Megamergers rarely mean megabucks for shareholders

The strategic megamerger is back. In the past couple of weeks, consumer group Heinz announced plans to buy Kraft Foods, Royal Dutch Shell said that it was taking over BG and, this week, Nokia struck a deal to acquire Alcatel-Lucent.

As with many deals aimed at industry consolidation, the acquirers have warned their shareholders that the benefits might take a while to arrive.

Shell said that its purchase of BG would not be accretive for earnings per share until 2018. Nokia promised 2017 in the case of its purchase of Alcatel-Lucent. Similarly, FedEx has said that its planned purchase of TNT would have minimal impact on its bottom line in 2016 and 2017 but would be "very accretive" afterwards.

Investors have every right to question these claims. Historically, mergers and acquisitions have been value destroying. A University of Virginia professor looked at several studies analysing deals struck between the 1960s through to 2000 and found that only 20 to 30 per cent of buying companies created long-term returns for investors significantly above the cost of capital. Twenty-first century mergers have been somewhat more sensible, with recent studies suggesting that about half create long-term shareholder value.

But the current crop of large strategic deals gives reasons to be concerned. Global dealmaking is off to its fastest start since 2007, up 21 per cent year on year in the first quarter to $811bn. Equity prices are at frothy levels already, particularly in the US, so the mad scramble for deals could easily lead buyers to over pay. While that is less of a problem in all-share deals where the buyer's equity benefits from market enthusiasm, investors may well ask whether cash payments could be better spent.

Shell, for example, offered a 50 per cent premium over BG's share price, including 383p per share in cash - and that money may be hard to make back if the oil price stays low.

Furthermore, many of the companies involved had already made substantial cost cuts during the recent recession. Much of their future savings will have to come from finding genuine synergies, rather than simply trimming fat. Laying off employees, consolidating supplier contracts and closing redundant sites can be great for profitability but they take time.

"All those measures have upfront costs and will take a year or two to break even," says Scott Moeller, a Cass University professor. "You don't get a payback for three or four years."

And, sometimes, the cuts do not work. A Cass study of UK deals from 1997 to 2010 found that acquirers on average failed to realise long-term gains in either efficiency (as measured by earnings over sales) or profitability (in terms of return on equity).

However, there are individual cases that do prove that long waits for M&A synergies are well worth it.

In 2011, drugs group Gilead spent $11bn to buy Pharmasset, which was developing treatments for hepatitis C, but could only promise investors that the deal would be "accretive in 2015 and beyond". Gilead shares lost a tenth of their value as some investors lost patience. But those who stuck around were rewarded. Gilead's share price has quadrupled since then, largely because of the hepatitis drugs.

Chief executives almost always benefit from big mergers because they end up with a larger remit and a pay cheque to match. Investors, meanwhile, are looking at 50-50 odds if the recent trends hold true. Proper scepticism is required.

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