ A BCG analysis of companies that pursued different growth strategies, from highly acquisitive firms to companies that relied on organic growth or a mix of organic growth and M&A, found

that highly acquisitive companies generated greater ten-year median shareholder returns than mixed-strat-egy or organic-growth companies (9.9 percent and 9.6 percent, respectively). More important, the most ac-quisitive firms produced the biggest returns (12.4 per-cent), implying that practice makes perfect.6

Profitable growth is critical. ◊ Profitability above the cost of capital is a prerequisite for value-creating growth. And unprofitable growth is a recipe for value destruc-tion. Before embarking on a deal, acquirers must en-sure their profitability has passed the weighted-aver-age-cost-of-capital threshold. Even if it has, now might be a good time for companies to examine their portfo-lio of business units and identify value destroyers. Downturns can be especially good times to sell busi-ness units.

< Median

< Median

> Median

Premium Premium

EV/EBITDA

38.1%(N = 396)

41.1%(N = 416)

43.9%(N = 465)

45.8%(N = 445)

> Median

–2.7%(N = 396)

–1.6%(N = 416)

–1.0%(N = 465)

–0.2%(N = 445)

< Median

< Median

> Median

EV/EBITDA

> Median

Share of value-creating deals1 Average value impact of deal (CAR)2

Exhibit 10. Value-Creating Deals Are Positively Associated with Higher Acquisition Premiums and Lower Multiples

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.Note: Analysis is based on a sample of 3,190 M&A transactions (1992–2006) for which complete data were available. CAR is calculated using a market model (180-day estimation period). This analysis is taken from The Brave New World of M&A: How to Create Value from Mergers and Acquisitions, BCG report, July 2007. 1Value-creating deals have positive CAR over a seven-day window centered around announcement day (–3/+3).2Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).

6. See “Successful M&A: The Method in the Madness,” Opportuni-ties for Action in Corporate Finance and Strategy, December 2005.


During the latest M&A wave, acquirers have tended to concentrate on public-to-public transactions. However, the recent trend toward smaller transactions indicates that divestitures could be stepping out of the shadow of public-to-public transactions—a development that is likely to accelerate if there is a global economic down-turn. For many corporate buyers and sellers, this could provide a fertile moment to increase their returns. As we

explain in the following chapter, divestitures have a high-er chance of success for acquirers and generate large, positive returns in all economic conditions for both buy-ers and sellers. The recent retreat of PE firms, which have traditionally played predominantly in the divestitures market, is likely to make divestitures an even more ap-pealing proposition.


Superior value creation is about smart selling as well as smart buying. The top players manage their portfolios of businesses as a collection of value creators and destroyers, supporting the winners and either fixing or divesting the los-

ers. To evaluate the economic impact of divestitures for buyers and sellers, we applied a standard event-study analysis that measures cumulative abnormal returns net of market returns, surrounding the days of the initial deal announcement.7 We found that divestitures can have a powerful impact on both buyers’ and sellers’ shareholder returns.

Key Success Factors for Buyers

Acquirers not only have a greater chance of creating val-ue from private divestitures than from public-to-public transactions, they also produce substantially higher re-turns when buying divested assets. On average, buying divested assets creates value for 57.5 percent of buyers, compared with a success rate of just 41.7 percent in pub-lic-to-public deals. More dramatically, acquirers generate consistently higher returns from divestitures than from public-to-public deals (a cumulative abnormal return of 2.2 percent versus one of –1.2 percent). (See Exhibit 11.) Returns from buying divested assets are also positive for buyers under all economic conditions—although slightly lower in downturns compared with upturns (1.9 percent

versus 2.4 percent)—and they are more stable. (See Ex-hibit 12.) But how can buyers optimize value creation when divesting assets? Three steps are key to success.

Focus on the core. Companies that acquire divested as-sets that strengthen their core business, enabling them to reap cost and revenue synergies, earn 23.8 percent higher

The Benefits of Divestitures for Buyers and Sellers

7. An event study is based on the logic that the market will reflect most of the value-relevant implications of a transaction within a few days of a deal’s announcement. Although event studies cannot capture all the contingencies that surface in the aftermath of an M&A deal, they provide the most objective assessment of a deal and follow a widespread convention in academic literature. For a more detailed description of the event study approach, see the Ap-pendix: Methodology.

