In a recent article, Andrew Willis suggested that the shareholders of Alimentation Couche-Tard Inc. ATD-T may be better off if the bid to acquire 7-Eleven’s Japanese parent company falls through. In support of this argument, he observed that the deal size was very large, at US$47-billion, debt–fuelled, cross-border and to be completed by a newly-named CEO at a time when the company was reporting earnings short of analysts’ expectations.
These comments are right on the mark and are confirmed by a recently published book titled The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How the Few Succeed. The authors, finance and accounting professors Baruch Lev and Feng Gu, created a database of 40,000 M&A transactions over the 43-year period 1980 through 2022, introduced 42 variables which might possibly have an impact on the success or failure of a transaction and then ran a regression analysis to see which of them had any predictive value.
The book will be of interest to any investor hoping to assess the likelihood of success or failure of a proposed merger or acquisition in their portfolio. As the authors point out, theirs is a purely statistically driven study. Most research on the topic involves anecdotal accounts of individual transactions.
First, we need to be onside with their definition of a successful acquisition as the checklist will only be of value if we agree with the outcome. In their words, a successful acquisition is one which achieves above industry-average sales growth or gross-margin growth, a positive stock price return and no goodwill write-off, all during the three-year period after the date of the transaction. This is a reasonable approach as it focuses on the longer-term financial test of an acquisition rather than the immediate stock-market reaction, so I am inclined to accept it. Using this definition on the 40,000-item database, they found that 70 per cent to 75 per cent of transactions fail to meet expectations.
The 42 variables which they think may have predictive value range from the easy-to-identify, such as the size of the deal, whether it is in the same industry or a conglomerate merger, the percentage of shares versus cash in the offer, to more arcane items such as the “buzzword intensity of buyer’s acquisition announcement.” All of these variables had a role in the first version of the equation, but several of them were not statistically significant and so the authors reduced to only 10 observations to make it of practical value.
Because most transactions fail, it is no surprise that seven out of the 10 factors in the equation have a negative sign. In other words, the higher the score for the deal under review, the less likely it is to succeed. Each of the factors has a different weighting, which is beyond the scope of this article, so what follows is a listing of each factor followed by my one-line explanation of its significance. For more detail, you will have to invest in the book.
1. Deal size: Negative and increasingly so as the size grows.
2. Buyer’s goodwill growth as a result of the transaction: Less than 5 per cent is neutral, more is negative.
3. Conglomerate merger: Same industry is neutral, different industry is negative.
4. High stock percentage in acquisition payment. More than 80 per cent is negative.
5. Foreign target: Domestic is neutral, foreign is negative, owing to unknown cultural issues.
6. Buyer’s long-term debt growth: The more debt growth, the more negative.
7. Change in buyer’s return on assets over previous three years: Could be positive or negative. Declining profitability may indicate the deal is a hasty attempt to reverse a trend.
8. Buyer’s market-to-book ratio: Higher is better.
9. S&P 500 change over previous 12 months: Negative is good as it is better to buy after a market decline.
10. Number of buyer’s acquisitions during the previous five years: A small positive indicating prior experience at integration.
To be fair, in looking back over this checklist, we see that the proposed Alimentation Couch-Tard deal also deserves some positive scores. It is in the same industry and so not a conglomerate merger, the market-to-book ratio is high at 3.97 and the company has made many acquisitions over the past few years, so it has ample experience with successful integration of operations. The acquisition payment will be in cash with no share content at all, so that is also a positive, although it will be offset by a dramatic increase in the debt burden and likely the goodwill accounts.
Not included in the 10-factor equation, but the subject of a lengthy discussion in the book, is the topic of CEO tenure. Acquisitions made during the first year that a CEO occupies that post are associated with the lowest success ratio. In this case, the CEO arrived one month after the company announced the bid, which undermines the predictive score somewhat.
At this point, many of the details of the proposed deal are still lacking and so it is not possible to calculate an accurate score for the professors’ equation, but the evidence to date points toward a high probability of failure if it is completed. As Andrew Willis suggests, shareholders in Alimentation Couche-Tard may breathe a sigh of relief if it quietly fades away.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
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