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While M&A deals and turnarounds are individually hard to pull off, combining the two can be even more challenging. Yet based on our research, including an analysis of roughly 1,400 M&A-based turnarounds between 2005 and 2018 in which the target had experienced a drop in performance before acquisition, we have identified six factors that can help acquiring companies improve their odds of success.
In the current business environment, M&A and turnarounds are both increasingly important. Let’s start with M&A. As long-term growth rates trend downward in many economies, business leaders are turning to acquisitions to fuel growth. According to research by our colleagues at Boston Consulting Group, roughly 36,000 M&A deals were announced worldwide in 2017, about 6,500 more than the long-term annual average.1 That trend continued into 2018, when the total value of transactions fell just shy of the record set in 2007.2 However, research has consistently found that most of these deals fail to create value,3 and our analysis supports that.4
Turnarounds are also becoming imperative. Companies face a seemingly endless stream of disruptions from new technology, emerging competitors, shifts in consumer behavior, regulatory changes, slowing economic growth, and other threats, any of which can hurt performance and require substantial and prompt changes in operations and strategy. We have found that, at any point in time, 1 in 3 companies requires a turnaround due to a significant deterioration in total shareholder return (TSR).5 Furthermore, the current economic environment may amplify this need. As of early 2019, leading global economic indicators have weakened, economists and policy makers generally expect growth to slow even more over the next couple of years, the stock market has been increasingly volatile, and geopolitical risks are multiplying — all of which are likely to further threaten companies’ performance and increase the need to transform. Still, only about 1 in 4 turnaround programs leads to long-term improvements in performance.6
Turnaround acquisitions make up roughly half of all M&A deals. (And the share of such turnaround deals is likely to increase should the economy experience a downturn — as was the case during the last recession, when turnarounds comprised nearly 60% of all M&A deals.) Yet our analysis shows that these deals have a high failure rate: 61% do not lead to an improvement in financial performance. The odds are somewhat better for M&A turnarounds than they are for turnarounds generally, given the discretionary nature of M&A and buyers’ ability to “price in” deal difficulty to some extent. But the odds still are not great.
For the other roughly 40% of turnaround M&A deals, however, the rewards are considerable. This group of winners generated gains in both revenue growth and profit margins, and — most important — significantly better returns. In fact, they posted a 25-percentage-point difference in TSR compared with unsuccessful deals.
Six Critical Factors
How did these companies generate such improvements? To answer that question, we looked at an array of quantitative and qualitative data, including language about companies’ strategic orientation based on semantic patterns in Securities and Exchange Commission filings. (For more details, see “About the Analysis.”) From that analysis, we determined that six factors — all within the control of management — correlate to success in turnaround deals.
1. High investment in R&D. The right level of R&D investment varies significantly between sectors, from 6% to 8% of revenue in fields such as technology and health care to less than 1% in energy and financial services.7 That said, among companies within an individual sector, buyers with higher R&D spending than the median generated higher average annual TSR over the three years following the deal — 4 percentage points more than those spending below the median, controlling for other factors.
In contrast, higher capital expenditure investment than the sector median has a slightly negative impact on post-deal performance. Investing in hard assets for an underperforming business — a “more of the same” approach — is not likely to improve its performance on average. Instead, companies need to invest in innovation as part of a turnaround program.
2. A long-term orientation. Leaders integrating an underperforming business may focus, understandably, on the short term — days or weeks matter for issues that require urgent attention. (When a building is on fire, you put that out before worrying about things like the structural integrity of the foundation.) However, our analysis shows that maintaining a long-term strategic orientation led to an increase of 4 percentage points in three-year average TSR. This does not mean that companies can ignore day-to-day concerns, of course; rather, leaders must strike a balance between short- and long-term objectives. While they are attending to integration activities such as colocating teams and consolidating functions, for instance, they also need to anticipate the new opportunities they may be able to capitalize on, such as investing in new markets or business models.
3. A well-defined purpose. Our previous research on corporate purpose showed that companies with a well-defined purpose — meaning goals and aspirations that go beyond maximizing financial performance — generate more value.8 An acquiring company with a clear corporate purpose can help inspire the target organization in a turnaround M&A deal as well. In fact, buyers with an explicit purpose generated a 3-percentage-point improvement in average three-year TSR. The message for leaders in acquiring organizations is clear: Rather than focusing only on the financial or competitive benefits the deal is expected to generate, articulate a common purpose that will motivate and help align employees around specific activities to achieve a long-term goal.
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4. Sufficient investment in transformation. Significant turnaround efforts — whether organic or through a deal — often lead to restructuring costs. For example, a company may choose to close some plants and consolidate others, reorganize its business units, or write off assets that have become obsolete. Rather than thinking of these as expenses, successful acquirers treat them as investments. We found that buyers that made such investments in excess of the average for their sector generated a higher three-year average TSR — 5 percentage points more than those making below-median investments. Buyers should be willing to make the required investments in the target’s business and factor those into their acquisition strategy and price.