–2

–1

0

1

2

3–3.4 percentage points

2.2

Private targets

–1.2

Public targets

3,027 3,215Sample size

Result from2007 M&A report

CAR (%)1

Exhibit 11. Acquirers Generate Consistently Higher Returns in Private Divestitures

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.1Results are statistically significant at conventional levels of confidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).


returns than they do if they acquire divested assets in noncore areas. The returns from buying core and noncore assets are 2.6 percent and 2.1 percent, respectively. (See Exhibit 13.)

Think big. Divestitures that are relatively big for the buyer but small for the seller generate the greatest re-turns for the acquirer. In fact, our study found that dives-titures that account for more than 50 percent of the buy-er’s total value and less than 10 percent of the sellers’ value create a cumulative abnormal return of 6.5 percent, but deals in which the value shares are reversed generate an abnormal return of –0.2 percent. (See Exhibit 14.)

There are two possible explanations for this result. First, businesses that are relatively small for the seller tend to be neglected assets, creating significant value-creation opportunities for buyers. Second, relatively large acquisi-tions tend to receive greater attention and commitment from the buyer’s management because the stakes are that much greater.

By contrast, buying an asset that is relatively large for the seller entails significant risks for the buyer and therefore results in lower returns, on average, even if it is only a small transaction for the acquirer. It is also worth noting that public-to-public transactions are unlikely to conceal a large neglected asset with substantial untapped value-creation potential.

Pay in cash or stock? Intriguingly, paying for a divested target in stock or a combination of stock and cash pro-duces noticeably higher returns for buyers (2.5 percent) than pure cash payments (1.8 percent). (See Exhibit 15.) This result is the opposite of our finding for cash pay-ments for public-to-public deals.

This discrepancy is the result of specific institutional fea-tures of private deals. One of the difficulties with private deals is that the risks are higher: less is known about the targets owing to their lower reporting requirements. Al-though cash payments generally communicate a buyer’s confidence in a deal, stock payments ensure that the sell-

0

1

2

3

42007 M&A report

2007 M&A report

0 0

1

2

3

CAR (%)1

CAR (%)1

CAR (%)1

CAR (%)1

Acquirers’ returns: public-to-public deals Acquirers’ returns: private divestitures

Sellers’ returns: public-to-public deals Sellers’ returns: private divestitures

30

20

10

1996 1998 2000 2002 2004 2006

Ø 18.6

1992 1996 2000 2004 2008

1992 1996 2000 2004 2008

Ø 1.5

0

Ø 2.2

1996 1998 2000 2002 2004 2006

–1

–2

–3

Ø –1.2

Exhibit 12. Divestitures Create Value, Whereas Public Takeovers Destroy Value for the Acquirer, on Average

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum; The Brave New World of M&A: How to Create Value from Mergers and Acquisitions, BCG report, July 2007.1Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).


CAR (%)1

Sample size 627 2,400

0

1

2

3

4

2.6

Core segmentacquisition2

2.1

Noncore segmentacquisition

+23.8%

Exhibit 13. Strengthening the Core Business Creates More Value for the Acquirer

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.1Results are statistically significant at conventional levels of con-fidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).2Core segment acquisition is defined as an acquisition in which the primary four-digit SIC code of the target and the acquirer is iden-tical.

CAR (%)1

Sample size 126 298

–0.2

2.2

6.5

0

2

4

6

10 to 50% >50%

50 to 10%>50%

248

≤10%

≤10%

Relative value (for the acquirer)2

Relative value (for the seller)2

Exhibit 14. Acquirers Benefit Most from Making Investments in Neglected Units

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.1Results are statistically significant at conventional levels of confidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).2Relative value is measured as a fraction of the value of the sold asset (total deal consideration, including debt) as a percentage of the equity market value of the acquirer/seller.

