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Winning Through Mergers in Lean Times

The Hidden Power o f Mergers and Acqu is i t i ons in Per iods o f Be low-Average Economic Growth

BCG REPORT

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The Boston Consulting Group is a general management consulting firmthat is a global leader in business strategy. BCG has helped companiesin every major industry and market achieve a competitive advantage bydeveloping and implementing winning strategies. Founded in 1963, thefirm now operates 58 offices in 36 countries. For further information,please visit our Web site at www.bcg.com.

2278.cvr 7/1/03 4:58 PM Page IFC

Winning Through Mergers in Lean Times

JEFFREY KOTZEN

CHRIS NEENAN

ALEXANDER ROOS

DANIEL STELTER

J U LY 2 0 0 3

www.bcg.com

The Hidden Power o f Mergers and Acqu is i t i ons in Per iods o f Be low-Average Economic Growth

2278.txt 7/1/03 4:59 PM Page 1

© The Boston Consulting Group, Inc. 2003. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: [email protected]: 1-617-973-1339, attention IMC/PermissionsMail: IMC/Permissions

The Boston Consulting Group, Inc.Exchange PlaceBoston, MA 02109USA

2 BCG REPORT

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3Winning Through Mergers in Lean Times

Table of Contents

About This Report 4

For Further Contact 5

Executive Summary 6

The Above-Average Performance of Weak-Economy Mergers 7

Characteristics of a Successful Weak-Economy Merger 10

Why Most Companies Don’t Pursue Weak-Economy Mergers 16

Methodology 20

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About This Report

4 BCG REPORT

This research report is a product of the Corporate Development practice of The Boston Consulting Group.Jeffrey Kotzen is a vice president and director in the firm’s New York office. Chris Neenan is a vice presidentand director in the New York office and global topic leader for mergers and acquisitions. Alexander Roos isa manager in BCG’s Berlin office. Daniel Stelter is a vice president and director in the Berlin office andleader of the firm’s Corporate Development practice in Europe.

AcknowledgmentsThe authors would like to thank BCG’s global experts in corporate development for their contributions tothis report:

Brad Banducci, a vice president and director in BCG’s Sydney office and leader of the firm’s CorporateDevelopment practice in Asia-Pacific

Gerry Hansell, a vice president and director in BCG’s Chicago office and a global topic leader for corporatefinance

Mark Joiner, a senior vice president and director in BCG’s New York office and global leader of the firm’sCorporate Development practice

Eric Olsen, a senior vice president and director in BCG’s Chicago office and global topic leader for valuemanagement

Mark Sirower, a corporate development adviser and M&A specialist in BCG’s New York office

Miki Tsusaka, a senior vice president and director in BCG’s New York office and global topic leader for post-merger integration

The authors would also like to thank Jens Kengelbach, a consultant in BCG’s Munich office, and Hans le Grand, a senior research analyst in BCG’s Amsterdam office, who helped create the framework for theanalysis and conducted the research.

To Contact the AuthorsThe authors welcome your questions and feedback.

Jeffrey KotzenThe Boston Consulting Group, Inc.430 Park AvenueNew York, NY 10022USATelephone: 1 212 446 2800E-mail: [email protected]

Chris NeenanThe Boston Consulting Group, Inc.430 Park AvenueNew York, NY 10022USATelephone: 1 212 446 2800E-mail: [email protected]

Alexander RoosThe Boston Consulting Group GmbHDircksenstrasse 4110178 BerlinGermanyTelephone: 49 30 28 87 10E-mail: [email protected]

Daniel StelterThe Boston Consulting Group GmbHDircksenstrasse 4110178 BerlinGermanyTelephone: 49 30 28 87 10E-mail: [email protected]

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For Further Contact


The AmericasStuart GriefBCG Boston1 617 973 [email protected]

Gerry HansellBCG Chicago1 312 993 [email protected]

J PuckettBCG Dallas1 214 849 [email protected]

Thomas WenrichBCG Mexico City52 55 5258 [email protected]

Mark JoinerBCG New York1 212 446 [email protected]

Miki TsusakaBCG New York1 212 446 [email protected]

Rohit BhagatBCG San Francisco1 415 732 [email protected]

Walter PiacsekBCG São Paulo55 11 3046 [email protected]

Peter StangerBCG Toronto1 416 955 [email protected]

Robert HutchinsonBCG Washington, D.C.1 301 664 [email protected]

EuropeKees CoolsBCG Amsterdam31 35 548 [email protected]

Yvan JansenBCG Brussels32 2 289 02 [email protected]

Pascal XhonneuxBCG Düsseldorf49 2 11 30 11 [email protected]

David RhodesBCG London44 20 7753 [email protected]

Félix RiveraBCG Madrid34 91 520 61 [email protected]

Immo RupfBCG Paris33 1 40 17 10 [email protected]

Per HalliusBCG Stockholm46 8 402 44 [email protected]

Matthias HugBCG Zürich41 1 388 86 [email protected]

Asia-PacificNicholas GlenningBCG Melbourne61 3 9656 [email protected]

Janmejaya SinhaBCG Mumbai91 22 2283 [email protected]

Byung Nam RheeBCG Seoul822 399 [email protected]

Jean LebretonBCG Shanghai86 21 6375 [email protected]

Roman ScottBCG Singapore65 6429 [email protected]

Brad BanducciBCG Sydney61 2 9323 [email protected]

Naoki ShigetakeBCG Tokyo81 3 5211 [email protected]

For more information about The Boston Consulting Group’s capabilities in corporate development andM&A, please contact the individuals listed below.

