A telltale sign of a merger mania: A raft of investment firms jump into the M&A market and start outbidding acquirers that are buying companies in their own businesses.
On Monday, the signs of M&A mania seemed obvious. A group led by China’s Anbang Insurance Group has made a $76 a share, or roughly $13 billion, bid for Starwood Hotels (HOT), which had already agreed to be acquired by Marriott International (MAR). Apollo Management has made a $1.7 billion offer for Fresh Market (TFM), the grocery store company, which Kroger had been rumored to be considering buying.
Anecdotally, there are certainly cases where private equity and other financial firms have got into bidding wars and the deals have turned sour. Just one example: Back in 2007, private equity firm Bain got into an ugly bidding war with other private equity firms before purchasing Clear Channel, which has since changed its name to iHeartmedia. That deal has been a disaster. Last week, lenders issued a notice of default to iHeartmedia pertaining to more than 25% of its debt.
But research shows that isn’t typically the case. In fact, private equity managers have proven themselves to be pretty formidable acquisition competitors—so good, in fact, that Marriott and Kroger may consider higher bids for Starwood and Fresh Market, respectively. Over the last 27 years, 23% of all competing bids were made by financial sponsors, according to research from Amy Dittmar at the University of Michigan. But the percentage of financial bidders peaked during other merger market tops—1988 and 2006, when they comprised 42% and 36% of all competing bids respectively, according to the research.
Intuitively, it seems like a recipe for disaster. If Marriott were to buy Starwood, the combination could take advantage of all the synergies the two can create: cutting back office jobs that overlap at the two firms, for example. Private equity and other financial firms don’t have these advantages. But while financial firms may not benefit from synergies, they also don’t have to take on all the costs and messy business of integrating two companies, either. That gives them more time to focus on either improving or closing underperforming divisions.
“Managers of less well-performing subsidiaries… have an incentive to lobby parents to secure additional resources to protect their unit, costly activities…that harm parent value,” according to a study from researchers at HEC Paris. “After acquiring control, private equity can eliminate these costs, implement restructuring plans, and enforce managerial discipline.” These restructuring capabilities are “a salient factor in the auction.”
Second, private equity buyers often use more debt, which helps inflate potential returns, especially when interests are low and debt is cheap, as it is now. Marc Martos-Vila of the London School of Economics who has written a Harvard Business School paper on the subject says, “Our theory predicts that PE firms will tend to dominate strategic buyers during times when debt markets are overvalued.”
Still another report shows that private equity firms are actually the pros when it comes to hunting assets. In the study called “Follow The Leader: Acquiring Targets Picked by Private Equity,” University of Michigan’s Dittmar says that private equity firms, by definition, have to be more selective about their targets.
“While corporate buyers may share operational synergies with the target firm, financial buyers rely primarily on improving the stand-alone value of the target firm or buying undervalued assets.” In short, they’re finding the good ones. And even in cases when the financial bidder ends up losing out on a deal, the combinations tend to work out better. She says deals earn about 12% better returns in the six months following announcement of a transaction if the acquiring firm out bid a financial acquirer rather than a rival or strategic bidder.
What does this mean for shareholders in companies like Starwood and Fresh Market? If the studies are right, buyout firms trying to go over the top and break up deals, will only spur more bidding and more contested M&A battles. That means the bubble, if it is, in the merger market will continue to grow.