0

1

2

3

1.8

Pure cashpayments

2.5

Other paymenttypes

0

1

2

3

1.8

Pure cashpayments

1.3

Other paymenttypes

Sellers’ perspective: take the cash and run

CAR (%)1 CAR (%)1

Result is drivenby payments

with cashon balance

Buyers’ perspective: try to use stock as acquisition currency

Exhibit 15. Buyers and Sellers in Divestitures Prefer Opposite Payment Types

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.1Results are statistically significant at conventional levels of confidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).


er shares these risks with the buyer—encouraging the seller to make the deal a success. In addition, a stock-ori-ented transaction frequently turns the seller into a major block shareholder, introducing a new pair of eyes and ears to police the acquirers’ actions. This tightens gover-nance and tends to lead to superior returns. In a public-to-public transaction, by contrast, shares used for pay-ments usually go to a dispersed universe of individual shareholders and thus do not lead to a substantial change in the buyer’s ownership structure and governance.

Key Success Factors for Sellers

Although divestitures can have a powerful impact on both sellers’ and buyers’ shareholder returns, there is evidence that sellers are failing to extract the maximum value from their sales. Better timing, sharper targeting of prospective buyers, and a strong equity story can all help close this gap.

Companies that divest businesses increase their share-holder returns by 1.5 percent on average, with more than half of sellers (55.4 percent) producing positive returns. More important given today’s economic climate, sellers enjoy higher returns during an economic downturn (1.7 percent) than during an upturn (1.3 percent)—a 30.8 per-

cent difference in returns. (See Exhibit 16.) This finding not only contradicts the popular belief that downturns are a suboptimal time to divest but also suggests that sell-ers pay greater attention to divestitures when the chips are down and every cent counts.

Indeed, sellers might be leaving large amounts of money on the table. Comparing sellers’ returns from divestitures with those from public-to-public transactions is difficult owing to differences between the two types of transac-tions. For example, divesting business assets might in-volve separation costs—such as additional costs for estab-lishing independent IT and accounting systems—which is not the case in public-to-public transactions. However, given these scaling problems, the “scaled-up” difference in returns is a strikingly high 11.8 percentage points.8

Based on an average divestiture value of $235 million, this translates into $28 million of lost value per deal for the seller, on average. (See Exhibit 17.) Although the va-

Sellers’ perspective: downturns are better divestiture times

Buyers’ perspective: downturns are less good, but positive returns are still possible

CAR (%)1

1.9

Downturn

2.5

1.5

1.0

2.4

Upturn

–20.8%

0.0

2.0

0.5

1.3

Upturn

1.7

Downturn

+30.8%

0.0

1.0

1.5

2.0

0.5

3,288 1,870Sample size 3,288 1,870

CAR (%)1

Sample size

Exhibit 16. In Downturns, Sellers of Private Assets Do Better Than Acquirers, but Even Acquirers Can Create Value

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.1Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).

8. We scaled up the return by dividing the observed announcement return of the seller by the relative size of the deal (in other words, the total transaction value divided by the market value of the sell-er). This approach enabled us to calculate a synthetic return that is equivalent to a 100 percent sale of the parent company so that we could compare the returns of the divestiture with those of a true, 100 percent public-to-public transaction.


lidity of the precise figure can be challenged, its size indi-cates that companies that divest tend to undersell their assets. The question is, How can they reduce the gap?

To close sellers’ value-creation gap between divestitures and public-to-public deals, companies need to divest units with same systematic rigor they apply to acquiring a com-pany. And that requires taking five main steps.

Prepare a strong equity story. A crucial step in any di-vestiture is to develop a clear and compelling strategic rationale for potential buyers. The increased involvement of PE firms in the M&A market has made this especially important.

PE firms have not just become major buyers over the last decade, they have also transformed how companies mar-ket themselves. To appeal to PE firms, which often lack in-depth industry knowledge and experience, successful sellers now provide much more information for buyers and address two key questions in their sales documents: How can the business help a buyer achieve its strategic and financial goals, given likely industry and competitive

trends? And why would the business be a good fit for the buyer’s portfolio?

Systematically building and presenting buyers with a powerful business case supported by the full range of “teaser” documents, information memoranda, manage-ment presentations, and due diligence materials for po-tential bidders, has several major advantages for sellers, beyond increasing the asset’s marketability. First, it en-ables the seller’s executives to estimate bidders’ price limits in negotiations. The process can also help identify the buyer that is likely to create the most value from the deal—and, therefore, offer the best price. In addition, the divested unit’s line management should be positioned not as passive victims but as knowledgeable executives who can contribute to the future success of the business. This increases the likelihood that the executives will find a role in the business after the sale—and motivates them to put forward the most compelling business case for the sale.