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Executive Summary

6 BCG REPORT

Since the end of the late-1990s economic boom,there has been a massive decline in mergers andacquisitions. After reaching a peak of $3.4 trillionin value in 2000, the value of deals declined approx-imately 66 percent to $1.17 trillion in 2002. Parallelto this decline has been a growing realization of justhow difficult it is to create value through mergersand acquisitions. Numerous studies in recent yearshave concluded that most mergers actually destroyvalue rather than create it. For example, a studyconducted last year by The Boston ConsultingGroup for Business Week magazine found that 61 percent of large U.S. mergers occurring betweenJuly 1, 1995, and August 31, 2001, failed to createvalue for the acquirers’ shareholders.1

New research by BCG, however, paints a more dif-ferentiated picture and suggests that executives maybe missing an important opportunity by avoidingmergers during the current downturn. We analyzed277 M&A transactions in the United States between1985 and 2000. In an effort to assess the impact ofeconomic cycles, we compared the performance ofmergers that occurred during periods of above-average economic growth with those that occurredduring periods of below-average economic growth.2

We found that although most of the mergers in oursample (64 percent) did indeed destroy value, dealsthat took place during periods of below-averageeconomic growth had a higher likelihood of suc-cess. Even more important, these weak-economymergers generated considerably more shareholdervalue on average. Over a two-year time frame, theycreated 14.5 percent more value than the strong-economy mergers in our sample.

What explains the superior performance of weak-economy mergers? Even though control premiumsremain roughly the same in both low- and high-

growth periods, weak-economy mergers benefitfrom the lower valuations common to periods ofbelow-average economic growth. As the stock priceof potential targets approaches fundamental value,the “hidden premium” represented by high expec-tations built into the stock price shrinks dramati-cally, and potential deals become cheaper inabsolute terms. In addition, successful weak-economy acquirers tend to target companies withsound finances but relatively weak profitability—and, therefore, room for creating additional valuethrough operational improvement. Finally, weak-economy acquirers don’t get distracted by short-term market reactions. Instead, they focus on busi-ness fundamentals and on making sure that thepostmerger integration is a success and that poten-tial synergies are realized.

These findings suggest that executives who aredeliberately avoiding mergers in today’s economymay be missing an important strategic opportunity.Periods of weak economic growth can be an idealtime for companies to use M&A strategically to buyweaker competitors, consolidate markets, gainshare, strengthen competitive advantage, andotherwise position themselves to “accelerate out ofthe turn” as the economy improves. Now more thanever, companies need to develop a strategicapproach to pursuing value-driven deals. Whenthey do, they can create value through mergers andacquisitions—in good times and in bad.

The following pages describe the key findings ofBCG’s new research and identify some of the mis-conceptions that prevent many companies from tak-ing advantage of mergers and acquisitions in peri-ods of below-average economic growth. The reportalso suggests what companies should do to createvalue through M&A in the current weak economicenvironment.

1. David Henry, “Mergers: Why Most Big Deals Don’t Pay Off,” Business Week, October 14, 2002, pp. 60-70.

2. For a more detailed discussion of our methodology, see page 20.

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The Above-Average Performance of Weak-Economy Mergers


A consistent finding of many recent studies is thatmost mergers fail to create value for the investors ofthe acquiring company. Our study is no different.We found that a full 64 percent of the deals in oursample destroyed value at the time they wereannounced, and 56 percent continued to do so twoyears after the deal. (See Exhibit 1.)

When we de-average those findings by economiccycle, however, a different story unfolds. Mostmergers and acquisitions still continue to destroyvalue, but weak-economy mergers have a somewhathigher chance of success. Whereas only 42 percentof the strong-economy mergers created value over atwo-year period, more than 47 percent of the weak-economy mergers did so. (See Exhibit 2, page 8.)

More significant, however, the average performanceof those weak-economy mergers was markedly bet-ter than that of the strong-economy deals. Whereasthe strong-economy deals in our sample destroyedvalue, on average, the weak-economy deals createdvalue. After two years, the relative total shareholderreturn (RTSR) of the weak-economy mergers was14.5 percent greater than that of the strong-economy mergers—and 8.3 percent greater thanthe returns of the market as a whole.3 (See Exhibit3, page 8.)

Interestingly, on average, both types of mergers inour sample destroyed value at the time ofannouncement—a sign that the market is not dif-ferentiating in the short term between strong-

3. Total shareholder return (TSR) measures the change in a company’sshare price, plus accrued dividends, over a given period of time. Relativetotal shareholder return (RTSR) compares a company’s TSR with that ofa relevant stock-market index. In this report, we calculated the short-term RTSR of a transaction by taking the change in the acquiring com-pany’s returns from five days before the announcement of the deal tofive days after and comparing it with the equivalent change in the S&P500. We calculated the long-term RTSR of a transaction by comparingthe acquiring company’s returns with the average performance of itsindustry peer group from five days before the announcement of the dealto two years after the year in which the deal was announced.

