The Performance of Acquisitions by High Default Risk Bidders

M&A is controversial. Many acquisitions are viewed as value-destroying for shareholders, and takeovers often encounter staunch opposition. To date, research into M&A performance has tended to focus on acquisitions where a weakened company was the target. A study from academics at Vlerick Business School, Cass Business School, and Swansea University looks at the scenario where the acquirer itself is in a financially parlous condition.

In fact, many global mergers and acquisitions are undertaken by bidders that are not in the best financial shape. These deals are intriguing, as they raise questions about the motivation behind them, and their ability to create value.

Do all bids by distressed bidders destroy value?

In the paper The Performance of Acquisitions by High Default Risk Bidders the bid characteristics, post-deal operating performance, announcement returns, and long-term returns of high default risk bidders are examined.

A sample of 1,758 completed US takeovers over the period 1989-2011 was examined. From this, 440 high risk default bidders were identified. The study finds that the average 3-year post-bid, peer adjusted buy-and-hold returns are significantly negative, whereas the low default risk control group exhibit a small positive gain. Analogous results were seen in a global sample of 2,351 completed bids from 38 non-US companies. These results indicate that managers of high default risk firms pursue worse acquisitions on average.

In light of this, how can such mergers be justifiied? Some claim they may create value if they constitute a turnaround option when the strategies of previous managers have failed. They may represent an attempt to improve the firm's competitive position, or to exit a difficult environment. Firms may use such takeovers in an attempt to strengthen themselves by acquiring firms that are a good fit for their core business. Alternatively, acquisitions may help high default risk bidders to mitigate risk by diversifying. These arguments, if robust, would suggest that M&As involving high default risk bidders can be value enhancing.

Yet high default risk companies would normally be presumed to seek to undertake cash conserving and/or generating strategies, rather than risky acquisitions that may deplete cash. This report finds that high default risk bidders adopt unconventional M&A strategies. They are indeed more likely to take over unrelated targets, probably to generate diversification synergies. They pursue transactions during recessions. Their targets tend also to be relatively larger, more levered, and more likely to be loss-making.

The high default risk bidder is also more disposed to pay with shares, paying higher premiums to target firms, possibly to entice shareholders that would otherwise be wary of accepting the bidder's stock. It is likely also that these bidders are so highly levered that offering shares is the only way they can finance a deal.

With high premiums paid and other risks evident, many such deals lead to substantial wealth destruction for the acquirer's shareholders. Acquisitions by high risk default bidders would, on the face of it, seem to be unwise. So why are managers determined to pursue such deals? This paper argues that acquisitions by high default risk bidders could be undertaken to enable managers to avoid personal bankruptcy costs and loss of reputation. The motivation for such takeovers therefore may simply be for managers to maintain their own financial compensation, at the ultimate expense of shareholder value.

A key finding of the paper is that the long-term underperformance of M&A should not be generalised. Control groups do not underperform, implying that the well-established long-run negative returns of acquiring firms is largely driven by the High default risk bidder group. This suggests that M&A's generally poor reputation amongst investors may be undeserved.

The paper The Performance of Acquisitions by High Default Risk Bidders is available for download at City Research Online. It was published in 2019 in Journal of Banking and Finance.