McKinsey Quarterly Article: A Return to Deal Making in 2010

M&A volumes rose last year for the first time since the crisis. Capital markets think deals created more value too. The return of market confidence in deal making during the latter half of the year was perhaps the most encouraging aspect of M&A in 2010. Overall deal activity was measured rather than excessive, and capital markets looked favorably upon the resulting value creation. Companies also once again seem willing to engage in more ambitious cross-border deals. Barring any major macroeconomic upsets in 2011, a positive trend seems to have begun.

The global M&A market ended two years of malaise in 2010, rebounding decisively in the second half of the year. After languishing for the first six months in the wake of higher market volatility and the sovereign-debt crisis in Europe, companies ended the year having announced more than 7,000 deals, at a value of $2.7 trillion. This marked the first increase in M&A deal numbers and volumes since 2007, as well as a 23 percent increase over 2009 levels, which were the lowest since 2004.

Judging by share price movements before and after deals were announced, investors felt upbeat in 2010 about the acquirers’ ability to extract value from M&A. Our analysis found that deals created more value overall than they did in any year since we began tracking them, in 1997—and that acquirers were more disciplined at capturing this value for their shareholders. Other trends in M&A for the year included continued growth in cross-border M&A, an increase in the number of deals in Asia and Latin America, and modest growth in private-equity deal volumes.

A measured rebound

M&A activity recovered in 2010 but remained well short of a deal frenzy. A rally in stock markets around the world drove growth in the total value of deals: global market capitalization rose to around 80 percent of the 2007 peak, up from around 65 percent in 2009. M&A activity for 2010 as a share of market capitalization³ (a good indicator of overall deal sentiment) was slightly below the long-term average of 7 to 8 percent. Despite the resurgence, M&A activity as a share of market capitalization was still considerably lower than it was in 1999, when volumes rose as high as 11 percent of global market cap. Last year’s other highlights included:

• Cross-border activity regained momentum. The long-term trend of increasing cross-border M&A activity seemed to stall in 2009, with a significant drop to just 25 percent of global M&A volumes, down from 40 percent in pre-crisis years. But cross-border activity returned to pre-crisis levels in 2010 as a result of both megadeals,⁴ and numerous smaller cross-border transactions.
• Asia–Pacific outbound M&A continued to grow impressively. Asia–Pacific⁵ acquirers increased their share of cross-border activity in 2010. Outbound M&A from that region into Europe and the Americas more than doubled (after having slowed down the year before), growing around twice as fast as M&A volumes in the opposite directions. The Asia–Pacific became a net exporter of around $46 billion in M&A deal volume, while Europe, the Middle East, and Africa exported $9 billion and the Americas imported $55 billion. The Asia–Pacific region accounted for 23 percent of all global activity in 2010, up slightly from 2009.
• Latin America saw by far its largest M&A volume ever. In 2010, M&A volumes in Latin America grew to $250 billion (more than double the 2009 level), accounting for almost 9 percent of global M&A. The growth has been continuous since 2005, and although 2010 volumes were supported by a few megadeals, such as telco América Móvil’s bid for Carso Global Telecom, the number of deals also stood close to an all-time high.
• Private-equity activity recovered but remained concentrated in OECD countries. From late 2007 to mid-2009, as access to cheap debt ended abruptly, private-equity activity levels declined steeply, falling to just 4 percent of global deal activity. As many predicted, private-equity activity picked up again in late 2009 and throughout 2010 as credit spreads narrowed and banks again started to offer financing for leveraged buyouts, albeit at significantly higher prices. For 2010, private-equity M&A, at a bit above $200 billion, accounted for 8 percent of deals by volume. Although nearly double the levels of 2009, this remains far from the $700 billion peak seen in 2006 and 2007. This rebound was, however, mostly a phenomenon of Organisation for Economic Co-operation and Development (OECD) countries. In 2010, as in previous years, private equity’s share of M&A elsewhere remained small. Non-OECD countries constitute around 30 percent of global M&A but only 10 percent of private-equity activity.

Positive market sentiment toward acquirers

Stock markets have typically assessed the value of M&A to acquirers cautiously. Over the past decade, capital market reactions to deals, as gauged by share price reaction to deal announcements, suggested that investors perceived them as creating around 10 percent of their value for the seller and destroying around five and a half percent for the acquirer. This perception reversed sharply in 2010, however: for only the second time in the past decade, markets viewed the average deal as creating value for both acquirer and seller. The net value created by M&A, measured as deal value added (DVA), has fluctuated between 3 and 9 percent over the past 14 years, excluding 2000, when it fell to –6 percent. It fell to around 3 percent during the past recession but rose sharply in 2010, to 13 percent—the highest level seen over the past 15 years and far above the historic average of 4.6 percent (Exhibit 1).

Moreover, the data suggest that acquirers also exercised more discipline in their deal making in 2010. The proportion of deals in which the immediate market reaction caused the acquirer’s share price to fall—the percentage of overpayers (POP)—fell to 47 percent (Exhibit 2). This level, which implies that investors thought slightly above half of the deals created value for the acquirers’ shareholders and slightly below half destroyed value, is significantly better than the historic average of 60 percent, which we have observed since we began tracking this metric in 1997. Yet premiums paid remained fairly high during 2010.

Markets often treat cash and share deals differently, and that gap widened dramatically. Capital markets consistently perceive cash deals as creating more value than stock deals. On average, cash deals create 11 percent of the deal value, partly as a result of the positive signaling effects of using cash; in contrast, markets typically perceive share deals as destroying around 3 percent of the deal value. The gap between the two funding methods dropped to a mere 4 percent in 2008, widened again in 2009, and rose as high as 20 percent by 2010. Markets gave extremely positive responses to cash-only deals in 2010, but they also perceived share deals as creating value on average, to the tune of 2 percent.
Furthermore, small deals created significantly greater value than larger ones. Indeed, deals with a value above $5 billion had a significantly lower deal value-added (DVA), at 3 percent, than smaller deals, at about 15 to 16 percent (Exhibit 3). While markets rewarded sellers equally, regardless of deal size, they on average rewarded acquirers significantly less for large than for small deals. This pattern lines up with long-term averages, in which large deals have a slightly negative DVA, while small to midsize deals have a positive 5 to 6 percent DVA.

The gap is not a result of higher premiums for large deals, as premiums paid are fairly similar across deal sizes: for stock deals, there is also no substantive difference across deal sizes. For cash deals, however, a significant difference can be found: markets give a much better reception to small cash-financed deals than to large cash-financed ones. Potential explanations for this negative attitude could be an anticipation of paying out cash as dividend, worry about increased debt levels, or a need for a rights issue.