64

36

44

Value destroyed Value created

Announcement Effect1

n=277

n=277

Deals analyzed (%)

Deals analyzed (%)

20

40

60

80

56

36

Value destroyed Value created

Two Years After the Deal2

20

40

60

80

E X H I B I T 1

THE IMPACT OF MERGERS ON THE ACQUIRER’SSHAREHOLDER VALUEMost Deals Destroy Value for the Acquirer’s Shareholders

SOURCES: Securities Data Company; Compustat; BCG analysis.

1Relative total shareholder return from five days before the announcement of

the deal to five days after.


the deal to two years after the year of announcement.

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8 BCG REPORT

economy and weak-economy deals. When we divideour sample between those deals with positiveannouncement effects and those with negativeannouncement effects, we find further evidence ofthe superior performance of weak-economy merg-ers. Although on average all deals with positiveeffects created value two years after the deal, weak-economy mergers outperformed strong-economymergers by 11.1 percent. (See Exhibit 4.) And ofthe deals with negative announcement effects, onlythe weak-economy mergers created long-termvalue, outperforming the strong-economy mergersby nearly 17 percent.

If we factor out the gains (or losses) from the initialannouncement effect, the findings are even moredramatic. Whether they had positive or negativeannouncement effects, strong-economy deals subse-

quently declined in value, on average. By contrast,weak-economy mergers increased in value. This isan indication that the market may systematicallyoverestimate the long-term performance of strong-economy mergers and underestimate that of weak-economy mergers.

One further sign of the superior performance ofweak-economy mergers is the fact that they hadalmost twice the likelihood of producing relativelylarge returns. A full 13.5 percent of weak-economymergers produced two-year returns in excess of 50 percent, whereas only 7.4 percent of strong-economy mergers did so. (See Exhibit 5.) In dra-matic contrast, 14.9 percent of the strong-economydeals produced losses in excess of 50 percent,whereas only 6.7 percent of the weak-economy dealsdid so.

42.0

Deals analyzed (%)

40

80

47.2

Successful strong-economy mergers1

n=188

Successful weak-economy mergers1

n=89

E X H I B I T 2

SUCCESS RATES OF WEAK-ECONOMY AND STRONG-ECONOMY MERGERSIn Periods of Below-Average Economic Growth, Mergers Have aSomewhat Greater Likelihood of Success



the deal to two years after the year of announcement was greater than zero.

E X H I B I T 3

LONG-TERM PERFORMANCE OF STRONG-ECONOMYAND WEAK-ECONOMY MERGERSOn Average, Weak-Economy Mergers Create Value and Significantly Outperform Strong-Economy Mergers

SOURCES: Securities Data Company; BCG analysis.

NOTE: The share price five days before the announcement date (T–5 on the

horizontal axis) equals 100. Share performance from T–5 to five days after

the announcement date (T+5 on the horizontal axis) equals the announce-

ment effect.

n=277

104.5

108.3

97.8

101.4

93.894.195.5

97.4

95

100

105

110

T–5 T+5 End of announcement year

Year 1 Year 2

5.9% 10.4% 14.5%

Cumulative relative total-shareholder-return index

Weak-economy mergersStrong-economy mergers

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E X H I B I T 4

LONG-TERM PERFORMANCE OF STRONG-ECONOMY AND WEAK-ECONOMY MERGERS BY ANNOUNCEMENT EFFECTOn Average, Successful Weak-Economy Mergers Create Long-Term Value—Regardless of the Initial Announcement Effect


NOTE: The share price five days before the announcement date (T–5 on the horizontal axis) equals 100. Share performance from T–5 to five days after the announcement

date (T+5 on the horizontal axis) equals the announcement effect.

End of announcement year

End of announcement year

105.6

110.6113.7

102.8

105.9

102.6101.6104.7

T–5 Year 1 Year 2T+5

105.6

92.491.2

89.7 88.7

94.3

99.2

101.5

T–5 Year 1 Year 2T+5

Deals with Positive Announcement Effect

n=100 n=177


Deals with Negative Announcement EffectCumulative relative total-shareholder-return index

Weak-economy mergersStrong-economy mergers

90

95

100

105

110

115

90

95

100

105

110

115

Strong-economy mergers Weak-economy mergers

14.9

39.4

14.4

6.7

13.5

10

20

30

40

50

60

< –50% –50% to –20% –20% to +20% +20% to +50% > 50%n=277

7.4

13.514.6

23.9

51.7

RTSR two years after the deal

Deals analyzed (%)

E X H I B I T 5

THE DISTRIBUTION OF LONG-TERM RETURNS OF STRONG-ECONOMY AND WEAK-ECONOMY MERGERSWeak-Economy Deals Are Nearly Twice as Likely to Produce Shareholder Returns Greater Than 50 Percent

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Characteristics of a Successful Weak-Economy Merger

10 BCG REPORT

In addition to demonstrating that weak-economymergers create more value than mergers that occurduring periods of above-average economic growth,our study suggests some of the common character-istics of successful weak-economy deals. Two in par-ticular stand out.

