Tell-Tale Signs

Can You Spot an M&A Dud?

The numbers behind failed deals suggest greater risks for AT&T-Time Warner and Disney-Fox.
Photographer: Matthew Staver/Bloomberg

The risky game of merger arbitrage is for the hedge funds. But in a world where many CEOs are turning to megamergers as their last line of defense against incursions by tech giants like Amazon.com Inc., or as their only real shot of boosting growth in a meaningful way, it's just as vital for long-term shareholders that deals get done.   

Already, more than 50 deals among those exceeding $1 billion have been scrapped since March 2016, so it's worth knowing how to spot the tell-tale signs of a transaction doomed to fail. A new analysis by S&P Global Market Intelligence found that the following factors tend to be key drivers of canceled M&A agreements, and they sure seem to check the boxes for some of the high-profile deals we're watching this year:

  • Size and proportionality ratio -- The bigger the deals, the harder they fall. Larger takeovers are more costly to an acquirer and therefore tougher to finance, according to the February report by S&P. And the closer the deal size to the acquirer's market cap, the more difficult it can be to manage. The average transaction size has gone up about 50 percent since 2010, data compiled by Bloomberg show. The five largest mergers still awaiting completion this year are each bigger than $50 billion, including CVS Health Corp.'s $69 billion bid for Aetna Inc. (figure doesn't include debt). CVS is valuing Aetna's equity at about the same as its own market cap, making it the ultimate example of this size and proportionality risk.

Recipe for Failure

Below are the predictors of canceled M&A that were found to have significant t-stats, meaning the relationship probably isn't due to chance (t-stat's absolute value shown):

Source: S&P Global Market Intelligence

  • Perceived price discount -- Buyers want a bargain, but sellers dig in their heels when they think an offer's too cheap. S&P found that when a target company's shares are "well off their 52-week highs," shareholders tend to think their positions are being undervalued and management, of course, will further inspire that notion. Price has been the biggest point of contention in the squabble between chipmakers Broadcom Ltd. and Qualcomm Inc., another one of the biggest transactions outstanding. But even if Broadcom wins the now-delayed proxy fight, a merger may never survive a review by the Committee on Foreign Investment in the U.S. 

  • Regulatory risk -- As transactions get larger and industries more consolidated, this will be the biggest question mark. And it certainly doesn't help would-be dealmakers to have to guess the reaction of the Trump administration. It's been 17 months since AT&T Inc. offered to buy Time Warner Inc. for $109 billion, including debt. In a couple of weeks, the wireless carrier and TV-network operator will head to court to fight the Justice Department's argument that their merger will be harmful to consumers. The latest trading activity implies a 50/50 chance of success. Should the deal collapse, it's not just the arbitrageurs who will feel the pain. AT&T has staked its strategy for wireless entertainment on the Time Warner purchase, and without it, the company is left with shrinking satellite-TV operations, a growing streaming service whose financial contributions are still negligible, and a wireless business facing heightened competition.

Merger Thermometer

Based on predictors of M&A cancellations, the likelihood that AT&T's Time Warner deal falls apart is almost twice that of random chance, according to research from S&P Global Market Intelligence

Source: S&P Global Market Intelligence (as of Feb. 27)

  • CEO's age -- Respect your elders. Younger, male CEOs "can be less diplomatic, more combative and less willing to concede in negotiations," the S&P researchers wrote, defining "young" as 50 years or under. I'd hazard to guess that if we had a large enough sample size for female dealmakers, the findings would align with what I've written about the advantages of women investors and how Warren Buffett exhibits their same characteristics -- cautious, patient, not overconfident and more thoughtful in decision making. 

There's a lot riding on these megamergers. Some may be dead on arrival and carry huge losses for investors. But just remember that even the deals that do make it to the finish line won't necessarily be good for shareholders in the long run. I've said it again and again: Beware of desperate dealmaking.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Tara Lachapelle in New York at tlachapelle@bloomberg.net

    To contact the editor responsible for this story:
    Beth Williams at bewilliams@bloomberg.net

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