The Window for Mergers and Acquisitions is Open

By Michael Megarit 

Given the current state of the market, a window of opportunity for transformational, accretive mergers and acquisitions is opening that will allow you to advance your strategic position and increase your competitive advantage. Valuations are down, and while the economy has continued its volatility, historical studies indicate that acquisitions in a down market sometimes deliver even better results.

To take just one recent example, the acquisition by the giant drugmaker Pfizer of the multinational pharmaceutical company Wyeth in 2008 (in the midst of the Great Recession), which filled out Pfizer’s capabilities in biotechnology and vaccines, enlarged its critical disease areas and positioned Pfizer well for the future, including for its successful COVID-19 response.

But these deals take work to pull off in such high uncertainty. Lower valuations are attractive to buyers, but they could be a deterrent to potential targets. And there’s now a new wrinkle: higher interest rates increase the interest on debt, which is an integral part of deal pricing.

Those challenges notwithstanding, the sheer amount of ‘dry powder’ (un-spent capital) on corporate balance sheets and pressing needs to pivot to significant trends such as digital transformation or sustainability will see deal flow proceed apace: getting in first allows strategic bidders to pick off the choicest morsels.

In fact, the biggest deals are already happening. Just this week, the Germany-based RWE bought Con Edison’s clean energy operations for $6.8 billion as it shifts away from coal, and Avery Dennison bought Vestcom for $1.45 billion to expand into digital retail solutions.

It’s time to think imaginatively and radically about your business model so you can be here tomorrow. But the window is now – while valuations are favorable – before this certainty kicks in.

M&As in the Current Economic Landscape

Swings in valuations and deal volumes are strongly correlated with the level of business confidence. So, while transaction flows decline under uncertain economic conditions, the deals that take place will often prove to be a good bet and add value. According to McKinsey’s analysis of historical data, M&As during downturns outperformed those in benign economic times by an average of 9.6 percent in total shareholder return over two years following the announcement of the acquisition.

Today’s cycle is a mix of old and new. Once again, bubble behavior is evident in equity markets, but this time there are considerable pandemic-related disruptions and geopolitical tensions that are affecting different regions and sectors with varying degrees of intensity.

Even though market-wide valuations have come down, performance across companies has been uneven, and it is likely that acquisitions will come at a substantial premium to what shareholders may put on the table, especially for relatively better-performing targets in a market downturn.

To help manage this complexity, new structures such as partnerships or minority stakes may be considered, where sellers share in future upside. In the face of high valuations, corporate cash balances and private equity funds provide plenty of capital as a fire hose and for deals in strategically important areas that can create change through digital and strategic acceleration.

Setting an Action Agenda

For companies ready to capitalize on these conditions, four strategic moves are recommended:

1. Portfolio Review. Take a step back and look at your business segments to examine strategic alignment and opportunities to enhance capabilities and market positions or divest assets, based on their potential for growth.

2. Planning Your Divestiture. Think through the implications of a sale of non-core assets, both in terms of value and strategic focus.

3. Target Identification. Raise critical questions and considerations about potential acquisition targets to help fill the strategic gap and ensure that integration plans make sense.

4. Organizational Readiness. Make sure the board and advisors are ready to make quick decisions and have due diligence and integration teams ready to go.

These approaches can help firms either build a ‘virtuous cycle’ dynamic for the company’s current dilemma or forward-stepping strategies, through which a mindful approach to navigating shifts in market dynamics can propel the company well into the future.