Be Daring When Others Are Fearful

Seizing M&A Opportunities While They Last

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Be Daring W

hen Others A

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9/09

Be Daring When Others Are Fearful

Seizing M&A Opportunities While They Last

bcg.com

Jeff Gell

Jens Kengelbach

Alexander Roos

September 2009

The Boston Consulting Group, Inc. 2009. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: bcg-info@bcg.comFax: +1 617 850 3901, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. One Beacon Street Boston, MA 02108 USA

B D W O A F

Contents

Preface 5

Executive Summary 6

M&A: Down but Not Out 8A Changed M&A Environment 8M&A Trends in 2008 9The Capital Markets Started to Stabilize in 2009 10Never Let a Crisis Go to Waste 14

Current M&A Opportunities 16Are You Ready for M&A? 16Who Are the Predators? 18Who Are the Prey? 19

A Guide to Distressed M&A 21Distressed M&A for Smart Predators 21Smart Strategies for Distressed Targets 22

The Clock Is TickingBe Ready for Action 23Successful Strategies for Predators in the Downturn 23Integrate and Restructure Fast 24

Guidance in the Crisis for Predator CEOs 25

Appendix: Methodology 26

For Further Reading 28

Note to the Reader 29

T B C G

B D W O A F

As the world comes to terms with the a er-math of a fi nancial crisis unprecedented in the lives of most executives, it can be tempting to see mergers and acquisitions (M&A) as a distant prospect. The M&A market seems frozen, it remains di cult to fi nance deals, and continuing insecurity about the future has kept risk aversion high. Yet the experience of past crises shows that companies can fi nd M&A opportunities in downturns that give them the capacity to reshape their industries and take commanding leads within them. Indeed, our re-cent survey of some of the worlds biggest investors found that they want companies to be ready to capitalize on M&A opportunities when they arise. This 2009 edition of The Boston Consulting Groups annual M&A report high-lights that even in this most severe of downturns, buyers and sellers can create signifi cant value for their owners.

Earlier BCG research has established that the returns from M&A in downturns are much greater than those in upturns. This years report, which is based on analysesconducted by the BCG M&A Research Centerof more than 5,200 M&A transactions since the start of the sub-prime crisis in the late summer of 2007 (with a special focus on distressed M&A), confi rms that insight. More-over, it shows that some of the best opportunities in the last two years have been acquisitions of fundamentally healthy but fi nancially distressed companies in danger of fi nding themselves unable to refi nance their ongoing business. Drawing on the M&A Research Centers fi nd-ings, we present the key ingredients of success for both buyers and sellers.

Companies that want to take advantage of the opportuni-ties must analyze their position to ensure that they are prepared for the coming upturn in M&A. A good one-fi h

of all companies will be predators that are ready for ac-quisitions, while another one-fi h will be preyunless they take radical steps to survive. Most companies, how-ever, will be in-between: many could become predators by taking appropriate action now, while others could be-come prey if they fail to make the right moves.

But time is of the essence. The capital markets are gradu-ally reopening, and growth is returning in economies that had previously fallen into recession. When the window of opportunity fl ies open, the prizes will go to those that have grasped their position and prepared themselves for the surge in M&A. With the clock ticking, there is no time to losefor either predators or prey.

About the AuthorsJe Gell is a partner and managing director in the Chi-cago o ce of The Boston Consulting Group and a global sector coleader of M&A. Jens Kengelbach is a principal in the fi rms Munich o ce and a member of the Euro-pean Corporate Finance Task Force. Alexander Roos is a partner and managing director in BCGs Berlin o ce and a global sector coleader of M&A. If you would like to discuss any of the observations and conclusions in this report, please contact one of the authors.

Preface

T B C G

T he global fi nancial and economic crisis has taken its toll on M&A, but there are strong signs of stabilization in the capi-tal markets. The crisis has created op-portunities for acquisitive businesses to reshape industries and create new leaders, as compa-nies like IBM and Procter & Gamble did in the 1930s.

The number of deals is down and their value has fall- en sharplya trend that accelerated a er the bank-ruptcy of Lehman Brothers in September 2008 and has continued into 2009. The number of deals in the fi rst half of the year was down 17 percent compared with the fi rst six months of 2008, and their value was down 45 percent.

On average, buyers in 2008 fared worse than in prior years, having moved too early in the downturn of M&A in, for example, fi nancial services and manufacturing. The acquisition of smaller companies produced far better returnsas in previous years.

The capital markets are gradually reopening, however. Corporate debt issuance has picked up in 2009 for in-vestment-grade debt, although high-yield debt has been slower to recover.

Initial public o erings (IPOs) are still scarce, with just 119 in the fi rst half of 2009, but secondary-equity issu-ance has risen sharplyin June 2009 reaching the highest level in two years. The cost of debt fi nancing fell steeply in the second quarter of 2009, a er reach-ing a record peak in March.

Our research has shown that downturns should be seen as opportunities for acquisitions, a view shared

by some of the worlds most prominent investors, whoin a recent BCG surveysaid they want strong companies to use the crisis to reinforce their competi-tive position through acquisitions. Almost two-thirds of these investors said they are comfortable using equity when the acquirer has a relative valuation advantage.

BCGs analysis of a sample of companies in the S&P 500 shows that about 20 percent are predators, ready to take on the risks of a deal, while another 20 per-cent are preyso weak and vulnerable that they must focus on survival or be swallowed. The remain-ing 60 percent have the potential to be either preda-tor or preybut up to one-quarter of these compa-nies could become predators by rigorously strengthening their finances and reshaping theirbusinesses.

Potential predators include large companies, many of whichwith the cash reserves of the S&P 500 still at or close to record levelshave the fi repower for M&A. Acquirers with strong balance sheets, high prof-itability, and su cient cash will be able to capitalize on the weaknesses of competitors and transform their industries.

Private-equity (PE) fi rms will certainly not play the same role in M&A as in the years before the credit crunch. In the absence of debt fi nancing, the value of their M&A deals in 2008 was 60 percent down over 2007. However, with dry powderthe undrawn capital commitments of limited partnersof about $500 bil-lion at their disposal, these fi rms can be a source of funds for corporate predators; indeed, they have made 552 public investments worth more than $56 billion in the last two years.

Executive Summary

B D W O A F

Sovereign wealth funds (SWFs) are unlikely to become predators, but they have become a signifi cant force in the capital markets. They have also shown themselves ready to take stakes in high-profi le institutions in par-ticular instances.

The primary driver of deal volume in this period is likely to be distressed companies with further fi nanc-ing needs. They include businesses divested by larger distressed groups and PE portfolio companies unable to refi nance their debt, which in many cases is trading at distressed levels.

M&A will also occur in relatively healthy sectors such as pharmaceuticals, where those companies whose shares have fallen the most willunder consolidation pressuresbecome downturn targets for competitors with higher valuations.

BCGs research on previous economic crises has shown that M&A in downturns is more likely to cre-ate value than deals done in upturns. Our latest re-search shows that this is even truer for deals involv-ing distressed target companiesbut there are ingredients that make success more likely.

Predators can help maximize the returns from dis- tressed M&A by fi xing their own problems before launching an acquisition in the current environment.

Acquisitions of distressed targets are more likely to be successful when the predator is above average in prof-itability and more profi table than the target. Other measures that increase the chances of success include choosing targets that have financial problems but have not yet run into operating di culties, and acquir-ing smaller companies.

Distressed companies that have identifi ed themselves as prey can command the highest price by courting larger predators with sound fi nancials. Deals involving companies from di erent sectors tend to produce bet-ter returns for both sides than transactions within the same sector.

When the M&A market returns to growth, there will be a three- to six-month window of opportunity for the best-prepared companies to act before the rest of the world catches up. With the clock ticking, smart predators must be prepared for action and ensure that they have brought investors on board.

