By John Colley
In this article the author sheds light on why the likelihood of success, in terms of shareholder value creation, is further diminished during an enormous spending spree. He concludes that the various corporate governance measures designed to ensure there is alignment between boards and shareholder interests, although better than nothing, are far from being fully effective.
Year 2018 may become a global record year for the sheer volume of mergers and acquisitions, possibly approaching the previous highest of $4.6 trillion in 2015. Driven by high corporate profits, large cash balances and the ease of lending, corporates have spent like never before. Real costs of borrowing are around zero after tax relief and inflation. In the U.S.A., the spending spree has in addition been driven by significant tax concessions and a relatively strong dollar. The business environment outlook is also benign with only Brexit a significant shadow together with other global moves towards protectionism. How will shareholders fare during this enormous spending spree? Certainly, if large corporates have access to significant funds there is a temptation to spend it rather than distribute to the shareholder. History suggests the likely outcome is destruction of shareholder value on an industrial scale.
Shareholder Value Destruction
We do know that business prices relative to earnings have been increasing steadily ever since 2008,1 largely consistent with the increasing availability of funds for acquisitions. In effect the availability of more money is chasing prices higher to the point of almost certain shareholder destruction. In recent months we have seen Comcast, a U.S. global telecommunications conglomerate, acquire Sky, a European cable operator with 23 million customers, for £30.6bn. This was over 100% more than the previous undisturbed share price. Comcast shareholders immediately sold shares wiping £10bn off the Comcast share price indicating the extent of overvaluation they felt the deal demonstrated. On a lesser scale, Coca Cola has just agreed with UK-based Whitbread on the acquisition of Costa Coffee, a chain of predominantly UK-based coffee shops, for £3.9bn. This is around £1bn more than the expected IPO would have raised. The bid was also significantly above other buyer interest possibly also by £1bn. Coca Cola thought it was buying a “scalable coffee platform” to develop a global position. Instead they are buying a business with 88% of its sales and 95% of its profits in the rapidly maturing UK market. It is their first move into hot beverages. Some may say 20 years too late in view of the speed of the coffee market development.
Research is relatively clear and unambiguous on the success or otherwise of large scale mergers and acquisitions activity. Study after study finds that 60% to 80% fail to meet expectations and around 60% destroy shareholder value.2 Around half of all acquisitions are sold off again within 5 years. We also know that the performance of so-called mega deals is worse. When prices are reaching current heights, the likelihood of success in terms of shareholder value creation are still further diminished. In effect, very few of the recent mega deals will create value and the vast bulk will be value destroying. So why do shareholders let boards commit to so many deals which are not in shareholders’ interests? What motivates boards to take such major risks?
About the Author
John Colley is Professor of Practice in Strategy and Leadership, Pro Dean, at Warwick Business School. Following an early career in Finance, John was Group Managing Director of a FTSE 100 business and then Executive Managing Director of a French CAC40 business. Currently, John chairs two businesses and advises private businesses at board level. Until recently he chaired a listed PLC.
2.Martin RL. (2016). M&A The One Thing You Need to Get Right. HBR Org. https://hbr.org/2016/06/ma-the-one-thing-you-need-to-get-right