Valuation: Measuring and Managing the Value of Companies, Fifth Edition

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Mergers and Acquisitions

Mergers and acquisitions (M&A) are an important element of a dynamic economy. At different stages of an industry’s or a company’s life span, resource decisions that once made economic sense can become problematic. For instance, the company that invented a groundbreaking innovation may not be best suited to exploit it. As demand falls off in a mature industry, companies that have been in it a long time are likely to have excess capacity. At any time in a business’s history, one group of managers may be better equipped to manage the business than another. At moments like these, acquisitions are often the best or only way to reallocate resources sensibly.

Acquisitions that reduce excess capacity or put companies in the hands of better owners or managers typically create substantial value both for the economy as a whole and for investors. You can see this effect in the increase in the combined cash flows of the many companies involved in acquisitions. Even though acquisitions overall create value, however, the distribution of any value they create tends to be lopsided, with the selling companies’ shareholders capturing the bulk. In fact, most empirical research shows that one-third or more of acquiring companies destroy value for their shareholders because they transfer all the benefits of the acquisition to the selling companies’ shareholders.

The challenge for managers, therefore, is to ensure that their acquisitions are among those that do create value ...