Successful M&A in the current environment requires meticulous planning to deal with the uncertainties of the times. Smart predators must be prepared to go be-yond traditional acquisition procedures and act quick-ly when potential targets emergeeven when those targets are not ones that would normally be seen as ideal acquisitions.

Funding arrangements must include backup alterna- tives in case of further turbulence in the fi nancial mar-kets. PE fi rms and SWFs could both provide fi nancing in particular circumstances.

Predators should ensure that they are ready to take on the risks of M&A by screening their businesses through a downturn lens and stress-testing them against sud-den and fundamental changes in the business and fi -nancial environment. Then they should do the same for potential targets and for the new company that would be created by any deal.

Due diligence must be thorough and rigorous to pre- vent undisclosed problems from coming to light a er a deal is completed.

Postmerger integration planning must be rigorous, with cash generation the top priority. The strategic and tactical choices made before a deal is closed ultimate-ly determine its successand never more so than in a downturn.

T B C G

T he fi nancial-market turmoil that began with the subprime crisis in the late summer of 2007 is reshaping the global economyand with it the business landscape. The upheav-al is unprecedented in the working lives of todays executives, presenting challenges that require constant reassessment of their strategies for managing and developing their companies. A natural response is to hunker down in order to survive the storm and emerge from the downturn intact. Yet the crisis has created a win-dow of opportunity for transformational M&A deals that some companies are already seizing. As the storm begins to moderate, now is the time to be daringwhen others are still fearful.

A Changed M&A Environment

The last two years have seen the biggest jolt to the global economy since the crash of 1929, which ushered in the Great Depression of the 1930s. Although government measures appear to have succeeded in halting the melt-down in the markets, the fi nancial system remains a long way from normal functioning.1 The economic impact of the current crisis continues to be felt, overturning old cer-tainties.

The speed and scale of the crisis have been refl ected in the stock markets, with leading share indexes falling much more sharply than in previous postwar recessions. Despite the rally in the equity markets in the spring of 2009, by the end of June the indexes were still about 40 percent below where they had been two years before. Some industries have been particularly hard-hit by the credit crunchconstruction and automotive, for exam-ple. The banking industry has been turned upside down by both the fi nancial turmoil and the political response,

with some well-known names disappearing from theleaderboard.

Superfi cially, the impact on M&A appears muted. For ex-ample, the number of deals executed in 2008almost 30,800was just 2.4 percent less than in 2007. Moreover, there were 6.6 percent more deals in 2008 than in 2006and more even than in 2000, at the peak of the dot-com boom. The value of M&A deals plummeted along with as-set prices, however: at just over $2.5 trillion, the total last year was almost one-third less than the total for 2007. Even so, the 2008 fi gure was only 11.7 percent less than the total for 2006, and still the fourth highest for M&A transactions in the last decade.

If we break the numbers down into monthly fi gures, however, it is clear that the bankruptcy of Lehman Broth-ers in September 2008 strongly a ected M&A markets and that a signifi cant decline in activity occurred in the fi nal quarter of that year. Deals already in the pipeline still tended to go ahead, but since then, the number and value of transactions have fallen sharply. The number of deals in June 2009 was 25 percent down over December 2008, and the monthly value of deals dropped to very low levels in the fi rst half of this year. (See Exhibit 1.)

The ultimate outcome for 2009 is still unclear. In the fi rst half of the year, the number of transactions was just over 12,700, a drop of 17 percent compared with the fi rst six months of 2008. The value of those deals, at $681 billion, was 45 percent less than the value of M&A deals in the fi rst half of 2008. If the number of transactions for all of 2009 turns out to be double the fi gure for the fi rst six

1. See Collateral Damage Quick-o-Nomics UpdateLeading-Indicator Edition: Searching for Green Shoots, BCG White Paper, July 2009.

M&ADown but Not Out

B D W O A F

months, that would produce a drop of almost 18 percent compared with 2008bringing the number of deals back down to 2004 levels. Similarly, if the value of transactions for all of 2009 is double the value of those in the fi rst six months, total M&A value for the year would be almost 46 percent less than in 2008and down to levels last seen in the mid-1990s.

But even if the outcome for the rest of 2009 does prove to be more of the same, the M&A environment would still be more buoyant than the upheaval in the markets might suggest. The especially sharp decline in the value of trans-actions at least partly refl ects lower asset prices, which make deals easier to close for both buyers and sellers. M&A is defi nitely down, but it is not out.

M&A Trends in 2008

Given the turmoil in the capital markets, it is hardly sur-prising that M&A activity in 2008 was dominated by fi -nancial services. With governments aggressively promot-

ing mergers in the sector, fi nancial services accounted for 44 percent of total M&A value in 2008, compared with its long-term average of 39 percent. Energy came in second at 12 percent of total M&A value, followed by basic mate-rials at 7 percentboth above the long-term average for these industries.

The credit crunch brought PE down to earth in 2008, as the leveraged fi nancing intrinsic to its business model dried up. The number of PE deals fell below 1,000down almost one-third over the previous year and ap-proaching levels last seen in 2004. (See Exhibit 2.) The value of those PE deals fell even more precipitously: the total was 60 percent down, from $958 billion in 2007 to $385 billion last year. Again, the biggest drops were in the second half of the year, and they continued into 2009.

Acquirers in public-to-public deals fared worse than in previous years, as shown by an event study analysis of re-turns calculated over a seven-day window centered

Planned deals were still executed, with the full impact materializing in 2009

$billions

700

600

500

400

300

200

100

0

Number of deals

3,500

0

500

1,000

1,500

2,000

2,500

3,000

Jan2007

Mar2007

May2007

Jul2007

Sep2007

Nov2007

Jan2008

Mar2008

May2008

Jul2008

Sep2008

Nov2008

Jan2009

Mar2009

May2009

Lehmanbankruptcy

25%

Value of deals Number of deals

Exhibit 1. The Financial Crisis Has Strongly Affected M&A Markets

Sources: BCG M&A Research Center; Thomson Reuters SDC Platinum.Note: Figures are based on a total of 76,958 completed M&A transactions, excluding repurchases, exchange offers, recapitalizations, and spinoffs. Enterprise values include the net debt of the target.

T B C G

Overall PE deal value droppedby 60 percent in 2008 ...

... mainly driven by precipitous declines in the second half of the year, and 2009 looks similar

958940

563

352

182157124179162

11673

0

200

400

600

800

1,000

0

500

1,000

1,500

19971998

19992000

20012002

20032004

20052006

2007

385

2008

60%

807

$billionsNumber of deals

13114

1156

11

2419

1318

40

89

28

45

30

44

24

0

20

40

60

80

100

0

50

100

150

Number of deals Value of deals

$billions

73%

Number of deals

Jan2008

Feb2008

Mar2008

Apr2008

May2008

Jun2008

Jul2008

Aug2008

Sep2008

Oct2008

Nov2008

Dec2008

Jan2009

Feb2009

Mar2009

Apr2009

May2009

Jun2009

Exhibit 2. The Credit Crunch Has Brought Private Equity Down to Earth

Sources: BCG M&A Research Center; Thomson Reuters SDC Platinum.Note: Figures are based on announced deal value, including the net debt of the target (rank value >$25 million), buyouts, or financial-sponsor involvement.

around announcement day.2 The cumulative abnormal return for buyers in 2008 was 1.5 percent, below the long-term average. (See Exhibit 3.) As so o en in M&A, overpayment was the culprit, with acquirers jumping in too early in the downturn, particularly in fi nancial ser-vices and manufacturing.

However, BCGs research has shown that acquisitions during downturns have a higher probability of success than those that occur when the economy is more buoy-ant. Our analysis of thousands of deals indicates that, in the two years following the announcement year, such ac-quisitions produce returns 14.5 percentage points higher, on average. (See Exhibit 4.) It also shows that it is nor-mal for downturn acquisitions to su er an adverse mar-ket reaction during the announcement window period, before going on to generate positive returns. It is too soon to judge the long-term returns from many of the deals executed in 2008.

