While most M&A transactions start off hopeful, not all are destined for completion. Each year, a sizable number of deals are abandoned – and that number appears to be rising. A recent study published by the M&A Research Centre at the University of London's Cass Business School and enterprise data management firm Intralinks (the Study) undertakes a broad analysis of over 78,000 M&A transactions from the past 25 years, concluding that the deal failure rate of 7.2% in 2016 was the highest markets have seen since 1995. This number doesn't appear to be anomalous either – the year-on-year failure rate has been steadily increasing since a near-decade low in 2013.
Contributing factors
These statistics beg the question of what might be causing deals to be abandoned and what firms can do in order to reduce the chances that their transactions meet the same fate. The Study attempts to answer this question with a data-driven approach, narrowing in on a handful of factors which appear to be the prime contributors to deal failure. The first major distinction drawn is between transactions involving public company targets and those involving private company targets. During the period reviewed by the Study, private company target transactions boasted failure rates that were on average 66% lower than those of their public company target counterparts.
For transactions involving a private company target, the major factors affecting deal failure identified by the Study are as follows (from most significant to least significant):
- Size of the
target
As the size of the target approaches or exceeds that of the acquirer,1 the deal is more likely to fail. Industry experts consulted in the Study cited several reasons for these results, ranging from smaller firms' lower "headroom" for risk, to the psychological security exuded by larger firms.
Strategy: The Study suggests that firms focus on "strategic" transactions and to avoid "biting off more than you can chew". - Liquidity of the
acquirer
Deals where the acquirer has a higher liquidity ratio are at greater risk of failure. The difference is significant, in that deals in which the acquirer's liquidity ratio is 25% are over twice as likely to fail than those in which the acquirers assets equal its liabilities. Further reduction of deal failure risk does not appear to result, however, from acquirer liquidity ratios over 100%.
Strategy: The Study suggests using caution before entering into transactions with acquirers that have "weak balance sheets". - Method of
payment
Particularly in recent years, where cash is offered as the only form of consideration, deals are less likely to fail. Experts quoted in the Study refer to valuation and price fluctuation risk to explain why equity or mixed cash-and-equity deals are more often abandoned.
Strategy: The Study suggests that simple, cash-based consideration is preferable. - Reverse break
fees
Deals featuring break/termination fees payable by the acquirer have a lower risk of failure, which the Study suggests results from increased interest alignment created by the fee. Interestingly, the Study found that target break fees did not impact deal failure rates in terms of private company target transactions.2
Strategy: The Study recommends that targets negotiate reverse break fees.
Additional findings and takeaway
The Study also presented several other interesting statistics, including the effects of catastrophic political, versus economic, global events on deal failure rates and the relative deal failure rates broken down by industry and country of origin – each of which provide valuable insight.
Though the Study did not ultimately conclude what was the chief cause of the recent rises in the rate of abandoned deals, it proposed a plausible explanation – growing uncertainty in the marketplace as a result of significant geopolitical events – which may be causing price misalignment between acquirers and targets. Whatever the reason for the current trend, however, the factors identified by the Study are based on long-term data and should be of interest to any firm planning a deal, target or acquirer.
Footnotes
[1] Measured by the Study in terms of sales volume.
[2] The results were opposite for public company target transactions, wherein a target break fee reduced deal failure risk and reverse break fees had no impact.
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