Lots of ink has been spilled lately about how M&A activity in the legal sector has picked up. Let’s stipulate that’s true. I for one believe it to be the case, and have been involved in more conversations along those lines in the last several months than within any comparable earlier period.
But what’s the real track record of M&A value creation? Do we know what we’re doing? Is this a sustainable path to enduring growth, or just the fad du jour?
The answer turns out to be fairly nuanced, and while of course the jury is still out on mergers in Law Land announced recently, we ignore the experience of the rest of the for-profit economy at our peril. So let’s see what that track record looks like.
Conveniently, McKinsey just published Taking A Longer-Term Look at M&A Value Creation, which explores precisely that question. Caveat: One of the key metrics they rely upon for determining “value creation” is obviously stock price, which we have no analog for. But the analysis holds across industries, and share price itself has some intrinsic flaws, such as a skew towards larger deals, which actually have the value to move stock price, while a consistent series of small deals leaves no obvious immediate footprints.
The dataset McKinsey used was the top 1,000 nonbanking firms in the world, which concluded over 15,000 deals during the past decade; data was available for 639 institutions.
Here’s how McKinsey segmented the patterns of M&A activity:
- Large deals: “transformed company through at least 1 individual deal priced at above 30% of market cap.” 112 of the dataset of 639, or 17.5%
- Selective: “small number of deals but possibly significant market cap acquired.” 28.2%
- Programmatic: “many deals and high percentage of market cap acquired.” 22.2%
- Tactical: “many deals but low percentage of market cap acquired.” 21.8%
- Organic: “almost no M&A.” 10.3%
The most striking observations about this data (I believe) are:
- 90% of the firms did not rely on organic growth, and
- 70% of the firms did deals above the merely tactical level.
In other words, M&A is clearly viewed as a core component of strategy for these global 1,000 companies.
The next question is whether the uses and purposes of dealmaking varied by size or other discernible characteristic. The answer is, yes it did:
This shows remarkable consistency across all four cohorts of size: The larger the firms (moving left to right), the less they engaged in “selective” or “organic” M&A (from 36% to 9%), and the more they engaged in big deal behavior (from 64% to 91%, and from 39% to 60% combining the two most aggressive M&A strategies, “large deals” and “programmatic.”) I find this utterly striking.
Slicing the data differently, our faithful analysts posit that the “programmatic” approach is actually the single most successful technique.
But there’s more to it than “median excesss total returns to shareholders” (that is to say, returns above median industry averages over the same timeframe):
Those with a more programmatic pattern of M&A (defined as many small deals that over time represented 19 percent or more of the acquirer’s market capitalization) on average performed better than companies relying on organic growth. They also had a higher probability of positive excess returns. Finally, the data suggest that a growth strategy built around a series of small deals can actually be less risky than avoiding M&A altogether. Organic strategies showed the greatest variability in excess TRS between top performers and companies in the lowest quartile, while programmatic and tactical M&A had the smallest range. (emphasis mine)
How’s that for a two-fer? Programmatic strategies not only give you greater returns, but at less risk than doing nothing or next to nothing.
But we’re still generalizing at too gross a level. So much depends on industries, the match of existing assets with strategy, and execution (God, not the devil, is in the details). Needless to say, they don’t have any information on Law Firm Land, but here’s what they do have:
This shows the dominant strategies by industry, and reading from left to right Programmatic is one of the top two for 6 of the 8 industries shown, organic one of the top two for only a single industry.
What’s enlightening about his is how hard it is to conduct value-adding M&A in High tech (column 4). The “best” strategy, tactical, yields only a 1.2% median excess TRS, and the second best, programmatic, actually yields a negative 1.2%–it’s just that everything else produces an even bigger negative number.
The outlier that benefits from organic growth, however, is potentially deeply instructive. It’s the closest, in a way, to Law Firm Land, of all the industries shown here: Insurance and Related. Interestingly, the second best strategy is Large deals.
Now, are we really “like” insurance?
Yes, only in the sense that we’re more like insurance than we are like anything else shown there–but no in the sense that insurance profits largely from financial engineering and the time value of money (invested from the time policyholders pay their premiums until the time, far down the road, when claims are submitted). It’s also of course critically an actuarial game, which we’re not.
Yet McKinsey generalizes to posit that large deals are more successful in “slower-growing, mature industries.” At first blush, this would be BigLaw post-2008. But why does McKinsey say so? Now we learn it’s not analogous to BigLaw at all: “Here, there is great value in reducing excess industry capacity and improving performance, and a lengthy integration effort is less disruptive.”
Of course, no law firm merger “reduc[es] industry capacity”-that would only be the case if some percentage of the lawyers were taken out and shot, or, more mercifully, disbarred or expelled from the country. No such luck. And “lengthy integration effort[s]” are immensely disruptive, as clients and partners become queasy and start looking for the exits. So that’s not us either.
Is there, then, anything germane to be learned?
Let’s recur to the promising “programmatic” deal approach. Does its widespread success turn out to be industry-specific or industry-reliant? At last we might be on to something (emphasis mine):
Companies across a variety of industries do well using the programmatic approach. In most sectors for which we had sufficient data, it tended to score in the top two strategies (based on excess returns over the last decade). Companies using the strategy completed many acquisitions that together represented a material level of investment as a percentage of market cap. In addition, we found a volume effect–the more deals a company did, the higher the probability it would earn excess returns.
Evidence shows that executing a high-volume deal program requires certain corporate capabilities but not necessarily a specific industry structure. Most programmatic acquirers prioritize one or two markets or product areas where they can build businesses with leadership positions.
Now we’re talking. Firms that do serial acquisitions-of other firms not representing a huge proportion of the acquiring firms’ personnel-can develop, if you will, a core competence in acquiring other firms (the “execution” premium), and if they also focus on “one or two markets or [practice] areas where they can build a leadership position,” you may have a quite winning strategy indeed.
So: Who has done this over the past period of time? I have a few nominees, and more suggestions from readers are exceedingly welcome. In particular, if you think your firm has done just this and I’ve omitted them, please let me know. I nominate as core examples:
- Bingham, and
- K&L Gates
Discuss among yourselves.