Finally, acquisitions of smaller companies in the current crisis are likely to produce better returns for both acquir-er and targetas in the past. In 2008, in cases where the acquirers sales were more than double the targets, the

cumulative abnormal return for both was substantially higher than in cases where the acquirers sales were less than double the targets. The markets see small deals as less cash intensive and easier to implement for the ac-quirer, and investors recognize the safe harbor e ect for smaller companies of acquisition by a larger one. (See Exhibit 5.)

The Capital Markets Started to Stabilize in 2009

Funding M&A transactions has been di cult since the summer of 2007, with the capital markets grinding almost to a halt a er the start of the subprime crisis. Funds for deals have been scarce and the cost of fi nancing has o en been high. However, there was evidence of a revival in global capital markets in the second quarter of 2009, which began to increase the availability of fi nancing and reduce its cost.

2. A standard event-study analysis measures cumulative abnormal returns net of market returns in the period between the three days before and the three days after the day of the initial deal announce-ment. For a more detailed description of the event study approach, see the Appendix: Methodology.

B D W O A F

4

3

2

1

0

1

2

1.22

For acquirers, takeovers created less value because of the

tendency to overpay

2008:1.5% (N = 142)

1996 1998 2000 2002 2004 2006 2008

For targets, cumulative abnormal returns exceeded those of

the late 1990s

CAR1 (%)

0

10

20

30

1996 1998 2000 2002 2004 2006 2008

2008:30% (N = 132)

CAR1 (%)

19.5

Escape into safe harbors waspositively rewarded by the capital markets

Exhibit 3. On Average, Public-to-Public Deals in 2008 Brought Higher Target Returns and Lower Acquirer Returns Than in Previous Years

Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis.Note: The difference in sample size is the result of limitations in the targets return data.1Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/3).

T 5

Downturn mergers create value

Upturn mergers destroy value

T + 5 Year 1 Year 2

10.4percentagepoints

Cumulative relative-total-shareholder-return performance (T 5 = 100)

Event window

End ofannouncement

year

94.193.8

108.3

104.5

5.9percentagepoints

95.5

97.4

97.8

110

105

100

95

90

101.4

14.5percentagepoints

Exhibit 4. Downturn Mergers Systematically Outperform Upturn Deals

Sources: Thomson Financial/SDC Platinum; BCG analysis.Note: T 5 is the five days before the announcement date; T + 5 is the five days after the announcement date. The entire period is considered to be the event window. This analysis is taken from Winning Through Mergers in Lean Times: The Hidden Power of Mergers and Acquisitions in Periods of Below-Average Economic Growth, BCG report, July 2003.

T B C G

3

2

1

0

50

3.2

>50 100

2.7

>1000

10

20

30

40

26.6

14.6

CAR1 (%)

1.3

N = 92

33.5

For acquirers, small deals are less cash intensive and easier to implement Targets benet from the safe-harbor eect

Targets sales as a percentage of acquirers sales

4

CAR1 (%)

50 >50 100

>100

Targets sales as a percentage of acquirers sales

N = 11 N = 17

N = 92 N = 11 N = 17

Exhibit 5. In a Downturn, the Smaller the Target the Better in Public-to-Public Deals

Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis.Note: Results based on a sample of 120 public-to-public M&A deals announced in 2008.1Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/3).

For example, it has become easier for companies to bor-row money by issuing corporate debt. (See Exhibit 6.) Last year, levels of debt issuance plummeted. Globally in October 2008, there were only 137 issues of investment-grade debt worth just $57 billion, compared with 604 is-sues worth $351 billion in May. But activity picked up in 2009, with the number of investment-grade debt issues topping 400 in both May and June, to raise more than $200 billion a month. High-yield debt issuance has taken longer to recover, but May and June saw 85 issues worth $41 billion across the two months, restoring levels similar to those seen before the subprime crisis.

Debt fi nancing remained expensive well into 2009, with the cost of insuring against the risk of corporate default having increased dramatically in three waves since the start of the credit crunch. (See Exhibit 7.) The cost of cred-it default insurance, as measured by the iTraxx index, reached a record peak in March 2009 of more than fi ve times the cost in the summer of 2007. In the months that followed, credit spreads over Treasury bills fell sharply a er the central banks pumped liquidity into the fi nan-cial system. But at the end of June 2009, they were still at more than three times their pre-credit-crunch levels.

Raising equity through IPOs remained di cult in the fi rst half of 2009, with just 119 o erings, compared with 783 in the fi rst half of 2007, before the markets seized up. (See Exhibit 8.) The average value of IPOs was almost halved in the fi rst six months of 2009, as the total value fell from $189 billion in the fi rst half of 2007 to $15.7 billion. Hav-ing fl atlined over the winter months, the number and to-tal value of IPOs rose slightly beginning in Aprilbut they were still at very low levels, with the value in June 2009 down 44 percent over the previous June.

The picture was more encouraging for corporate fund-raising through the issuance of secondary equity. The number of secondary issues rose from 94 in January 2009 to 384 in Junethe highest level since the start of the credit crunch. Their total value also climbed steeply in the fi rst half of 2009, reaching $131 billion in June, com-pared with $26 billion in January.

Yet this partial revival in the capital markets came too late to prevent a further deepening of the recessionin the advanced economies, as the fi nancial crisis spilled over into the real economy. The corporate credit crunch was still reducing investment in the summer of 2009,

B D W O A F

Global high-yield debt issuanceGlobal investment-grade debt issuance

0

200

400

600

800

0

100

200

300

400$billions

Numberof issues

Dec2005

Dec2008

Jun2006

Dec2006

Dec2007

Jun2007

Jun2008

Jun2009

Number of issues Issuance volume

0

20

40

60

0

10

20

30

40$billions

Numberof issues

Dec2005

Dec2008

Jun2006

Dec2006

Dec2007

Jun2007

Jun2008

Jun2009

Exhibit 6. Corporate Debt Issuance Decreased Dramatically in 2008 but Picked Up Again in 2009

Sources: Thomson One Banker; BCG analysis.

0

250

500

750

1,000

1,250

The cost of debt nancing

0

2

4

6

8

10

12

14

16

18

20

High-yield TreasuryInvestment-grade TreasuryA-rated Treasury

AA-rated TreasuryAAA-rated Treasury

Credit spreads over T-bills (%)

The price of insuring againstthe risk of credit defaults

iTraxx Europe Crossover index

75 percentincreasein rstwave

185 percentincreasein second

wave

400 percentincreasein third

wave

May 1,2007

Jul 1,2007

Sep 1,2007

Nov 1,2007

Jan 1,2008

Mar 1,2008

May 1,2008

Jul 1,2008

Sep 1,2008

Nov 1,2008

Jan 1,2009

Mar 1,2009

May 1,2009

1997

First quarter1998

19992000

20012002

20032004

20052006

20072008

2009

Exhibit 7. The Costs of Default Insurance and Debt Refinancing Are Falling Following Sharp Increases

Sources: Thomson Reuters Datastream; BCG analysis.Note: Composition of series 7 to 11 of the iTraxx Europe Crossover five-year (midfixing) indexes; credit spread analysis based on Barclays bond indexes.

T B C G

and output remained weakleading to mounting corpo-rate defaults and job losses. With confi dence anemic among consumers and businesses, demand remained de-pressed, creating a downward spiral in a wide range of industries.