5. Ambitious synergy targets. Synergies play an important role in M&A value creation in general, and that’s even more true in the current environment, with deal multiples near historic highs. In this market, buyers need to aim for above-average synergies — in terms of both increased revenue and reduced costs. Although high aspirations don’t automatically guarantee higher results, they do appear to be a necessary condition for success. Among the deals we looked at, those in which management set above-average targets for their sector registered 8 percentage points more in three-year average annual TSR. In particular, we found that the sweet spot for capturing value from synergies is roughly 15% to 20% of a target’s revenue. Less than that, acquirers are not being ambitious enough. Beyond that level, they begin to see diminishing returns.
6. A willingness to act quickly. The single most important factor in a turnaround deal’s success is a willingness to take action quickly. Buyers that launched a turnaround program within the first year after a deal closed generated 12 percentage points more in three-year average TSR than those who waited until later. (We measured this by looking at the first quarter after the close in which the buyer reported restructuring costs.) In fact, among successful deals, companies captured roughly one-fourth of the total revenue growth and the total margin expansion within the first year. Although these companies built on that momentum and generated even bigger improvements in years two and three, the meaningful contribution in the first year signals the importance of taking steps to improve performance right away.
Engaging quickly has two benefits. First, it generates momentum and frees up capital, both of which can spur longer-term initiatives. Second, early action helps boost investors’ confidence, which is a particularly important factor in TSR in the short term.
While these six management actions can improve post-deal performance on their own, combining multiple actions is even more powerful. Indeed, there is a direct relationship between the number of success factors deployed and three-year TSR performance. Although only a small minority of companies used five or six of them, those companies performed significantly better than the rest. In addition, our analysis identified several deal characteristics that lie outside management’s control yet still have a significant impact on success rates. (See “Identifying the Right Target.”)
Investor Expectations Are Critical Early On
To make appropriate trade-offs during a turnaround effort, leaders need to know not only which factors lead to success but also which components of TSR generate the biggest payoff — and at which points in the process — so that they can adjust performance targets appropriately. To answer these questions, we looked at how revenue growth, cost reductions, and investor expectations each affected TSR performance during the five years following successful deals.
During the first year after a deal closes, cost-cutting and revenue growth both make similarly large contributions to TSR in successful deals. However, investor expectations are a stronger factor than revenue and costs combined, accounting for 54% of TSR among the best-performing companies we studied. It’s not until year three that revenue growth becomes a bigger contributor to TSR than investor expectations. And by year five, revenue growth accounts for 64% of TSR outperformance. (See “How Three Factors Affect Deal Performance.”) This suggests that a winning strategy in turnaround M&A balances clear and persuasive communication to investors early on (that is, telling them a convincing story about long-term value creation and then delivering on that promise), growth over the long term, and a steady focus on costs throughout.
Individually, corporate transformations and acquisitions are challenging and risky; turnaround M&A deals combine both sets of risks — but also offer opportunities. By leveraging empirical lessons about which managerial actions and deal characteristics have the largest impact on outcomes, leaders can design deals and integration programs that capture more value.
1. Long-term average refers to 2000-2017. J. Kengelbach, G. Keienburg, and T. Schmid, et al., “The 2018 M&A Report: Synergies Take Center Stage,” Boston Consulting Group, Sept. 12, 2018, www.bcg.com.
2. S. Basak and K. Porter, “Goldman Set to Lead M&A for 2018 After Buyout Firms Lift Business,” Bloomberg, Dec. 28, 2018, www.bloomberg.com.
3. A. Lewis and D. McKone, “So Many M&A Deals Fail Because Companies Overlook This Simple Strategy,” Harvard Business Review, May 10, 2016, https://hbr.org; and D. Walker, G. Hansell, and J. Kengelbach, et al.,“ The Real Deal on M&A, Synergies, and Value,” Boston Consulting Group, Nov. 16, 2016, www.bcg.com.
4. To assess performance, we looked at total shareholder return (TSR), a metric that includes both capital appreciation and dividends, as that is a more comprehensive indication of performance than changes in the share price alone.
5. A two-year decline in TSR of at least 10 percentage points.
6. M. Reeves, L. Faeste, and K. Whitaker, et al., “The Truth About Corporate Transformation,” MIT Sloan Management Review, Jan. 31, 2018, https://sloanreview.mit.edu.
7. R&D spend by sector represents median values, computed based on our data set of M&A deals.
8. M. Reeves, C. Dierksmeier, and C. Chittaro, “The Humanization of the Corporation,” Boston Consulting Group, Feb. 8, 2018, www.bcg.com.
i. R. Weisman, “Sanofi Chief Says Genzyme Purchase Paid Off,” The Boston Globe, Sept. 19, 2013.
ii. We determined the ESG scores of both buyer and target based on Eikon data.