Will Mergers & Acquisitions Take Off in Europe?Published: February 27, 2002 in Knowledge@Wharton
The art of the deal is alive and well in Europe – yes, traditionally merger-averse Europe – even if it has entered something of a slump.
The pace of mergers and acquisitions in Europe grew at a torrid pace in the last half of the 1990s. According to figures published by Thomson Financial’s Mergers & Acquisitions magazine, the value of cross-border European deals was $51 billion in 1996. That figure rose to $85 billion in 1997, then to $148 billion in 1998, $311 billion in 1999 and $526 billion in 2000. (A cross-border deal is one with both a European acquirer and a target that are not based in the same country.)
The year 2001, however, saw the pace of cross-border European transactions ease considerably, to $179 billion. But Robert W. Holthausen, professor of accounting and finance at Wharton, says that should not be surprising. "One reason for the European M&A decline is that equity values have fallen," says Holthausen, who is academic director of a one-week program on mergers and acquisitions program offered by Wharton Executive Education. "Using stock is one way that companies pay for acquisitions, and that currency is not as valuable as it once was. Now, you might think that if my stock price falls 20% and yours falls 20%, then we are in some sense even. But, historically, we have observed that a decline in stock prices does result in reduced M&A activity.
"The second reason, which is reflected in the decline in equity values, is that managers are more uncertain and more pessimistic about economic prospects. We had an economic boom for years, but managers’ expectations have become less optimistic about their companies and industries – and this was even prior to Sept. 11. The situation after the terrorist attacks has added to the uncertainty. So, if you are a corporate manager and you are more uncertain about next year’s revenues and earnings, you may not want to spend potentially very scarce resources on acquisitions. We see companies cutting back on capital expenditures and hiring, too. So it’s not just M&A activity which has been affected."
Holthausen also points out that the credit markets have tightened considerably, making it harder for companies to issue debt or to borrow from banks to pay for acquisitions if they are cash transactions. Uncertainty about the economy and the markets means that Europe was not the only place where mergers tailed off in 2001.
M&As involving U.S. companies declined last year, too, after a hot and heavy period of merger activity in the 1990s. The total value of transactions rose from $572 billion in 1996 to $784 billion in 1997, $1.373 trillion in 1998, $1.438 trillion in 1999, and $1.786 trillion in 2000, before falling back to $1.143 trillion in 2001. These figures include any M&A activity involving the United States: U.S. firms acquiring other U.S. firms; non-U.S. companies acquiring U.S. concerns; and U.S. firms acquiring non-U.S. companies.
For the world as a whole, the value of M&A transactions was $2.063 trillion in 2001, down from $3.576 trillion in 2000, according to Thomson Financial.
The rise in M&A activity in Europe was a noteworthy development during the 1990s because European firms, due to cultural and legal factors, traditionally shied away from the kind of go-go approach to consolidation common in the United States. Some mega-deals that took place during that period involved Vodafone Airtouch and Mannesmann; France Telecom and Orange; and BP-Amoco and Arco.
"Global reach became important for companies in Europe as well as the U.S. in the 1990s," Holthausen says. "They realized they had to be global competitors. In some European countries, there were changes in statutes that allowed transactions to take place across borders where they had been very difficult to achieve before." Holthausen adds that mergers have also been fostered by the creation of a common currency, the euro, and a growing sense that "Europe is one large entity rather than a collection of individual countries."
Wharton management professor Harbir Singh says three industries that have undergone major consolidation worldwide in recent years are telecommunications, autos and pharmaceuticals. "National phone companies are merging to take advantage of new technologies," Singh notes. "In autos, you have globalization so that one company can produce cars that can be sold around the world. Ford’s acquisition of Volvo shows the benefits of global coordination of product designs and of sourcing parts and components. Pharmaceutical companies are going through M&As because of the high costs of developing new drugs. Mergers mean a higher likelihood of developing blockbuster drugs down the road."
Two examples of pharmaceutical combinations in the last two years are France-based Aventis, which was formed by the integration of Hoechst and Rhone-Poulenc, and London’s GlaxoSmithKline, which was formed by the combination of GlaxoWellcome and SmithKline Beecham.
Singh cites three fundamental reasons why companies merge:
- To achieve cost savings and efficiencies . These are achieved through workforce reductions, economies of scale, sharing resources across products and instituting more effective cost controls in the combined company.
- To increase market power . "This means increasing profit margins in the combined firm," Singh explains. "This market power is not inherent in any firm. It’s driven by the firm’s unique assets, such as its brand name, technologies and reputation."
- To respond to changes in the competitive landscape . Companies frequently feel compelled to combine forces to meet challenges they feel they cannot tackle alone. In the telecom business, for example, companies once competed on how much market share they could grab in the long-distance market. But that is no longer enough. "Today," says Singh, "companies feel that adding value-added service for customers, such as DSL [digital subscriber lines] is essential. But this is risky because it may not end up the way you want it to go." Witness AT&T’s ill-conceived attempt to become one giant corporation with interests in cable TV, long distance and broadband player, only to decide later to break up into four separate businesses.
Many mergers do not succeed, however, and Singh wonders whether European and U.S. firms that rushed to combine in the 1990s will last. Germany-based DaimlerChrysler is one high-profile example of a firm that continues to struggle. "Combining Daimler Benz and Chrysler, for which a case could be made on paper, looking at their locations and products, has not yielded the benefits that were expected," notes Singh.
Still, it seems that M&A activity will accelerate again once the world economy improves. Philip Yates, Merrill Lynch’s head of European M&A, says that even though growth slowed in 2001, interest in M&As continues to build in Europe, according to an article published by ThomsonMergers.com. Although growth slowed in 2001, the market is still strong, Yates told a conference on European securities regulation in London in December.
The U.K. market accounted for about half of all European M&A activity in 2000, but Yates said this proportion may decline significantly in years to come. For one thing, he said, "America has bought the best British companies already." What is more, shareholder value is becoming more important as European firms realize that they must be accountable to investors.
"There is a heightened equity culture because companies are waking up to the fact that their competitors aren’t local but global. European companies understand that they will have to be more attuned to M&A culture," Yates was quoted as saying. Yates said pension fund assets make up 33% of investment in Europe, compared with 86% in the United States. There is a huge pension deficit that will require greater capital flow into the market, and M&A activity will rise as a result.
A survey released Feb. 14 by PricewaterhouseCoopers also found that a rise in mergers is expected within the next 24 months. According to the firm’s quarterly "Management Barometer" survey, 58% of senior executives from large multinationals anticipate an increase in M&As within the next 12 months, and 89% say they expect greater M&A activity within the next two years.
Among the executives who reported reductions in mergers in their industries, 57% say a resurgence will depend on increased demand for goods and services, including an overall improvement in the U.S. economy (48%) and increased consumer spending (9%). Some 21% say improved stock market prices are needed if M&A activity is to pick up, while 11% cited a need for improved earnings growth by leading U.S. corporations. A small number, just 5%, point to need for more-favorable M&A regulations in the United States and Europe.
Indeed, many of those surveyed by PwC who are planning mergers and acquisitions say they will be spending a lot more effort on due diligence than in the past. Areas they will pay close attention to include projected financials, non-financial performance measures, current financials, and technology leadership.
Wharton’s Holthausen agrees that M&A activity should get a boost once the economic outlook is brighter. "It will help if the credit markets loosen a bit and it will also help if managers become less uncertain about the economy. A rise in equity prices will also help, but that’s not as critical as the other factors. It’s important to realize that the economic fundamentals for acquisition activity haven’t gone away, so there’s no reason to believe that deal flow won’t pick up again."