Never Let a Crisis Go to Waste

In the adverse economic and fi nancial conditions that have prevailed since the start of the credit crunch, com-panies have tended to focus inward. Cost cutting and re-structuring are seen as the overwhelming priorities, nec-essary to maximize cash fl ow, strengthen the balance sheet, and ensure survival. Yet, as BCG has pointed out in previous research, recessions typically accelerate the forc-es reshaping industries and create new winners and los-ers. In the Great Depression, companies such as IBM and Procter & Gamble placed aggressive bets on acquisitions that helped them to strengthen their competitive posi-tion in later years.3

Interestingly, investors appear to recognize that todays extraordinary circumstances will again throw up once-in-a-lifetime M&A opportunities on which companies should capitalize. Contrary to what many executives might think,

investors and analysts recently surveyed by BCG said they want companies to use the crisis to strengthen their com-petitive positioneven if their stock price falls as a short-term result.4 Investors expect companies to do what is necessary to secure their fi nancial viability, but they are concerned that potentially game-changing moves will be neglected for fear of missing quarterly earnings-per-share guidance. This is a unique time in history to gain share and keep it, said one investor. No one is pricing stocks on 2009 anyway.

The top priority for the investors in our survey was or-ganic investment in the business. (See Exhibit 9.) How-ever, M&A came in a close second. As one respondent put it, Eight times out of ten, companies wait too long and end up paying three times more than they would have had they taken advantage of the situation when times were bad. Now is the time to step on the throat of the competition and pick something o .

Global secondary-equity issuanceGlobal IPO issuance

0

100

200

300

44%

0

100

20

40

60

80

$billionsNumberof issues

Jan2007

Mar2007

Jun2007

Sep2007

Dec2007

Mar2008

Jun2008

Sep2008

Dec2008

Mar2009

Jun2009

Number of issues Issuance volume

0

100

300

400

403%

0

200

50

100

150

$billionsNumberof issues

Jan2007

Mar2007

Jun2007

Sep2007

Dec2007

Mar2008

Jun2008

Sep2008

Dec2008

Mar2009

Jun2009

200

Exhibit 8. Raising Equity Through IPOs Has Been a Challenge, but Secondary OfferingsAre Picking Up

Sources: Thomson One Banker; BCG analysis.

3. See Collateral Damage, Part 7: Green Shoots, False Positives, and What Companies Can Learn from the Great Depression, BCG White Paper, June 2009.4. See Collateral Damage: Function FocusValuation Advantage: How Investors Want Companies to Respond to the Downturn, BCG White Paper, April 2009.

B D W O A F

Giving cash back to investors in the form of dividends or share repurchases was a much lower priority. Investors are prepared to see equity used in M&A transactions, with 63 percent of those surveyed saying they are com-fortable or very comfortable when the acquirer enjoys a relative valuation advantage. Most managers look at their stock as currency today and see its value cut in half, said one respondent. They dont understand the relative value of their equity currency. Another said, Us-ing stock is okay if what you are buying is cheaper. If

the math works in terms of relative valuation, Im okay with that.

Although it is di cult to predict when there will be a sig-nifi cant upturn in M&A, the investors surveyed by BCG suggested that it could come within the next 12 to 24 months. Our survey was conducted at the start of 2009, so the clock is ticking. Investors are urging companies to be ready to seize the opportunities while they last, and not to let the crisis go to waste.

0 20 40 60 80

Organic investmentin the business

Potential uses of excess cash Number of respondents who chose the option as a high priority

Strategic and accretive M&A

Retirement of bonds beingtraded at a discount

Accumulation of cashon the balance sheet

Signicant stock repurchase

Dividend increase

71

60

55

30

17

14

Exhibit 9. Investors Want Companies with Strong Financials to Seize Opportunities

Sources: BCG survey, Investment Thesis for 2009 and Beyond; Collateral Damage: Function FocusValuation Advantage: How Investors Want Companies to Respond to the Downturn, BCG White Paper, April 2009.Note: Respondents were asked, If a company generates excess cash well beyond its committed debt payments and dividend, how would you rank the following options based on your preference for use of this excess cash? The exhibit shows the number of times each option was selected first or second. The sample size was 135, but not all the surveyed investors responded to this question.

T B C G

T odays M&A opportunities vary according to a companys fi nancial strength. BCGs anal-ysis of more than half the S&P 500 compa-nies showed that just one-fi h have the fi -nancial muscle to take on the risks of a deal without putting themselves in playthey are classic pred-ators. (See Exhibit 10.) A similar proportion are preyso weak and vulnerable that they need to focus on surviving the downturn. But 60 percent are in the gray area in-between, with the potential to become either predator or preyor simply to miss the boat. With the recovery not yet as strong as hoped, these businesses must assess their fi nancial and market positions as a matter of urgency in order to ensure that they make the right strategic moves.

Are You Ready for M&A?

Despite the sharp downturn and continuing fi nancial un-certainty, a recent BCG survey found that 22 percent of European companies intend to step up their deal-making activity, having increased their M&A plans during the cri-sis.5 More than half the respondents (51 percent) said they are sticking to their M&A plans despite the deterio-rating fi nancial and economic climate. Nearly one-third (29 percent) of the companies surveyedincluding half of the largest companiesare likely to do a deal in the next 12 months involving a company with sales of more than 250 million. But who will be the predators and who will be the prey in such transformational deals?

To answer this question, every company should stress-test its business to evaluate the options. But this must be done through a downturn lens because traditional indicators of fi nancial health, such as free cash fl ow and relative val-uation multiples, can no longer be relied upon. What ap-

pear to be strengths can rapidly become major weakness-es if trading conditions suddenly deteriorate, pushing profi tability and cash fl ow deep into the red. Each busi-ness unit must be stress-tested against worst-case scenar-ios, such as a 25 percent drop in sales, a prolonged down-turn, or default by a major customer or supplier.

Even those companies that appear to be battle ready overall may still fi nd weaknesses that need to be correct-ed in order to further strengthen their fi repower and al-low them to focus on acquisitions. If there are value-destroying business units that cannot be fixed, they should be sold to release resources for the value creators. As BCGs research has shown, divestments in a downturn can create substantial value for the sellers when assets are sold to the right buyers.6

For the majority of companies that are neither predator nor prey, the good news is that up to one-quarter of them can transform themselves into predators before the M&A market surges. To do so, however, they will have to take the actions that will allow them to strengthen their fi -nances and reshape their businessesin readiness to seize M&A opportunities when they arrive.

BCGs predator-prey matrix can be used to clarify a com-panys M&A strategy. (See Exhibit 11.) It maps operation-al stability against fi nancial stabilitytaking into account liquidity, the relative vulnerability of business units in a recession, and other considerationsand indicates the

5. See M&A: Down but Not OutA Survey of European Companies Merger and Acquisition Plans for 2009, BCG White Paper, December 2008.6. See The Return of the Strategist: Creating Value with M&A in Down-turns, BCG report, May 2008.

Current M&A Opportunities

B D W O A F

0 1 2 3 4 5 6 7 98 10 11 12

2468

101214161820222426

Five-year CDS spread2 (%)

P/E ratio1

Predators ~20%

Gray area ~60% Prey ~20%

Median CDS spread

Median P/E

A company with a higher CDS spread isconsidered more likely to default by the market

Exhibit 10. BCGs Analysis Indicates That Roughly 20 Percent of the Surveyed S&P 500 Companies Can Be Considered Predators

Sources: Bloomberg; Thomson Reuters; BCG analysis.Note: The sample consists of 281 companies in the S&P 500 with positive earnings forecast for 2010 and available data on CDS spread; data as of February 3, 2009.1Forward-looking price-to-earnings (P/E) ratio through 2010, based on consensus estimates.2CDS is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller and in return receives a payoff if the underlying financial instrument defaults. CDS spread reflects the default risk of a company as viewed by the market. A five-year CDS spread reflects the annual price premium as a percentage of nominal value to insure a five-year bond against default. (1 percent = 100 basis points.)

