Buy-side Directors and Risk Management in M&A

Risk and value creation are closely related concepts. M&A may provide companies with an opportunity to grow, capture synergies, or accomplish other strategic objectives that can create value, but most transactions fail to accomplish their stated objectives. While the reasons behind the success or failure of a particular transaction depend on the circumstances, risks like incorrect valuation, adverse changes in the economy after the deal closes, failure to capture synergies, and inefficient post-merger integration are generally applicable M&A-related exposures that can destroy value in any transaction. Regardless of how advantageous a deal appears on paper, optimum performance depends on an acquiring board’s ability to evaluate, plan for, and manage risk in all stages of the transaction. Effective risk management requires the board to accurately value a target, to account for factors that increase the likelihood of failure, and to shape a merger plan that supports efficient integration and synergy capture. In this way, the Board of Directors and other officers play a vital role in determining whether M&A activity will create or destroy shareholder value. Valuation, Merger Waves, and Risk Management through Deal Structure About half of M&A transactions fail to accomplish the objectives stated when the deal is announced, and an estimated 67-75% of M&A transactions fail to create additional value. Historically, acquiring companies have experienced a drop in share price after plans for a deal are made public. Presumably, this decrease demonstrates the market’s recognition of the fact that M&A generally fails create to value. However, in more recent years this trend has reversed, and this year companies have seen an average 4.4% increase in share price shortly after a transaction has been announced. But regardless of whether a deal accomplishes a strategic objective or whether share-price increases in the short-term, M&A can only create value if the benefit of a transaction outweighs the cost of obtaining that benefit. While accomplishing a strategic objective may create value, over-paying for a target can only reduce the up-side value a transaction can represent for an acquirer. Therefore, the likelihood that a transaction will create value cannot be understood without a concrete understanding of the potential margin, and while synergy capture and accomplishing strategic objectives can create value for shareholders, evaluating that potential value creation starts with an accurate valuation of the target. Even if an accurate valuation shows that a transaction has the potential to create value, future market conditions often determine whether the deal will be a success. The cyclical nature of M&A activity is certainly the result of many factors, but these merger waves illustrate how market confidence influences M&A, and also highlights the importance of accurate valuation and risk management. Since 1893 there have been six complete merger waves. The last complete M&A wave began in 2003 and peaked in 2007, a year in which global M&A deals were worth a record $4.83 trillion, up nearly 24% from the previous record ($3.9 trillion) set in 2006. This wave ended with the financial crisis of 2008, a year in which stock markets fell nearly 50%.