2019's mega-mergers: What is really driving shareholder wealth creation?

“Finally, knowledge of the source of takeover gains still eludes us.” (Jensen & Ruback, 1983)

It is a known fact that global economic development is a driving force for international mergers and acquisitions (M&A) activity. For the 4^th quarter of 2019, Bloomberg estimated a 19% GDP and a

Figure 1. Global dealmaking numbers. Reprinted
from Financial Times, by E. Platt, J. Fontanella-Khan, L. Noonan
& A. Massoudi, 2019, https://www.ft.com

12.5% policy interest rate depreciation compared to the 3^rd quarter. Taking this data, the further ongoing global political uncertainty due to Brexit and several market events like the cancelled multi-billion tobacco merger between Altria and Philip Morris into consideration, it does not seem surprising that the global M&A activity has fallen 11 per cent by the 3^rd quarter 2019 in comparison to the previous year, presenting a 2 year low in terms of deal value (FT). Although those numbers may not directly imply prosperous business activities, 2019 was still characterized by several US publicly listed mega-mergers: The $89.5bn purchase of the pharma company Celgene by its direct competitor Bristol-Myers Squibb, the $88.9bn armaments concern merger between United Technologies and Raytheon and lastly, the $86.3bn fusion between the pharma giants AbbVie and Allergan. It seems obvious that one could believe the former mentioned economic and business developments have put pressure on the performance of the executed multi-billion-dollar mergers. In the following, I want to explore the actual short-term historic performance of 2019’s two biggest deals, taking into consideration major deal characteristics and furthermore, discussing possible alternative managerial firm-specific value drivers.

First of all, it is important to examine the research on historic M&A performance. The 1983 conducted meta-study by Jensen & Ruback delivered statistically significant evidence on shareholder gains or losses after takeovers, concluding that acquiring company shareholders make regular short and long-term losses while target company shareholders make significant gains in value. Moreover, empirical studies suggest that when it comes to M&A financing methods, share-based takeovers underperform compared to cash-based acquisitions (Fischer, 2017). Reasons for this may be due to deal value preciseness or acquiring shareholders’ retainment of company control. When looking at 2019’s two biggest deals now, the numbers paint a surprisingly different picture:

Figure 2. United Technologies (UTX) share price development.
Reprinted from Bloomberg, 2019.

The 5 months after each merger-announcement daily price data (Bloomberg) of each acquiring company suggest periodical positive geometric returns of 3.61% and 16.30%, respectively for Bristol-Myers Squibb and United Technologies. Taking into consideration the companies’ required capital return of the same 5 monthly period, calculated by the use of CAPM (See blog post from 03.11.19) with an overridden periodical beta, the 2 companies generate excess returns of 0.59% and 13.7%. Therefore, especially the United Technologies and Raytheon fusion created substantial short-term shareholder value, although the global economic state and conducted research might have implied different results. Additionally, the strong performance of both acquirers can not be explained in the context of M&A financing research as Bristol-Myers Squibb purchased with a well-balanced 53% to 47% Stock-Cash mix while United Technologies even financed its merger with a 100% stock payment.

Without doubt, my short analyses of those 2 recent mega-events in the M&A industry are due to its way too small number of observations not statistically representable at all. Although, they do symbolically represent a recent development in M&A research. While the study of specific deal characteristics like the aforementioned financing methods or political and regulatory effects have been researched for decades, more and more academics use a different approach, considering mainly firm-specific managerial characteristics for explaining shareholder wealth creation in M&A. “Extraordinary acquirers”, a paper published by Golubov, Yawson & Zhang in 2015, is one interesting example of this new school of thought. The three academics conclude that firm-specific fixed effects match, partially even overshadow, the explanatory power of important deal-characteristics. Going more into detail, they deduce that positive and negative acquirer returns are firm-specifically persistent over time and that they are also persistent under new managerial influences due to changes of the CEO. Golubov et al. explain those findings mainly by firm-specific organizational knowledge in form of M&A development teams and expertise in post-merger integration, by “bidder-specific synergies, […], derived from the nature of the firm’s assets or its business model that are particularly well-suited for acquisitions” and lastly, by prior success in acquisitions that may facilitate future M&A activities.

Unfortunately, qualitative analyses always bring the same problem with them: They allow academics to retrospectively understand events by the use of econometric methods, but they do not allow regular investors to form a quantifiable opinion on future events that may influence their actual wealth. Although, my small research on state-of-the-art developments on this topic implies the same results as my valuation-blog post from 01.12.2019: Even though the real-life application of many academic papers seems too complex, we should still learn from research and integrate major findings in our daily investment strategies. Looking at the present case of this blog again, acquirer performances of recent deals within the last 20 years or company characteristics like the availability of in-house M&A development teams are publicly available and it should be a matter of course for every shareholder to be in knowledge of such information when it comes to the question of investing or an approval of a possible future merger. 

Bibliography

Fischer, M. (2017). The source of financing in mergers and acquisitions. The Quarterly Review of Economics and Finance, 65, 227-239.

Golubov , A., Yawson, A., & Zhang, H. (2015). Extraordinary acquirers. Journal of Financial Economics, 116(2), 314-330.

Jensen, M. C., & Ruback, R. S. (1983). The market for corporate control: The scientific evidence. Journal of Financial economics, 11(1-4), 5-50.