Prey

Preserve intrinsic value of businesses

Pay down debt Sell nonstrategic businesses to pay o debt Restructure debt schedule to reduce risk of default

Liquidators

Sell o assets to reduce debt

Improve protability of remaining businesses

Liquidate if unable to improve protability above cost of capital

Operationalstability

Low

Low

High

Financial stability

Predators

Enhance competitive advantages Gain market share protably Invest wisely where returns are above cost of equity Acquire prey when long-term value can be added Acquire good pieces of business (that is, products that t) and avoid toxic portions of liquidators

Cyclical leaders

Improve near-term EBIT as quickly as possible; reduce operational volatility in order to become less vulnerable in future downturns

Avoid excessive debt that would turn the company into a liquidator

Operationalstability

Low

High

High

Exhibit 11. BCGs Predator-Prey Matrix Can Be Used to Clarify a Companys M&A Strategy

Source: BCG experience.

T B C G

steps companies need to take to move into an e ective defensive or o ensive position.

For example, potential predators should not just be think-ing about buying entire companies but also lookingout for business unit divestitures that could allow them to gain market share profitably. BCGs research hasshown that buyers can generate substan-tially higher returns from acquiring good pieces of business than from wholesale ac-quisitions.7

Some companies will realize that they are vulnerable and must act quickly and deci-sively. They must cut costs and make their cost structures as fl exible as possible. For these companies, it will also be critical to maximize cash generation, using both operational and fi nancial levers, such as working-capital reductions. Their aim must be to prevent a profi t slump from turning into a liquidity crisis that leads, in turn, to potentially life-threatening prob-lems in refi nancing.

Divestments should be contemplated not only to dispose of weaker units but also to generate funds for the remain-ing business. Companies that divest actively in a down-turn show that they are committed to restructuring their businesses, and they are o en rewarded by investors.

Who Are the Predators?

The most active acquirers right now are fi nancially sound companies with strong balance sheets, high profi tability, and su cient cash to capitalize on the weaknesses of com-petitors. They can take advantage of the current low valu-ation levels to transform their industry and improve their own position within it. But they must be ready to act promptly given the incipient recovery in asset prices in the fi rst half of 2009the bargains may not be there for long.

Many large companies certainly have the fi repower for M&A. The cash reserves of the S&P 500 companies reached nearly $1.5 trillion last yearhigher than at any time in history and 71 percent more than in 2000, the peak of the dot-com boom. In spite of record fi rst-quarter losses in 2009, fi nancially sound strategic buyers are still able to fund acquisitions in an environment in which val-uation levels can o er attractive returns. With investors keen for them to capitalize on these opportunities, they

can gain market share profi tably by consolidating their weaker competitors and acquiring parts of othersand increase their long-term value.

Transactions over the last yearin some cases promoted or at least supported by governmentshave o en been in industries such as fi nance and automotive that are on

the ropes. But there are also opportunities for large-scale transactions that could transform the competitive landscape of other industries, including currently ro-bust sectors such as pharmaceuticals and utilities.

The PE fi rms whose acquisitions fueled the M&A wave in the runup to the credit

crunch still have dry powderthe undrawn capital com-mitments of limited partnersof around $500 billion at their disposal.8 While the amount of funds raised has fall-en 11 percent since 2006, the aggregate capital raised is up 7 percent since then. More than $550 billion was raised in 2008, signifi cantly more than in the boom year of 2000, when the fi gure was $258 billion. While some limited partners with liquidity problems are trying to reduce their committed investments to PE funds, BCGs research sug-gests that this will result in a reduction of no more than 15 percent.

Yet, as noted in the previous section, the closure of the debt markets has hit PE hard. For now, PE fi rms are fo-cused on working and holding their portfolio companies rather than acting as predators. But they continue to be a source of funds for other predators by buying distressed debt in target companies and taking minority stakes. There were 552 public investments by PE fi rms worth more than $56 billion in the two years leading up to the end of June 2009. (See Exhibit 12.)

One other group of potential predators is sovereign wealth funds, which were sitting on assets of more than $3 trillion before the crisis started. Falling asset prices have hit SWFs just as they have other investors, but these funds are still estimated to be worth around $2.3 trillion. However, according to BCGs research, SWFs have been

7. Ibid.8. See Driving the Shakeout in Private Equity: The Role of Investors in the Industrys Renaissance, BCG and IESE Business School White Paper, July 2009.

Acquirers must

act promptlythe

bargains may not be

there for long.

B D W O A F

less likely than other investors to choose outright acquisi-tions to deploy their funds, instead taking minority stakeso en less than 5 percent. Rather than seeking a directing role, they prefer to interact with management at a personal and confi dential level.

For now, SWFs are not driving M&A activitynot even when divestments become available. But since hitting the headlines a few years ago, they have become a signifi cant force in the capital markets. In the early stages of the credit crunch, SWFs underpinned some leading fi nancial institutions and other companies in distress. And in par-ticular instances, they can play a decisive roleas recent developments in the German automotive industry have demonstrated.

Who Are the Prey?

Many of the targets for M&A in the current fi nancial cri-sis have been in sectors hard-hit by the credit crunch, such as fi nancial services and the automotive industry. Some distressed banks and carmakers were forced to fi nd refuge in wholesale acquisition by competitors. Others

survived by divesting businesses that were underper-forming, releasing much-needed capital.

But there has also been M&A activity in relatively healthy sectors such as pharmaceuticals. Even a er the stock mar-ket rebound in the fi rst half of 2009, the S&P 500 compa-nies were trading in June 2009 at price-to-earnings ratios that were half those of 2001, with bigger declines in their price-to-book ratios. (See Exhibit 13.) Companies whose shares have fallen the most will be seen as potential tar-gets by competitors, generating sporadic and unpredict-able hostile-takeover bids in 2009 and beyond.

A third target for M&A activity is businesses divested by larger companies. Some will be spun o by healthy com-panies to pay down debt and strengthen their balance sheets. Others will be put up for sale by less healthy com-panies that wish to improve their liquidity and focus on their value-creating business units.

The M&A pipeline will also be fed by PE-owned portfolio companies. In an analysis conducted in November 2008 by BCG and IESE Business School (University of Navarra),

0

10

20

30

0

50

100

150

200

1990

Number of deals$billions

Value of dealsNumber of deals

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Exhibit 12. Public Investments by PE Firms Soared Alongside the General Trend

Sources: Thomson One Banker; BCG analysis.Note: Figures are based on announced acquisitions of minority stakes in public companies by financial sponsors.

T B C G

half the PE portfolio companies studied were judged like-ly to default within the next three years.9 The partial re-covery in the debt markets in mid-2009 increased the availability of fi nancing, but our latest White Paper on PE noted that maturing leveraged-buyout and high-yield debt levels were rising sharply, with refi nancing needs ex-pected to reach nearly $400 billion by 2014.10

The largest driver of deal volume is likely to be divest-ments by distressed companies with immediate fi nanc-ing needs that either cannot borrow the funds they need

or can do so only by incurring unacceptably high costs. In the next chapter, we will look at distressed M&A in more detail and present BCGs fi ndings on how to dothe right deal in ways that do not drag the acquirer into distress.

3.2

0

2

3

4

5

6P/B ratio

The aggregate price-to-earnings ratio of theS&P 500 has dropped by 50 percent over 2001...

... while the aggregate price-to-book ratio hasdropped by approximately 60 percent

50%

20.3

0

10

15

20

25

30P/E ratio

Jun2009

Jan1995

Jul1998

Low valuation levelscreate a potentiallyattractive dealenvironment

Jan2002

Aug2005

High valuation levelscreate a lessattractive dealenvironment

Jun2009

Jan1995

Jul1998

Jan2002

Aug2005

60%

Exhibit 13. Valuation Levels Have Come Down Significantly

Sources: Bloomberg; BCG analysis.

9. See Get Ready for the Private-Equity Shakeout: Will This Be the Next Shock to the Global Economy? BCG and IESE Business School White Paper, December 2008.10. See Driving the Shakeout in Private Equity: The Role of Investors in the Industrys Renaissance, BCG and IESE Business School White Paper, July 2009.

