Boom or Bust: Keep Doing M&A Deals or Hunker Down? Deloitte Debates

Some business leaders think of M&A as a growth strategy that only applies when the economy is booming. But is that really the right approach? When times get tough, should companies turn off the deal pipeline and hunker down? Or should they keep looking for M&A opportunities to make their business stronger?

Here’s the debate:

My Take

Jeffery Weirens, Principal, Deloitte Consulting LLP 

At the moment, the acquisition and divestiture landscape is dominated by the financial crisis, which is prompting forced sales, bold acquisitions and an unprecedented level of government intervention. Economists expect real GDP growth to continue slowing as the credit markets remain fragile and the housing market continues its descent. The uncertainty around near-term economic growth will feed volatility in the equity markets and many firms may continue to struggle with the economic turmoil.

Additionally the U.S. recession has spread to many international economies, leading to an overall global downturn and resulting uncertainty, a chief nemesis of acquisitions and divestitures. Further, shifting oil prices has resulted in a volatile dollar which is prompting cash-rich Middle Eastern firms and Sovereign Wealth Funds to weigh their U.S. asset ambitions carefully.

The implication for the acquisition and divestiture market is that deal valuations are likely to be extremely favorable for strategic buyers that have cash to invest. At the same time, sellers will have an opportunity to unlock value through strategic divestitures and portfolio rebalancing.

The recession may cause an increase in distressed assets for sale, either through liquidations, forced sales of distressed assets, or simply the need for over-extended organizations to deleverage and free up cash. Although these types of divestitures present opportunistic buying situations that should not be overlooked, they should also not be the sole focus of a company’s acquisition and divestiture strategy.

Because of the factors noted above, acquisitions and divestitures will remain an important consideration for market-leading companies as they navigate the current economy. For sellers, these transactions are a powerful way to free up cash, focus on the core business and reposition in difficult times. For buyers -- both strategic and financial -- reevaluating the organization’s acquisition strategy may provide an effective means to improve its capabilities, expand its product offerings and enter new markets at a much lower cost. It can also help an organization position itself for accelerated growth once the global economy recovers.

Now is the time for companies to evaluate their overall portfolio and assess their current acquisition and divestiture strategy. The longer a company sits on the sidelines during the downturn, the further it will likely lag behind during the recovery. 

 
A view from the financial services sector

Paul Legere and Sachin Sondhi, Principals, Deloitte Consulting LLP 

There is a brewing debate about the amount of financial services M&A activity that is likely to occur in 2009 and beyond. We think the discussion should be less about deal volume and more about the nature of M&A as the industry grapples with the new economic order.

In our view there is going to be a fundamental shift in how financial services companies approach M&A. Consolidation has been the dominant trend in most financial services sectors in the U.S. While there may be room for further consolidation, the broader changes taking place in the industry will alter the way capital, risk and assets are viewed. Decisions about size, scope and reach will be reexamined under a new set of parameters. This will force some companies to manage their balance sheet through divestiture, while others capitalize on acquisition opportunities -- both situational and strategic -- to bolster their capabilities and diversify risk. In other words, M&A will continue to be used as a growth lever, but the purpose and intent it serves -- and the nature and pace in which it is applied -- will be different.

Sector differences will be particularly noteworthy. Asset Management is likely to experience consolidation, given the sector’s dramatic loss in asset values, sales of investment arms by commercial banks and insurers and interest by foreign buyers with healthy balance sheets. In the Banking and Securities sector, opportunistic M&A activity is likely. Some regional banks may use the infusion of treasury monies to fuel acquisitions, although we expect that government and public scrutiny could impact deal flow. However, the vast majority of the more than 8,000 regional and community banks in the U.S. will not receive cash infusions, which increases the odds for further consolidation.

Foreign buyers are likely to expand their footprint in the U.S. and Asia, capitalizing on growth opportunities and low pricing. Private equity firms are continuing to streamline their portfolios, but are expected to return as buyers as the market stabilizes. Sovereign Wealth Funds will probably continue with their wait-and-see approach and will likely be less aggressive in their direct foreign investments.

In the past, financial services firms have struggled to unlock value from M&A transactions, with some deals appearing to erode shareholder value. This may be due in part to the short attention span of investors and markets. Near-term success has been defined as: achieving a successful close, executing the first 90 days of business operations, or capturing the first wave of synergies. Rarely do investors and markets consider whether a deal successfully delivers the promised top- and bottom-line results. We believe this will change in the new world.

We expect an even greater emphasis on rigorous due diligence, deal execution and value capture -- and on critical details such as tax, accounting, compliance and controls. Companies won't be rewarded just for doing deals, but for delivering long-term results and achieving a sustainable competitive advantage. This will elevate the importance of managing issues, such as talent, customers, information, risk, tax and compliance, which are critical to a deal's ultimate success. True integration, not just corporate development or deal making, will become a core capability for companies that rely on M&A to achieve their strategic objectives. The focus will be on understanding customer needs and delivering a seamless customer experience efficiently, with effective integration across products and channels. Financial services companies that get this right will start to see their deals deliver real long-term value, not just short-term headlines or temporary bumps in share price.

 
A view from the automotive sector

Bruce Brown, Principal, Deloitte Consulting LLP 

The current economic crisis is having a profound impact on the automotive industry. Most major automakers have already seen their sales decline by 30-40 percent and it appears volumes may remain at this level for the immediate future. Because the industry is so capital intensive, it takes automakers and suppliers a long time to restructure their operations to accommodate such volume declines.

Although government interventions and automaker merger rumors grab most of the headlines, a significant amount of M&A activity is also likely to occur at the supplier level. In the coming months, some suppliers may consider divesting operations or liquidating portions of their business. We expect buyers to shy away from purchasing whole companies in favor of cherry-picking specific business units, product lines and facilities. These “carve out” deals tend to be far more involved than traditional M&A transactions due to numerous interdependencies with other parts of the seller’s business. In most cases, they also involve transition service agreements where the seller continues to provide the buyer with key services after the deal is complete. Structuring and executing such deals requires significant effort in a broad range of areas, including operational due diligence and integration, tax structuring, accounting, controls and compliance.

Foreign buyers are likely to play a major role in this new M&A environment. In the future, Asia is expected to be the automotive industry’s strongest growth market. While many Asian suppliers have not had significant exposure to Western automotive markets, the acquisition of an existing Western supplier can open opportunities to quickly establish relationships and credibility with major automakers. Over the past few years, Asian companies have been actively looking for acquisitions – especially in Europe -- but found the prices too high. Now, many of those buyers are shifting their focus to the U.S. where potential bargains abound.

Tight credit and uncertainty about the future are currently limiting the number of M&A deals; however, we expect the situation may change quickly going forward. In some instances, domestic suppliers with sufficient resources might want to consider making pre-emptive acquisitions – even if they don’t need the capacity – in order to stave off the threat of foreign competition.

Related Content:

Library: Deloitte Debates
Overview: Merger & Acquisition Services 
Industries: Banking & Securities and Automotive
Services: Consulting 

Additional M&A contacts:
Steven Butters, partner, Financial Services, Deloitte & Touche LLP
Andrew Wilson partner, Divestiture Services, Deloitte & Touche LLP

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