Acquirers create value through operational im-provement. One question we examined in our studywas, How do successful weak-economy mergerscreate value? Our hypothesis was that whereassuccessful strong-economy mergers tend to createvalue through profitable growth, successful weak-economy mergers do so more through operationalimprovement and industry consolidation.

For evidence supporting this hypothesis, considerthe differential between the average cash-flowreturn on investment (CFROI) of the acquirers inour study and the average CFROI of their targets.(See Exhibit 6.) CFROI is the ratio of operatingcash flow to inflation-adjusted gross assets and is themost accurate measure of profitability in a business.Successful strong-economy mergers have a rela-tively small differential: the profitability of acquir-ers is, on average, about one percentage pointhigher than that of their targets. But successfulweak-economy mergers have an average CFROI thatis five percentage points higher than that of theirtargets. In other words, successful weak-economyacquirers tend to be significantly more profitablethan the companies they buy.

This significant CFROI differential between acquir-ers and targets in periods of below-average eco-nomic growth is extremely important to subsequentshare performance. (See Exhibit 7.) Put simply,when the weak-economy acquirers in our samplebought targets with higher returns than their own,their value creation was comparable to the industryindex. By contrast, when they acquired targets withlower returns than their own, on average they out-performed the index by more than 14 percent.

4.4

1.1

Failure2 Success3

n=148

Strong-Economy MergersAcquirer-target CFROI differential1 (%)

2

4

6

8

2.2

5.0

Failure2 Success3

n=77

Weak-Economy MergersAcquirer-target CFROI differential1 (%)

2

4

6

8

E X H I B I T 6

THE IMPACT OF PROFITABILITY DIFFERENTIALS ON MERGER PERFORMANCESuccessful Weak-Economy Acquirers Are Significantly More Profitable Than the Companies They Buy

SOURCES: Securities Data Company; Datastream; BCG analysis.

1Average acquirer cash-flow return on investment (CFROI) minus average tar-

get CFROI.


the deal to two years after the year of announcement was less than zero.



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100.6 101.299.2

99.4

114.1

108.6

102.1

98.3

100

105

110

115

12.9%

T–5 T+5 Year 1 Year 2

n=77

Target CFROI > Acquirer CFROI Target CFROI < Acquirer CFROI


End ofannouncement

year

E X H I B I T 7

THE IMPACT OF PROFITABILITY DIFFERENTIALS ON THE LONG-TERM PERFORMANCE OF WEAK-ECONOMY MERGERSOn Average, Weak-Economy Mergers Are More Successful When the Target’s CFROI Lags That of the Acquirer


NOTE: The share price five days before the announcement date (T–5 on the

horizontal axis) equals 100. Share performance from T–5 to five days after

the announcement date (T+5 on the horizontal axis) equals the announce-

ment effect.

Further evidence that successful weak-economyacquirers create superior shareholder returns byimproving the lagging operating performance oftarget companies is the history of acquirers’ CFROIimprovement after the deal. (See Exhibit 8.) Notsurprisingly, unsuccessful acquirers—in strong-economy and weak-economy deals—degraded theirCFROI over time. Successful strong-economyacquirers improved it only slightly. Meanwhile, suc-cessful weak-economy acquirers not only hadhigher overall levels of CFROI than successfulstrong-economy acquirers (10.4 percent versus 7.8percent). They also improved their CFROI morethan three times as much (1.3 percent versus 0.4percent)—an indication that they were successfullyrestructuring their acquisitions and using opera-tional improvement to fuel profitability growth.

Successful weak-economy acquirers achieved thesegains through improvement in both cash-flow mar-

Year–1 Announcementyear

Strong-Economy Acquirers

n=184

Median CFROI (%)

Weak-Economy AcquirersMedian CFROI (%)

Year+1 Year+2

Year–1 Announcementyear

n=89

Year+1 Year+2

Failure Success

2

4

6

8

10

12

7.67.0 7.1 7.1

9.1

9.910.4

11.0

7.4 7.5

6.0

7.9 7.8 7.88.1

7.4

2

4

6

8

10

12

E X H I B I T 8

PROFITABILITY IMPROVEMENT OF STRONG-ECONOMYAND WEAK-ECONOMY ACQUIRERSSuccessful Weak-Economy Acquirers Grow Their CFROI More QuicklyThan Successful Strong-Economy Acquirers


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12 BCG REPORT

gins and asset productivity. (See Exhibit 9.) Thesuccessful weak-economy acquirers in our sampleimproved their margins by about 20 percent (from8.8 percent to 10.6 percent) over a three-yearperiod. (In contrast, the successful strong-economyacquirers improved their margins by only 6.7 per-cent.) They also had higher levels of asset produc-tivity (measured as the ratio of revenue to grossinvestment), which suggests that they were moresuccessfully exploiting this often overlooked leverfor increasing CFROI and, ultimately, total share-holder return.