B D W O A F

M&A is more likely to create value in a downturn than in an upturnand this downturn effect is even more pro-nounced when the deal involves a dis-tressed company. Interestingly, the se-verity of the current crisis appears to have accentuated the distressed M&A e ect, with even higher returns for both acquirers and targets in 2008 than in downturns during the previous 15 years. (See Exhibit 14.)

In such an adverse environment, it is more than ever im-portant to identify the right deal. Recent research con-ducted by BCG has identifi ed several factors that signifi -cantly affect the chances that a distressed deal will succeed:

The fi nancial strength of the acquirer

The cause of distress in the target

The relative size of the acquirer and the target

The core sectors of the acquirer and the target

Distressed M&A for Smart Predators

It has long been known that M&A destroys value for ac-quirers in the majority of deals. But BCGs research shows that the acquisition of deeply distressed companies in a downturn produces positive returns on average, with the cumulative abnormal return being 1 percent, compared with 1.1 percent in an upturn. However, these are aver-ages. Some distressed M&A transactions produce better results and some produce negative returns, so smart pred-ators must adopt strategies that exploit the factors that maximize value creation.

The fi rst success factor for a predator is to be a healthy companyand, crucially, healthier than the target. The acquisition of a distressed target is more likely to be suc-cessful if the predator is above average in profi tability and more profi table than the target. This is hardly sur-prising: capital markets are more likely to believe that a healthy acquirer can turn around a distressed target, and they value the deal accordingly. It is also a reminder that postmerger integration (PMI) requires resources and management focus, and an acquisition is more likely to create value if there are no weaknesses in the predators business to divert attention. The moral is to fi x your own problems fi rst to avoid parallel restructuring.

A second success factor for a predator is to choose tar-gets that have fi nancial problems but have not yet run into operating problemsfor example, a company that is breaking its debt covenants but remains profi table. In such cases, recapitalization is o en enough to turnthe target around relatively quickly. Even when the tar-get does have operating problems, the returns from ac-quiring it will be higher if it also has problems with its capital structure, such as excessive leverage, which the predator can sort out. In such circumstances, market ex-pectations will be depressed, producing very low valua-tion levels and making the target more attractive. It should also be easier to implement hard restructuring strategies with such a target, since the alternativebankruptcywill be evident to government, labor unions, and regulators.

The third success factor for predators is to acquire smaller distressed targets. More than 40 percent of deals in which the targets sales are less than half those of the predator are successful, compared with 32 percent in which the targets sales are more than half the predators. Acquiring

A Guide to Distressed M&A

T B C G

smaller targets carries less risk and is easier to fi nance, which the market will recognize in its response to the an-nouncement.

Finally, distressed acquisitions outside the predators core sector are marginally more successful than acquisitions within the same sector. Because of overconfi dencethe assumption that nobody knows the business better than they dopredators that make strategic acquisitions with-in their own sector are more likely to overpay. As a result, they wind up paying high premiums that can turn the deal into a failure for the predators shareholders. Smart predators screen for smaller distressed targets across in-dustries.

Smart Strategies for Distressed Targets

For distressed companies that have identifi ed themselves as prey, the objective must be to fi nd a buyer that is pre-pared to pay the highest price. Selling distressed assets is rarely a straightforward process, but where possible, the fi rst order of business should be to court predators with sound fi nancials. The return for a distressed target is much higher when the acquirer is above median profi t-ability. And a bid from an acquirer in good fi nancial shape is more likely to be completed, to the benefi t of the targets shareholders.

The second success factor for a distressed target is to fi nd a big brother. Being acquired by a signifi cantly larger company produces above-average returns, even if the tar-get company is not in distress. But when the target is a distressed company, acquisition by a company with more than double its sales will produce substantially higher re-turns than when the acquirers sales are closer to those of the target. Those higher returns refl ect the markets view that a distressed M&A bid is more likely to be concluded when the predator is biting o something it can chew and when the target is less able to bargain with the predator. Courting a predator of similar size therefore risks leaving shareholders money on the table.

Finally, distressed target companies should seek to attract bids from companies in a di erent sector. Shareholder re-turns are higher when a company in operating distress is sold to a predator from outside its core sector. In some cases, this may be because an outsider can see opportu-nities that insiders cannot spot, and therefore it is pre-pared to pay more. A smart target will not confi ne the search for a buyer to its own sector but will cast its eye further afi eldcompanies that are not direct competitors could be attractive buyers.

4

2

0

2

4

0

2.4 percentage points

0

20

40

6050.4

20.3

30.1 percentage points

Distressed M&Ain 2008

Distressed M&Ain previous downturns,

19922007

Acquirers Targets

2.4

N = 30 N = 149

Distressed M&Ain 2008

Distressed M&Ain previous downturns,

19922007

CAR1 (%)

CAR1 (%)

N = 31 N = 157

Exhibit 14. Returns from Distressed M&A for Both Acquirers and Targets Were Higher in 2008 Than in Previous Downturns

Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; BCG analysis.Note: A downturn year is defined as one in which worldwide GDP growth was below the average for the period 1990 to 2007. Distressed M&A is defined as a transaction whose target EBIT margin is below the sample median for targets.1Average cumulative abnormal return was calculated over a seven-day window centered around announcement day (+3/3).

B D W O A F

T here are signs that the tide could be turning for M&A. Equity values have stabilized and debt markets are returning to lifeimprov-ing liquidity and reducing the cost of credit from the exceptionally high levels reached in the 18 months following the start of the credit crunch. It is impossible to say when the M&A market will return to growth. But when it does, there will be a three- to six-month window of opportunity in which those companies that have prepared themselves for action can take advan-tage of itbefore the rest of the world catches up. With investors willing to sanction M&A in the coming months, now is the time to prepare for the rare chance to launch transformational deals.

Successful Strategies for Predators in the Downturn

The factors that make for successful M&Aa coherent strategy, fl awless planning, and rigorous PMIdo not change with the economic cycle. In a downturn as severe as the current one, however, predators cannot simply ap-proach potential acquisitions as if nothing has changed. Conventional M&A strategies and tactics must be updat-ed to deal with much more uncertainty.

Targets may become available overnight, requiring fast-er responses than those typical of the search processes traditionally used by business development teams. Target searches should scour the markets for attractive prospects that may not be up for sale now but could become available in the near future. Potential targets to scrutinize include companies with refi nancing is-sues, struggling PE portfolio companies, and seriously undervalued competitors that are ripe for hostiletakeover.

Returns may be higher from the acquisition of busi-nesses that are not the obviously perfect strategic fi t o en sought in less turbulent times. Predators should take a fresh look at their industry and beyond. The rules of the game are changing, and the most lucrative opportunities may be businesses that would not nor-mally be seen as potential targets.

Funding is still di cult, and arrangements can fall apart as banks respond to developments in the fi nan-cial markets and beyond. Predators should always have a plan B ready and should consider alternative sources, such as PE fi rms that have funds but lack the debt fi nancing needed to be predators themselves. SWFs, while less likely to provide majority funding and managerial leadership, may be interested in a strategic long-term investment.

Valuation methods may prove inadequate in the current extreme circumstances, as varying pressures on di er-ent stock markets make peer group comparisons di -cult. With earnings set to reach their lowest levels in the second half of 2009 or the fi rst half of 2010, exist-ing multiples may be too high. Valuation of targets re-quires a good deal more than analysis of their fi nan-cials and simple multiple calculationsreal business planning and exploration of worst-case scenarios are necessary.

Forecasts must factor in sudden and fundamental changes in a business and fi nancial environment that remains volatile. BCGs proprietary marketplace-research techniques probe revenue streams against ad-verse developments, such as a deepening downturnor even a lasting, L-shaped one. The results help provide an understanding of the shape of baseline

The Clock Is TickingBe Ready for Action

T B C G

cash fl ows, their vulnerability, and how they can be im-proved. Other elements in the BCG toolbox include analysis of the competitive positioning of the targets products and its vulnerability to consolidation among its competitors.