Target buyers that will gain the greatest value from the asset. Buyers that are likely to create the most value from the divestiture are also likely to have the greatest flexibility to pay a higher acquisition premium. As we dis-cussed above, an acquirer reaps the biggest returns from a divestiture when the asset is core to the business and when it represents a substantial involvement for the buy-er and the asset in question does not fit optimally in the strategic portfolio of the seller.

Divest in distress—and during downturns. Companies that divest when they are in financial difficulties send a powerful message to the capital markets that they are committed to restructuring their portfolios, often trigger-ing a sharp rise in shareholder returns. On average, firms that divest in distress earn more than twice the returns as financially healthy companies that sell a business (2.7 percent versus 1.3 percent). (See Exhibit 18.) This does not mean that companies should allow value-destroying units to deteriorate before selling them; remedial action should always be taken as soon as a unit exhibits weak-nesses. However, our findings do suggest that the capital markets will reward companies that divest businesses to resolve financial distress. Selling during an economic downturn, of course, is also a good move.

Choose the most appropriate disposal route. Is an IPO spinoff or a trade sale the best way to optimize value?

Calculation is based on the

median difference

between CAR in public-to-public deals

versus private divestitures

0Median

divestiture deal

$millions

Sellers leave almost 12 percent of $235 million on the table in a representative transaction

“Money on thetable” for median

divestiture deal

250

200

150

100

50

235

28

~11.8%

Exhibit 17. Sellers Are More Likely to Leave Money on the Table in Divestitures Than in Public-to-Public Deals

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum.


Although there is not a direct, mechanical link between value creation and disposal route, public spinoffs tend to create substantially more value (2.5 percent) than trade sales (1.4 percent)—which suggests that sellers should not jump prematurely at seemingly attractive offers from wholesale investors. (See Exhibit 19.) The main advan-tage of a spinoff is that it gives the asset high visibility. This approach is particularly relevant if sellers strongly believe in the asset and are able to provide a convincing equity story. Sellers should be aware of this difference: if they are convinced of the soundness of the deal and the economic rationale of parting with the asset, they should seriously consider the public divestiture route. The mar-ket is very likely to reward it. However, a spinoff is also vulnerable to the mood of the capital markets. If there is a limited number of appropriate prospective buyers and if the capital markets are depressed, a trade sale might be a more effective solution.

Push for cash payments. For sellers of divested assets, cash payments are always preferable to stock or a mix of stock and cash. The returns for cash-only divestitures are 1.8 percent, compared with 1.3 percent for other types of payment. (Please refer to Exhibit 15, page 23.) Cash is also the best bet for sellers in public-to-public deals. Since, in the case of buyers, the desired optimum pay-ment for divestiture assets is stock, the ultimate choice of payment will directly reflect the relative bargaining pow-er of the two parties or, more accurately, the skills and advice of their advisors.

CAR (%)1

2.5

1.5

0.5

Seller not in distress

2.7

Seller in distress2

+107.7%

1.3

0.0

1.0

2.0

3.0

4,357 801Sample size

Exhibit 18. Selling Assets in Response to (Seller) Distress Is a Value-Creating Way to Restructure the Business

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum. 1Results are statistically significant at conventional levels of confidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).2A seller is classified as in distress if EBIT < interest expense (EBIT coverage ratio < 1).

CAR (%)1

Sample size 295 4,863

2.5

1.5

0.5

1.4

Trade sales

–44.0%

2.5

0.0

1.0

2.0

3.0

Spinoffs

Exhibit 19. Divesting over the Public Route Has Strong Value Potential

Sources: BCG M&A Research Center; Thomson Financial/SDC Platinum. Note: Spinoff = majority divestment of parent as pro-rata distribution of new shares to existing owners. In spinoffs, new shares are floated in the market, whereas in trade sales (all remaining deals), the target is sold as a whole to a new block owner.1Results are statistically significant at conventional levels of confidence (at least 90 percent). Average CAR is calculated over a seven-day window centered around announcement day (–3/+3).