In conclusion, the evidence from our study suggeststhat a relentless focus on operational improvementis a key success factor in weak-economy mergers. Apotential acquirer should target acquisitions inwhich there are clear opportunities to enhance thetarget’s business and to create new sources of com-petitive advantage—through increased economiesof scale, the transfer of critical capabilities, or theexpansion of the company’s market share.

Acquirers avoid targets with financial weaknesses.Acquiring a company with financial weaknesses is

E X H I B I T 9

PROFITABILITY DRIVER TREE AT SUCCESSFUL WEAK-ECONOMY ACQUIRERSSuccessful Weak-Economy Acquirers Improve Their Cash-Flow Margin and Asset Productivity

SOURCE: BCG analysis.

NOTE: The sample size is 89. Owing to the aggregation effect, the product of cash-flow margin and asset productivity does not equal CFROI, as it would for an individual

company.

1Cash-flow return on investment.

2Cash flow divided by sales.

3Revenue divided by gross investment.

7.67.0 7.1 7.1

9.19.9

10.411.0

2

4

6

8

10

12

Year–1

Median CFROI1

7.9 7.7 7.4 7.9

8.8 9.0 9.410.6

2

4

6

8

10

12

0.920.96 0.99 0.96

0.97 0.97

1.12 1.08

0.8

1.0

1.2

1.4

Median Asset Productivity3

Median Cash-Flow Margin2

Announcement year

Year+1 Year+2

Year–1 Announcement year

Year+1 Year+2

Year–1 Announcement year

Year+1 Year+2

Failure Success

ƒ

2278.txt 7/1/03 4:59 PM Page 12


always a challenge. In periods of strong economicgrowth, however, the challenge is somewhat easierto address. Potential acquirers have wide access tocapital. And booming stock-market valuations givecompanies the option of using their own stock as anacquisition currency. In periods of weak economicgrowth, by contrast, dealing with financial weaknessin a target is often far more difficult. Althoughoperational problems represent an opportunity inweak-economy mergers, financial problems are awarning sign. Those weak-economy acquirers thattarget financially strong companies with minimalindebtedness tend to be more successful.

We categorized the relative financial health of thetargets in our sample by calculating their Altman Z-score.4 (See Exhibit 10.) During periods of below-average economic growth, healthy targets were farmore likely than distressed targets to have a positiveimpact on share price. However, during periods ofabove-average economic growth, this difference wasmuch less pronounced. The targets in successfulweak-economy deals also have substantially lowerleverage (measured as the ratio of debt to totalassets), on average, than those in unsuccessfulweak-economy deals. (See Exhibit 11, page 14.) Bycontrast, the difference in leverage between suc-cessful and unsuccessful strong-economy deals isnegligible.

To assess the impact of mergers on the long-termfinancial health of the acquirer, we also tracked theacquirers’ Altman Z-score from the year before thedeal to two years after the year in which the dealtook place. (See Exhibit 12, page 14.) Whereas thefinancial health of the unsuccessful acquirers in oursample declined substantially, and that of successfulstrong-economy acquirers deteriorated slightly, thatof successful weak-economy acquirers improvedsubstantially. In another sign of improving financialhealth, the successful weak-economy acquirers in

Announcement EffectSuccessful deals (%)

10

20

30

40

50

60

70

Two Years After the DealSuccessful deals (%)

10

20

30

40

50

60

70

39.8

34.3

43.2

25.0

Strong-economymergers

Weak-economymergers

n=113 n=35 n=46 n=28

39.8 40.0

56.8

39.3

Strong-economymergers

Weak-economymergers

n=113 n=35 n=46 n=28

Healthy target Distressed target

E X H I B I T 1 0

THE IMPACT OF THE TARGET ’S FINANCIAL HEALTH ON MERGER PERFORMANCEIn Weak-Economy Mergers, Deals with Financially Healthy Targets Are Far More Likely to Succeed

SOURCES: Securities Data Company; Datastream; Edward I. Altman, “Financial

Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy,”

Journal of Finance, September 1968; BCG analysis.

NOTE: We determined financial health or distress by using Altman’s empiri-

cally derived measure. Distressed targets have an Altman Z-score of less than

2.7; healthy targets have an Altman Z-score of more than 2.7.

4. The Altman Z-score is a measure used in corporate finance to gauge acompany’s financial health and has accurately predicted bankruptcyrates in a wide variety of contexts and markets. See Edward I. Altman,“Financial Ratios, Discriminant Analysis and the Prediction of CorporateBankruptcy,” Journal of Finance, September 1968, pp. 589–609; and“Predicting Financial Distress of Companies: Revisiting the Z-Score andZeta Models,” July 2000, available at http://pages.stern.nyu.edu/~ealtman/Zscores.pdf.