Execution should not skimp on due diligence if the ac-quirer is to avoid being sucked down by undiscovered problems in the target. With less activity and fewer buyers in the markets, there should be less pres-sure to complete transactions according to a tight timetable. The target may wish to impose such a timetable in a volatile environment, but completion of thorough due diligence is in its inter-est as well.

Advance preparation is essential in responding to these new circumstances. Shareholders and other stakeholders should be prepared for the possibility of deals before they emerge, and they should be briefed as soon as possible a er bids are made to maintain their support. BCGs sur-vey of investors showed the importance of managing ex-pectations before initiating M&A transactions.11 When asked to name the most important criteria for investing in a company today, investors cited management credibil-ity and a proven track record fi rst. Moreover, they said that the keys to establishing those attributes are transpar-ency, clear communication with investors, and a compel-ling long-term plan for creating value.

Integrate and Restructure Fast

In the current fi nancial environment, the focus during PMI must be on cash management. A well-planned and well-executed PMI strategy will release cost synergies as rapidly as possible, but earnings-oriented restructuring is

still time-consuming. From day one of the merger,measures to increase cash generation must be the top priorityand in tough credit markets, they may be essen-tial to funding the restructuring.

The quickest way to release large amounts of cash is to optimize the three key drivers of working capital: inven-

tories, receivables, and payables. BCGs ex-perience shows that by doing this through-out the entire value chainfrom product design to operations to salescompanies can easily reduce their working capital by as much as 40 percent and cut their costs by up to 10 percent, even when the busi-ness is stable. Carve-out opportunities can also release cash to fund restructuring, as

well as minimize PMI risks.

Todays severe downturn has one great advantage for predators: it can make the previously impossible deal possible. Governments, for example, are more receptive to consolidation of struggling businesses when the alter-native may be corporate failures or state bailouts. Like-wise, regulators are more likely to approve M&A that would previously have been seen as having adverse ef-fects on competitionparticularly in industries such as fi nancial services, where collateral damage in the wider economy could be severe. Employees have become more open to fl exible working arrangements, such as part-time work, shorter hours, and furloughs, making it easier to re-structure acquisitions and reduce fi xed costs in parts of the world where such measures would be harder to im-plement in less di cult times.

11. See Collateral Damage: Function FocusValuation Advantage: How Investors Want Companies to Respond to the Downturn, BCG White Paper, April 2009.

The downturn can

make the previously

impossible deal

possible.

B D W O A F

Success with M&A comes when preparation meets opportunity. The following is a six-point plan to minimize vulnerabilities before capi-talizing on acquisitions.Check your home turf1.

Improve the operating performance of your company

Maximize and build up your cash

Optimize your fi nancial structure

Secure short-term liquidity

Optimize your companys valuation2.

Manage investor relations to enhance your relative valuation

Reassess your dividend policyincreasing divi- dends could raise your valuation

Improve your debt rating

Examine the market thoroughly3.

Understand industry trends

Search for targets not for sale nowtheir time might come

Look for smaller acquisitions

Dont overlook good distressed targets from weaker companies or PE portfolios

Prepare for potential deals4.

Be ready to reassess value when the crisis distorts conventional methods

Think about how you will fi nance dealsand line up plan B

Have due-diligence teams briefed and on call

Evaluate potential pitfalls and test worst-case scenarios, including a prolonged downturn

Prepare shareholders and stakeholders for the pos- sibility of bids

Execute quickly5.

Start due diligence on main issues immediately

Use reps and warranties for minor issues

Consider o ering payment in shares if the targets equity is cheaper, but...

Finalize the deal structure fastcash, shares, or a combination

Capitalize on distressed targets and low valuations

Integrate rigorously in a more forgiving M&A envi-6. ronment

Cut fi xed and variable costs vigorously

Focus on cash

Involve labor unions and employee representatives, stressing the need for urgent action

Harvest synergies and make quick wins

Actively communicate rationales and achievements to improve your companys valuation

Guidance in the Crisis for Predator CEOs

T B C G

The research that underpins this report was conducted by the BCG M&A Research Center throughout the fi rst half of 2009. It is based on analyses of two di erent data sets totaling more than 400,000 M&A transactions.

General Market Trends. We analyzed all reported M&A transactions in North America, Europe, and Asia-Pacif-ic from 1981 through the middle of 2009. For the anal-ysis of deal values and volumes, we looked at deals with a minimum transaction value of $25 million and excluded those marked as recapitalizations, repurchas-es, or exchange o ers.1

Shareholder Value Created and Destroyed by Public-to- Public M&A.2 We analyzed deals involving publicly list-ed acquirers and targets from 1992 through 2008 (5,290 deals), focusing on the largest deals. To ensure that suf-fi cient explanatory data would be available, we set the minimum transaction size at $150 million for North America, $50 million for Europe, and $25 million for Asia-Pacifi c. Shareholder value was measured by total shareholder returns and calculated using the event study method. Unless otherwise stated, value creation and destruction refer to the value gained or lost by the acquirer.

Although distinct samples were required in order to ana-lyze di erent issues, all valuation analyses employed the same econometric methodology. For any given day and company, the abnormal (that is, unexpected) returns were calculated as the deviation of the observed from the expected returns. (See Equation 1.)

Following the most commonly used approach, we em-ployed a market model estimation to calculate expected returns.3 The market model approach runs a one-factor

ordinary least squares (OLS) regression of an individual stocks daily returns against the contemporaneous re-turns of a benchmark index over an estimation period preceding the actual event. (See Equation 2.)

The derived alpha and beta factors are then combined with the observed market returns for each day within the event window to calculate the expected return for each day. (See Equation 3.) The market model thus accounts for the overall market return on a given event day, as well

1. These are transactions that do not cause a change in ownership. Exchange offers seek to exchange consideration for equity or secu-rities convertible into equity.2. This analysis was taken from The Brave New World of M&A: How to Create Value from Mergers and Acquisitions, BCG report, July 2007.3. Eugene F. Fama, Lawrence Fisher, Michael C. Jensen, and Richard Roll, The Adjustment of Stock Prices to New Information, Inter-national Economic Review, vol. 10, no. 1 (February 1969), pp. 121; and Stephen J. Brown and Jerold B. Warner, Using Daily Stock Re-turns: The Case of Event Studies, Journal of Financial Economics 14 (1985), pp. 331.

Equation 1

Equation 2

Equation 3

with:ARi,t = Abnormal return for given security i and day tRi,t = Observed return for given security i and day tE(Ri,t) = Expected return for given security i and day t

with: = Regression intercept = Beta factor

ARi, t = Ri, t E (Ri, t )

ARi, t = Ri, t (i + iRm, t )

E(Ri, t ) = i + iRm, t + i, t

AppendixMethodology

B D W O A F

as the sensitivity of the particular companys returns rel-ative to market movements.

In Exhibit 1, we show the event study setup that we used to estimate the value created by an M&A transaction. Us-ing a 180-day period starting 200 days and ending 21 days before the deal announcement, we estimate a market model relating the return on an individual stock to the return of a relevant benchmark index.4 We do not con-sider the 17-day grace period from 20 days to 4 days be-fore an M&A announcement, in order to ensure that the data are not contaminated by leaks during the runup to the o cial announcement. We then derive the cumula-tive abnormal return, or CAR, by aggregating the abnor-mal returns (that is, the di erence between actual stock returns and those predicted by the market model) day by

day throughout the event period of 3 days before to 3 days a er the announcement date.

