M&As – value creation or destruction?

By Malini Hariharan

The current slowdown in M&As is perhaps for the best as according to a recent report by Alembic Global Advisors the chemical industry has a track record of value destroying M&A activity.

The study, which looked at deals of over $500m since 1990, evaluated M&As on stock performance, return on capital, operating results and synergies and found that many failed to achieve their objectives.

On stock performance, the study found that an initial 3-6 month period of outperformance after a deal was followed by underperformance over 1-3 year period.

Hefty premiums are often paid in the hope that a deal will result in considerable synergies especially through cost reduction and increased revenues from an expanded customer base.

But synergies are often not significant enough to justify premiums. And operating expenses as a percentage of sales usually fall marginally in the few years after the deal but are not sustained.

Operating margins also follow a similar trend reflecting the lack of revenue synergies through an increased customer base.

And all of this is reflected in the weak return on invested capital (ROIC) seen post deals. Alembic Global’s analysis showed that the average ROIC for the five years before the deal was 11.32% while the post deal number was 9.46%.

Have financial players who have been quite active in the chemical sector fared any better?

“By and large private-equity deals in the chemicals sector have proved to be extremely profitable generating returns in excess of LBOs (leverage buyouts) in other sectors and far outstripping returns generated by publicly traded chemical companies,” says Alembic Global.

The reason for this lies in the focus on cash flow as this is necessary to service the high debt levels that LBOs bring. Firms acquired in private equity deals are also unlikely to make capital spending errors that destroy value. And importantly, financial buyers are known for their focus on improving the bottom line by streamlining product portfolios and cost improvements, points out Alembic Global.

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