2278.txt 7/1/03 4:59 PM Page 13

14 BCG REPORT

4.65

4.414.25

4.47

4.023.89

3.69

4.17

3.5

4.0

4.5

5.0

5.5

6.0

4.07

3.80

4.24

3.91

4.594.42

4.67

5.12

4.0

5.0

6.0

Failure Success

Strong-Economy Acquirers

Year–1 Year+1 Year+2

n=85

n=176

Announcementyear

Year–1 Year+1 Year+2Announcementyear

Median Altman Z-score

Weak-Economy AcquirersMedian Altman Z-score

E X H I B I T 1 2

THE IMPACT OF MERGER PERFORMANCE ON THE FINANCIAL HEALTH OF THE ACQUIREROver Time, Successful Weak-Economy Acquirers Improve Their Financial Health


0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.450.49

Failure1 Success2

n=153

0.61

0.47

Failure1 Success2

n=76

Weak-Economy Merger TargetsRatio of average debt to total assets

Strong-Economy Merger TargetsRatio of average debt to total assets

E X H I B I T 1 1

THE IMPACT OF TARGET LEVERAGE ON MERGER PERFORMANCESuccessful Weak-Economy Mergers Generally Involve Targets with Low Leverage



the deal to two years after the year of announcement was less than zero.



2278.txt 7/1/03 4:59 PM Page 14


our sample also improved their interest coverage(measured as the ratio of earnings before interestand taxes, or EBIT, to interest expense) by morethan 16 percent (from 6 to 7). (See Exhibit 13.) Bycontrast, the interest coverage of successful strong-economy acquirers actually declined by 10 percent(from 5.9 to 5.3).

These findings reinforce the fact that despite com-mon fears about the negative impact of weak-economy mergers on the financial performance ofthe acquiring company, successful acquirers consis-tently improve their financial position throughoutthe merger and subsequent postmerger integration(PMI). As long as they are careful to select targetsthat are financially healthy, companies can afford toconclude deals in periods of below-average eco-nomic growth.

Strong-Economy AcquirersInterest coverage ratio1

5.6

4.2

3.2

2.7

5.9

6.5

5.4 5.3

4.8 4.9

4.24.7

6.0 6.0

6.77.0

2

4

6

8

2

4

6

8


n=87

Announcementyear

Weak-Economy AcquirersInterest coverage ratio1


n=175

Announcementyear

Failure Success

E X H I B I T 1 3

IMPROVEMENT IN INTEREST COVERAGE OF STRONG-ECONOMY AND WEAK-ECONOMY ACQUIRERSSuccessful Weak-Economy Mergers Improve the Acquirer’s Interest Coverage


1Ratio of earnings before interest and taxes (EBIT) to interest expense.

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Why Most Companies Don’t Pursue Weak-Economy Mergers

16 BCG REPORT

If the empirical evidence demonstrates that merg-ers during periods of below-average economicgrowth have created more value for the acquiringcompany’s shareholders, why do many executivesavoid them? Three common misconceptions leadmany executives to conclude that lean times are thewrong time to make an acquisition. Each miscon-ception needs to be examined critically.

“My stock price is significantly down from its high;I can’t afford to acquire.” A key factor drivingmergers and acquisitions during periods of stronggrowth is the relatively high market valuations thatwould-be acquirers enjoy. Many companies areeager to leverage those high market values andmake what they think will be a cheaper acquisitionby using shares instead of cash. For example, at thehigh point of the most recent boom, in 2000,almost 70 percent of the $3.4 trillion in dealsannounced globally were financed by equity. In aperiod of weak or negative growth, by contrast,potential buyers are preoccupied with the decliningvalue of their own stock as an acquisition currency.The decline in their stock price leads many toassume that they can’t afford acquisitions.

But, of course, the overall decline in market valuesmeans that the valuations of potential targets aremost likely dropping as well. As the stock price ofpotential targets approaches fundamental value,the “hidden premium” represented by high expec-tations built into the stock price shrinks dramati-cally, and potential deals become cheaper inabsolute terms. This decline in the hidden pre-mium happens despite the fact that control premiums(what the acquirer has to pay to a target’s stock-holders, over and above the current stock price, inorder to seal the deal) are roughly equivalent ingood times and in bad. (See Exhibit 14.)

What’s more, just because absolute valuations arefalling, it does not necessarily mean that acquirers

BCG REPORT

16.1

23.1

Failure2 Success3

n=202

n=97

Strong-Economy MergersMedian market premiums1(%)

10

20

30

15.9

21.7

Failure2 Success3

10

20

30

Weak-Economy Mergers

Median market premiums1(%)

E X H I B I T 1 4

MARKET PREMIUMS IN STRONG-ECONOMY AND WEAK-ECONOMY MERGERSGood Deals Command Premiums—in Good Times and Bad


1The premium equals the market value of the target at five days after the

announcement of the deal, minus the market value at five days before

the announcement, divided by the market value at five days before the

announcement.


the deal to five days after is less than zero.


the deal to five days after is greater than zero.

2278.txt 7/1/03 4:59 PM Page 16


can no longer take advantage of strong valuationmultiples. If a company funds an acquisition withequity, the strength of the company’s multiple rela-tive to its industry competitors and potential targetsis far more important than the absolute value.Independent of the economic climate, a strong rel-ative multiple can put a company in an attractiveposition when it comes to M&A and acquisition cur-rency.5 The end result can be that an acquirereither retains its relative valuation vis-à-vis the tar-get or attains an even more favorable position.