Finally, using macroeconomic time-series data, we fur-ther subdivide our sample into periods of economic up-turn and downturn. An economic downturn is defi ned as a period when the average annual growth rate of GDP for the world is below the long-term average of 3 percent. In 2008, the outbreak of the fi nancial crisis caused the fi rst downturn year since the bursting of the Internet bubble. (See Exhibit 2.)

4. We used the Dow Jones Industrial Average for North America, Dow Jones Euro Stoxx for Europe, and Dow Jones Asia Pacific for the Asia-Pacific region.

200 3

0

+3Days

21

Announcement day

Estimation period (180 days) Grace period(17 days)

Event period (7 days)

Exhibit 1. Event Study Setup

GDP change per year (%)5

4

3

2

1

01990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Long-termaverage:

3%

Upturn denition GDPt > 3.0% Downturn denition GDPt < 3.0%

2.9

2.3 2.3

1.7

3.6

2.9 3.13.5

2.0

3.2

4.1

1.51.8

2.6

3.83.3

3.8 3.7

2.0

Exhibit 2. An Economic Downturn Is Defined as a Period of Below-Average GDP Growth

Sources: Economist Intelligence Unit; BCG analysis.Note: Figures are based on real change in worldwide GDP (2008 was not included in the long-term average because of its distorting effect).

T B C G

For Further ReadingFor Further Reading

The Boston Consulting Group pub-lishes other reports and articles on the topic of M&A that may be ofinterest to senior executives. Recent examples include:

Collateral Damage: Industry FocusDrawing Lessons from the Past to Chart a Course for InsurersA White Paper by The Boston Consulting Group, July 2009

Collateral Damage Quick-o-Nomics UpdateLeading- Indicator Edition: Searching for Green ShootsA White Paper by The Boston Consulting Group, July 2009

Driving the Shakeout in Private Equity: The Role of Investors in the Industrys RenaissanceA report by The Boston Consulting Group, published with the IESE Business School of the University of Navarra, July 2009

Collateral Damage, Part 7: Green Shoots, False Positives, and What Companies Can Learn from the Great DepressionA White Paper by The Boston Consulting Group, June 2009

Real-World PMI: Learning from Company ExperiencesA Focus by The Boston Consulting Group, June 2009

The Clock Is Ticking: Preparing to Seize M&A Opportunities While They LastA White Paper by The Boston Consulting Group, May 2009

Collateral Damage: Function FocusValuation Advantage: How Investors Want Companies to Respond to the DownturnA White Paper by The Boston Consulting Group, April 2009

Get Ready for the Private-Equity Shakeout: Will This Be the Next Shock to the Global Economy?A White Paper by The Boston Consulting Group, published with the IESE Business School of the University of Navarra, December 2008

M&A: Down but Not OutA Survey of European Companies Merger and Acquisition Plansfor 2009A White Paper by The Boston Consulting Group, December 2008

Missing Link: Focusing Corporate Strategy on Value CreationThe 2008 Value Creators report byThe Boston Consulting Group, Septem-ber 2008

Venturing Abroad: Chinese Banks and Cross-Border M&AA report by The Boston Consulting Group, September 2008

Special Issues in PMI: Dealing with Carve-Outs, Unions, and Other ChallengesA Focus by The Boston Consulting Group, June 2008

The Return of the Strategist: Creating Value with M&A in DownturnsA report by The Boston Consulting Group, May 2008

B D W O A F

Note to the ReaderNote to the Reader

AcknowledgmentsThis report is the product of the Cor-porate Development practice of The Boston Consulting Group. Theauthors would like to acknowledge the contributions of their colleagues:

Pedro Esquivias, a partner and managing director in the fi rmsMadrid o ce and a member of the global M&A team

Tawfi k Hammoud, a partner and managing director in BCGs Toronto o ce and a member of the global M&A team

Gerry Hansell, a senior partner and managing director in the fi rms Chi-cago o ce and the leader of theCorporate Development practice in the Americas

Jrme Herv, a partner and man-aging director in BCGs Paris o ce and the leader of the CorporateDevelopment practice in Europe

Heino Meerkatt, a senior partner and managing director in the fi rms Munich o ce and the global private-equity sector leader

Daniel Stelter, a senior partner and managing director in BCGs Berlino ce and the global leader of the Corporate Development practice

Olivier Wierzba, a partner and managing director in the fi rms Paris o ce and a member of the global M&A team

The authors would also like to thank Markus Brummer, Kerstin Hobels-berger, Philipp Jostarndt, and Domi-nic C. Klemmer of BCGs M&A Re-search Center for their extensive support.

Finally, the authors would like to ac-knowledge John Willman for helping to write this report, and Gary Calla-han, Angela DiBattista, and Gina Goldstein for their contributions to its editing, design, and production.

For Further ContactBCGs Corporate Development prac-tice is a global network of experts helping clients design, implement, and maintain superior strategies for long-term value creation. The prac-tice works in close cooperation with the fi rms industry experts and em-ploys a variety of state-of-the-art methodologies in portfolio manage-ment, value management, mergers and acquisitions, and postmerger in-tegration. For more information, please contact one of the following leaders of the practice.

The AmericasDaniel FriedmanBCG Los Angeles+1 213 621 2772friedman.daniel@bcg.com

Je GellBCG Chicago+1 312 993 3300gell.je @bcg.com

Tawfi k HammoudBCG Toronto+1 416 955 4200hammoud.tawfi k@bcg.com

Gerry HansellBCG Chicago+1 312 993 3300hansell.gerry@bcg.com

Je rey KotzenBCG New York+1 212 446 2800kotzen.je rey@bcg.com

Eric OlsenBCG Chicago+1 312 993 3300olsen.eric@bcg.com

John RoseBCG New York+1 212 446 2800rose.john@bcg.com

Alan WiseBCG Atlanta+1 404 877 5200wise.alan@bcg.com

EuropeGuido CrespiBCG Milan+39 0 2 65 59 91crespi.guido@bcg.com

Peter DamischBCG Zurich+41 44 388 86 66damisch.peter@bcg.com

T B C G

Pedro EsquiviasBCG Madrid+34 91 520 61 00esquivias.pedro@bcg.com

Thomas HerbeckBCG Moscow+7 495 258 34 34herbeck.thomas@bcg.com

Jrme HervBCG Paris+33 1 40 17 10 10herve.jerome@bcg.com

Barry JonesBCG London+44 207 753 5353jones.barry@bcg.com

Stuart KingBCG London+44 207 753 5353king.stuart@bcg.com

Florian KhnleBCG Brussels+32 2 289 02 02kuehnle.fl orian@bcg.com

Heino MeerkattBCG Munich+49 89 23 17 40meerkatt.heino@bcg.com

Alexander RoosBCG Berlin+49 30 28 87 10roos.alexander@bcg.com

Daniel StelterBCG Berlin+49 30 28 87 10stelter.daniel@bcg.com

Peter StrvenBCG Munich+49 89 23 17 40strueven.peter@bcg.com

Asia-Pacifi cAndrew ClarkBCG Auckland+64 9 377 2297clark.andrew@bcg.com

Nicholas GlenningBCG Melbourne+61 3 9656 2100glenning.nicholas@bcg.com

Hubert HsuBCG Hong Kong+852 2506 2111hsu.hubert@bcg.com

Junichi IwagamiBCG Tokyo+81 3 5211 0300iwagami.junichi@bcg.com

Dinesh KhannaBCG Singapore+65 6429 2500 khanna.dinesh@bcg.com

Collins QianBCG Shanghai+86 21 2306 4000qian.collins@bcg.com

Byung Nam RheeBCG Seoul+822 399 2500rhee.byungnam@bcg.com

Harsh VardhanBCG Mumbai+91 22 6749 7000vardhan.harsh@bcg.com

The Boston Consulting Group (BCG) is a global manage-ment consulting fi rm and the worlds leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep in-sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet-itive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 66 o ces in 38 countries. For more infor-mation, please visit www.bcg.com.

For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.com/publications.

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