The research that underpins this report was conducted by the BCG M&A Research Center in the winter and spring of 2008. It is based on analyses of three different data sets totaling more than 400,000 M&A transactions.

General Market Trends. ◊ We analyzed all reported M&A transactions in North America, Europe, and Asia-Pacif-ic from 1981 through 2008 (408,076 deals). For the 2007 intrayear analysis of deal values and volumes, we looked at a subset of 7,655 deals with a minimum transaction value of $25 million. In all of our analyses, we excluded deals marked as recapitalizations, ex-change offers, or repurchases.1

Shareholder Value Created and Destroyed by Public-to-◊ Public M&A.2 We analyzed deals involving publicly listed acquirers and targets from 1992 through 2006 (3,190 deals), focusing on the largest deals.3 To ensure that sufficient explanatory data would be available, we limited the sample to the top transactions in North America, Europe, and Asia-Pacific by size. The mini-mum transaction sizes were $150 million in North America, $50 million in Europe, and $25 million in Asia-Pacific. Shareholder value was measured by total shareholder returns and calculated using the event study method. Unless otherwise stated, value creation and destruction refer to the value gained or lost by the acquirer.

Shareholder Value Created and Destroyed by Corporate ◊ Divestitures. We analyzed deals involving public sellers of divested assets from 1992 through 2007, focusing on the largest deals. (Starting from a total sample of 6,369 deals, we arrived at 5,157 deals for the actual event study.) The acquirers of the divested assets did not necessarily need to be publicly listed: 3,027 acquirers

were listed, whereas the remainder were private com-panies and financial investors or investor groups with initial or secondary placements with multiple “acquir-ers.” The methodology and the thresholds for deal sizes were the same as those stated in the preceding bullet point.

Although distinct samples were required in order to ana-lyze different issues, all the analyses employed similar econometric methodologies. For any given day and com-pany, the abnormal (that is, unexpected) returns were calculated as the deviation of the observed from the ex-pected returns. (See Equation 1.)

Using the most commonly used approach, we employed a market model estimation to calculate expected returns.4

Appendix: Methodology

1. Exchange offers seek to exchange consideration for equity or se-curities convertible into equity—in other words, those transactions that do not cause a change in ownership.2. This analysis was taken from The Brave New World of M&A: How to Create Value from Mergers and Acquisitions, BCG report, July 2007. 3. In an ancillary analysis, we updated and confirmed the results for 2007. To facilitate the comparison of the results across the reports, however, we refrain from displaying the updated results here.4. Eugene F. Fama, Lawrence Fisher, Michael C. Jensen, and Richard Roll, “The Adjustment of Stock Prices to New Information,” Inter-national Economic Review, vol. 10, no. 1 (February 1969), pp. 1–21; and Stephen J. Brown and Jerold B. Warner, “Using Daily Stock Re-turns: The Case of Event Studies,” Journal of Financial Economics 14 (1985), pp. 3–31.

Equation 1

Equation 2

Equation 3

with:ARi,t = Abnormal return for given security i and day tRi,t = Observed return for given security i and day tE(Ri,t) = Expected return for given security i and day t

with:α = Regression interceptβ = Beta factor

ARi, t = Ri, t – E (Ri, t )

ARi, t = Ri, t – (αi + βiRm, t )

E(Ri, t ) = αi + βiRm, t + εi, t


The market model approach runs a one-factor Ordinary Least Squares (OLS) regression of an individual stock’s daily returns against the contemporaneous returns of a benchmark index over an estimation period preceding the actual event. (See Equation 2.)

The derived alpha and beta factors are then combined with the observed market returns for the given event day to calculate the expected return for each day of the event window. (See Equation 3.) The market model thus ac-counts for the overall market return on the event day as well as the sensitivity of the particular company’s returns relative to market movements.

In the exhibit below, we show the event study setup that we used to estimate the value created by M&A transac-tions. Using a 180-day period starting 200 days (and end-ing 21 days) before the deal announcement, we estimated a market model relating the returns on individual stocks to returns of a relevant benchmark index.5 We did not consider the time period from day –20 to day –4 (that is, 17 days, from 20 days to 4 days before an M&A announce-

ment) to ensure that the market model parameters were not contaminated by leakage effects during the days pre-ceding the official announcements. Finally, we aggregated the abnormal returns (that is, the difference between ac-tual stock returns and those predicted by the market model) over different time windows around the an-nouncement date to derive cumulative abnormal returns, or CAR, whereby the figures reported throughout this re-port uniformly relate to the event period of plus to minus three days.