The bottom line: As market values deflate, there aremany excellent buying opportunities for manage-ment teams that really understand what drives valuein their businesses and how an acquisition canenable them to strengthen their position. What’smore, they can take advantage of the current eco-nomic environment to strip away nonperformingassets and fundamentally restructure their companyand their industry. But to succeed at M&A intoday’s environment, executives must view it as anintegral part of their corporate strategy—not just asa quick way to boost earnings.

“My core business has enough problems of its own;I can’t afford to lose focus by considering acquisi-tions.” When times turn bad, executives typicallybecome risk averse. They narrow their horizons andfocus almost exclusively on improving near-termprofits. They tend to neglect the task of identifyingstrategic opportunities, including potential acquisi-tions, to enhance competitive advantage and builda long-term growth agenda.

Improving the bottom line is a critical task in anyeconomic situation, but it is important to strike abalance. When it comes to M&A, lean times offercompanies an opportunity to be proactive ratherthan reactive. Often, they can take the time to ana-lyze a broader range of potential deals carefully,perform the due diligence necessary to understandthe potential synergies, and arrive at a morethoughtful and well-informed valuation of a target.The right strategic, operational, and financial

analysis can create a much greater degree of com-fort—in terms of both the strategic logic of a par-ticular deal and the precise impact it will have on acompany’s competitive positioning and financialperformance.

What often separates the winners from the losers inM&A is precisely this heightened degree of careand thoroughness in the fundamental analyticaltasks of “end-to-end M&A”: determining the strate-gic logic, screening potential targets, valuing thetarget, setting the price, evaluating the strategic fitthrough due diligence, determining the value cre-ation impact of the acquisition, and designing andexecuting the PMI.

Take, for example, the all-important issue of valua-tion, or what a potential target is really worth. It isstriking how many acquirers conduct only the mostrudimentary valuation and accretion-dilution analy-ses. Typically, they set the target’s standalone valueby looking at its current share price and tradingmultiples; estimate the potential value of the com-bined entity by citing some industry benchmarksfor, say, reduction in G&A; consider the impact ofthe merger on credit rating and cost of capital; andset a target price by looking at comparable transac-tions in their industry.

To be confident about valuation, however, compa-nies should take what we call a high-resolution ap-proach. The starting point is an in-depth assess-ment of the strategic, operational, and economicimpact of a potential merger at the level of individ-ual brands, specific customers and suppliers, andparticular business units and geographies. Armedwith this assessment, a company is in a position tobuild a more robust discounted cash-flow (DCF)model that includes scale-curve benchmarks toassess the impact of the combined entity on thescale economics of the business.

The next step is to produce a variety of scenarios toestimate the impact of changing business perfor-mance, economic trends, or capital-market condi-

5. For further information on the concept of relative multiples, see “The Continuing Relevance of Investor Expectations,” BCG Perspectives, December2001; and “New Directions in Value Management,” BCG Perspectives, November 2002.

2278.txt 7/1/03 4:59 PM Page 17

18 BCG REPORT

tions on this DCF model. Also, before closing thedeal, an acquirer must start planning the road mapfor PMI to ensure that the synergy assumptions inthe valuation analysis are as accurate as possible—and that they are then captured during the PMI.

“M&A is a discredited approach to growth.” Withthe backlash against using mergers as a quick way toboost earnings, M&A as a means to grow hasbecome discredited in the minds of some execu-tives and investors. And yet, given the likely growthgaps that most companies face in the current econ-omy, it is the rare company that will be able to relyon organic growth alone. An effective strategy formany companies is to use mergers and acquisitionsto consolidate the industry, improve profitability,and create a platform for future growth so that theyare in a position to “accelerate out of the turn” asthe macroeconomic situation improves. (See theinsert “A Checklist for CEOs.”)

Indeed, as the evidence of our study suggests, onereason weak-economy mergers are more successful

is that, unlike strong-economy deals, they tend tobe more squarely focused on long-term value cre-ation. This is due, in large part, to the fact thatweak-economy acquirers have a stronger motivationto achieve a good strategic and cultural fit with thetarget company: they need to focus on deliveringreal gains.

In conclusion, periods of low or no economicgrowth are an excellent time for companies to startputting into place the components of a compre-hensive and strategic M&A capability.6 Such a capa-bility will allow them to approach potential dealsstrategically, not opportunistically, and to makeM&A an integral part of a corporate strategy proc-ess. Such a capability will serve companies well notonly in the current economic environment but alsowhen good times return. It will allow them to ana-lyze their options continuously, pursue deals on thebasis of a sound and well-understood strategic logic,and beat the odds to create value through M&A—ingood times and in bad.

BCG REPORT

6. For a more detailed description, see Mark Sirower, “Strategic Screening: A Secret to M&A Success,” Forethought, Volume 1, Issue 2, March 2002, pp. 29–32.

