Archive for July 8th, 2009

Distressed and bankrupt acquisitions: Should you do one of these deals?

Posted on Wednesday, 8 July 2009. Filed under: Commentary, Mergers |

The answer to the question above?  Absolutely ‘yes’.  That is, If you’re the distressed seller.  And if you are the distressed seller, you may have no choice anyway if you’re actually already bankrupt, insolvent or moments away from being so.

The answer for distressed sellers is easy.  Sell.  But for buyers the answer is more complex.

Cass Business School’s M&A Research Centre (of which I’m the Director) recently completed a very comprehensive study of distressed and bankrupt / insolvent M&A deals (with the sponsorship and support of the law firm Allen & Overy, investment bank Credit Suisse, accountancy and advisor Deloitte and the Financial Times / Mergermarket).  In comparing those types of acquisitions with healthy ones, the study looked at over 12,000 deals, including 2652 distressed targets and 265 bankrupt / insolvent ones.  The study period spanned 25 years from 1984 through 2008.  It focused on strategic deals, and excluded so-called ‘financial sponsor’ deals (typically done by private equity firms).  Details of the study (including definitions used to define a company as ‘distressed’ are included in a full report that can be ordered here).

Unfortunately for the buyers, ‘buying cheap’ does not guarantee higher returns to shareholders, except in the time immediately around the announcement of the deal.  Thus, the market appears to like these acquisitions initially when announced, but then the bloom comes off the rose as the hard work of saving — in fact integrating — the target begins.  Interestingly, as is commonly known, the typical M&A deal announcement results in an immediate decline in the purchaser’s share price (which is confirmed in this study), so at least purchasers of a distressed or bankrupt company get a better initial reaction.

Longer term, whether they bought a distressed or bankrupt company, the study found that the performance of the purchasers declined,.  This was measured by looking at a number of financial factors, including return on equity.  Thus it appears that these deals didn’t meet their expectations.  Caveat emptor. Let the buyer beware.  As with all purchases in life, if it looks like too much of a bargain, there’s probably something wrong with it that you don’t know yet.

There were some other interesting findings in the study:

  • If a target is distressed, it is more likely that the acquirer will be from the same industry (a competitor) than for healthy acquisitions.  It does seem as if there’s at least some attempt by those who know the industry well to try to save a company that’s had problems, although perhaps in light of the finding about long-term success, perhaps this is a case of hubris or misplaced confidence.
  • There was an interesting geographic difference:  the US and UK stock markets react differently to acquisitions of distressed targets.  There is insignificant or even negative immediate reaction in the UK to the buyer’s share price when they announce a deal involving a distressed company, but in the US the opposite is true.  The UK shareholders appear to have made the correct decision!

Lastly, and critical to today market situation, the study found that the best time to strike a deal for a bankrupt target is just after a major crisis (such as we have right now) when the markets are starting to recover.  In these times, both the acquirer and target show gains.

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