We assessed the statistical significance of the abnormal returns using two alternative tests. The standard t-test establishes whether average abnormal returns are differ-ent from zero (one-sample test) and the statistical signifi-cance of the differences between the mean abnormal returns of different subsamples in the cross-section (two-sample test). We validated the results of the t-test, using a nonparametric Wilcoxon test of equality of medians.

Finally, an economic downturn is defined as a period when the average annual growth rate of GDP for the world is below the long-term average of 3 percent. The last sus-tained downturn occurred after the Internet bubble burst in 2001 and ended in 2003. (See the exhibit on the fac- ing page.)

–200 –3

0

+3Days

–21

Announcement day

Estimationperiod

(180 days)

Graceperiod

(17 days)

Eventperiod

(7 days)

Event Study Setup

5. We used the Dow Jones Industrial Average for North America, Dow Jones Euro Stoxx for Europe, and Dow Jones Asia Pacific for the Asia-Pacific region.

Equation 1

Equation 2

Equation 3






Equation 1

Equation 2

Equation 3







GDP change per year (%)1

5

4

3

2

1

0

Upturn definition: ∆ GDPt > 3.0% Downturn definition: ∆ GDPt < 3.0%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2005 20062004 2007

2.52.3

1.7

3.4

2.93.2

3.6

2.2

3.1

4.2

1.61.8

2.6

3.9

2.9

3.4

3.8

3.3Long-term

average3.0%2

An Economic Downturn Is Defined as a Period of Below-Average GDP Growth

Sources: Economist Intelligence Unit; BCG analysis.1Figures are based on real change in worldwide GDP. 2Long-term growth rate is calculated over the 1990–2007 period.


For Further Reading

The Boston Consulting Group publishes other reports and articles on the topic of M&A that may be of interest to senior executives. Recent examples include:

The Advantage of Persistence: How the Best Private-Equity Firms “Beat the Fade”A report by The Boston Consulting Group, published with the IESE Business School of the University of Navarra, February 2008

Thinking Laterally in PMI: Optimizing Functional SynergiesA Focus by The Boston Consulting Group, January 2008

Avoiding the Cash Trap: The Challenge of Value Creation When Profits Are HighThe 2007 Value Creators report by The Boston Consulting Group, September 2007

The Brave New World of M&A: How to Create Value from Mergers and AcquisitionsA report by The Boston Consulting Group, July 2007

Powering Up for PMI: Making the Right Strategic ChoicesA Focus by The Boston Consulting Group, June 2007

“Managing Divestitures for Maximum Value”Opportunities for Action in Corporate Development, March 2007

“A Matter of Survival”Opportunities for Action in Corporate Development, January 2007

Spotlight on Growth: The Role of Growth in Achieving Superior Value CreationThe 2006 Value Creators report by The Boston Consulting Group, September 2006

“The Strategic Logic of Alliances”Opportunities for Action in Corporate Finance and Strategy, July 2006

“What Public Companies Can Learn from Private Equity”Opportunities for Action in Corporate Finance and Strategy, June 2006

“Successful M&A: The Method in the Madness”Opportunities for Action in Corporate Finance and Strategy, December 2005

The Role of Alliances in Corporate StrategyA report by The Boston Consulting Group, November 2005

Growing Through Acquisitions: The Successful Value Creation Record of Acquisitive Growth StrategiesA report by The Boston Consulting Group, May 2004

Winning Through Mergers in Lean Times: The Hidden Power of Mergers and Acquisitions in Periods of Below-Average Economic GrowthA report by The Boston Consulting Group, July 2003

For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.com/publications.

To receive future publications in electronic form about this topic or others, please visit our subscription Web site at www.bcg.com/subscribe.

5/08

The Boston Consulting Group (BCG) is a global manage-ment consulting fi rm 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 offi ces in 38 countries. For more infor-mation, please visit www.bcg.com.

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