2278.txt 7/1/03 4:59 PM Page 18


Independent of the economic situation, mergersremain an important strategic tool for companies.Although periods like the current slowdown in theworld economy might seem less attractive for merg-ers and acquisitions, in fact they can be an idealtime for strategically sound deals with a good finan-cial and operational fit. There are seven steps thatcompanies considering them should take.

Put M&A in the context of corporate strategy. Tosucceed at mergers and acquisitions in the cur-rent environment, M&A must be an integral partof a coherent corporate strategy. Be clear aboutyour strategy and M&A’s role in achieving it.

Understand your industry landscape. The bigstrategic opportunity in lean times is to use M&Aas a force for consolidation in your industry.Develop a robust understanding of both the cur-rent state and likely evolution of your industry,and the most promising ways to fundamentallytransform your own competitive position.

Make sure your company is “M&A ready.” Don’tproceed unless your company is truly in a positionto pursue M&A opportunities successfully. In aperiod of weak economic growth, that means pos-sessing critical capabilities such as strategicscreening, due diligence, and effective PMI; hav-ing reasonable levels of debt and an adequatefinancial cushion; and ensuring that risks in the

A C H E C K L I S T F O R C E O S

core business are under control and transparentto investors.

Screen potential targets against key success cri-teria. In periods of weak economic growth, fourimportant factors are strategic fit, a financiallystable target, a high probability of wringingsignificant profit improvement out of the acquisi-tion, and the potential to create competitiveadvantage.

Be aggressive, but don’t rush. It is unclear howlong the current economic environment will last,but companies have time to prepare themselvesand carefully evaluate potential targets. Develop atarget list and continue to monitor it. Understandwhat targets are really worth and don’t overpay.Eventually, the right opportunity will emerge.

Be open to alternative financing and deal struc-tures. Although all-cash deals are currently infavor (a reaction to the all-stock deals of the1990s), there are still opportunities to use othertypes of financing (including equity and assetswaps) and deal structures (such as joint venturesand alliances).

Keep M&A at the top of the CEO’s agenda. TheCEO’s personal involvement in screening targets,executing the deal, and communicating thestrategic logic to investors is vital for success.

2278.txt 7/1/03 4:59 PM Page 19

Methodology

20 BCG REPORT

To develop the data sample for this study, we iden-tified the top 25 deals by size that took place in theUnited States during each year between 1985 and2000—a universe of 400 acquisitions. Next, we elim-inated those deals for which critical data (forexample, announcement date) were unavailable orin which the acquirer itself was taken over or wentbankrupt within two years. This left us with a sam-ple of 277 deals—an average of roughly 17 per year.

We then divided those deals into two categories:those that took place during a year in which realGDP growth was below the long-term average of 3.1 percent for this period (what we call weak-economy mergers) and those that took place in a yearwhen growth was above the long-term average(strong-economy mergers). In this manner, we iden-tified 89 weak-economy deals and 188 strong-economy deals.

Next, we assessed the performance of those merg-ers and acquisitions using two measures. To calcu-late short-term performance, we measured the announcement effect of the deal by taking the change

in the acquiring company’s returns from five days before the deal’s announcement to five days afterand comparing it with the equivalent change in theS&P 500. This gave us a measure of short-term rela-tive total shareholder return (RTSR). Those deals inwhich short-term RTSR was greater than zero cre-ated value and we considered them successful; thosein which short-term RTSR was less than zero de-stroyed value and we considered them unsuccessful.

To calculate long-term performance, we comparedan acquiring company’s market returns with the average performance of its industry peer groupfrom five days before the announcement of the dealto two years after the year in which the deal was an-nounced. This gave us a measure of long-term RTSRand, therefore, of long-term success or failure.

For the analyses of profitability, operational per-formance, and financial health in the section“Characteristics of a Successful Weak-EconomyMerger,” insufficient data caused us to use varioussubsets of our 277-deal sample. The precise numberof deals analyzed is indicated in each exhibit.

BCG REPORT

2278.txt 7/1/03 4:59 PM Page 20

“Thinking Differently About Dividends”

BCG Perspectives, April 2003

“Managing Through the Lean Years”

BCG Perspectives, February 2003

“Taking Deflation Seriously”

BCG Perspectives, January 2003

“New Directions in Value Management”

BCG Perspectives, November 2002

“Making Sure Independent Doesn’t Mean Ignorant”

BCG Perspectives, October 2002

“Treating Investors Like Customers”

BCG Perspectives, June 2002

“The Continuing Relevance of Investor Expectations”

BCG Perspectives, December 2001

“When Growth Is Not an Option”

BCG Perspectives, August 2001

Succeed in Uncertain Times: A Global Study of How Today’s Top Corporations

Can Generate Value Tomorrow

A report by The Boston Consulting Group, November 2002

Dealing with Investors’ Expectations: A Global Study of Company Valuations

and Their Strategic Implications

A report by The Boston Consulting Group, November 2001

For a complete list of BCG publications and information about how to

obtain copies, please visit our Web site at www.bcg.com.

The Boston Consulting Group has other publications on corporate finance and corporate development that may be

of interest to senior executives. Recent examples include:

2278.cvr 7/1/03 4:58 PM Page IBC

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