Pension liability can make or break an M&A deal

Report finds that pension liability risk impacts both target and acquirers.

The M&A Research Centre at Cass Business School has released a new report looking at pension liability and how pension schemes can vary the level of financial risk in M&A deals.

For acquirers, finding the right target with the best cost synergies and cultural fit is crucial. However, the liability of the target’s existing pension scheme could see a good deal turn sour quickly. For the buyers of Tata’s UK steel assets, this was almost the case. At the critical moment, the pension deficit was around £700 million and government intervention was needed to remove the obstacle.

Key findings

The report, ‘Pensions: Now something more to worry about (for dealmakers)’, looked a sample of 138 UK takeover bids across a ten year period. It took into account pension scheme assets and liabilities (i.e. the absolute size of a pension scheme and not just the deficit) of both the target and acquirer.

  • A target’s pension scheme type (defined benefit or defined contribution) has a significant impact on the choice of payment mix (cash or stocks/shares), with riskier defined benefit schemes leading to offers with a lower cash component signifying lower shareholder value.
  • Risk in the bidders own pension liabilities increase the probability of a higher proportion of cash in the offer but reduces the value gains to its own shareholders.
  • Bidders with risky pensions schemes (defined benefit) seek to reduce the information asymmetry concerns of target shareholders by offering cash in consideration
  • The target pension scheme type does not impact on the bidding shareholder’s wealth gains directly, and only have an indirect impact on payment currency choice.

Defined benefit scheme targets represent 61% of the sample by number, but 92% by deal value. The much larger size of defined benefit provision in targets is not surprising since defined benefit schemes are often historical legacies associated with mature industrial, and other large companies. Defined contribution schemes are a recent adoption in the UK, therefore, make up a smaller percentage of the sample.

Dr Naaguesh Appadu, Research Fellow, M&A Research Centre at Cass said, “When inspecting a potential target, the bidder should always take a closer look at the pension scheme as it would be present an unnecessary risk later on.

He added, “The report shows that an acquisition of a company with a riskier pension scheme was more likely to be financed with a lower proportion of cash and a higher proportion of stock.

“We also found that bidders with high risk defined benefit pension schemes sought to lessen the valuation risk posed to shareholders by offering more cash. However, these same high risk bidders make deals that are associated with reduced gains for their own shareholders.”

About the M&A Research Centre

The Cass M&A Research Centre (MARC), founded in 2008, is the only such research centre at any major business school focused on both the research and practice of M&A. The result has been and is new, cutting-edge insights into the entire M&A field, from deal origination to completion, from financing to integration, from emerging markets to the boardrooms of the world's largest companies.

For more information, please visit the MARC website.

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