Understanding The Impact Of Mergers And Acquisitions On Firm Values

by: Marcelo Bianconi


M&A impact on EV/EBITDA.

Evidence of negative medium-run M&A effects and positive instantaneous M&A impact on firm values.

EV moves faster relative to a slow moving EBITDA.

In recent research, Bianconi and Tan [Evaluating the Instantaneous and Medium-Run Impact of Mergers and Acquisitions on Firm Values (April 19, 2017). Available at SSRN] analyze a large sample consisting of global M&A deals for 65,521 firms over the period between the years of 2000 and 2010 with focus on the impact of M&A on the ratio of enterprise value ov er earnings (before interest, taxes, depreciation and amortization), EV/EBITDA, as the metric for firm value since it takes debt into account, which the acquirer will have to assume, and eliminates the potential influence of inflation and tax policy. The sample includes the Communications, Technology, Energy and Utilities sectors together and individually, in order to understand the differences in the impact of M&A on firm value in technology-intensive versus resource-intensive firms. We find that the medium-run and instantaneous effects of M&A on the EV/EBITDA are much different. A potential higher increase in firm's earnings relative to enterprise value in the medium-run 3 year annual horizon gives one effect but, by contrast, the instantaneous effect in the year when the M&A occurs may be in the opposite direction.

First, we find that, mainly in the Communications and Energy sectors, there is a clear instantaneous gain in the year of the M&A but it then fades quickly. Further evidence shows a statistically significant and robust positive effect of M&A activity on firm value in 2000 (relative to 1999), 2003 (relative to 2002), 2004 (relative to 2003), 2007 (relative to 2006) and 2008 (relative to 2007). New M&A deals impact positively on firm value from a short-term perspective across several consecutive years. First, 2000 relative to 1999 is the period of the burst of the internet bubble. The years 2003 and 2004 are relatively financial calm, but relative to 2007, 2008 represents the impact of the financial crisis. Our evidence shows that during crisis or calm, new M&A deals can have a distinct positive short-term impact on the value of firms at the year-by-year timeframe, even though, on average, the medium-run effect of each M&A deal decreases firm value. Instead of looking at the year-by-year effects, we also consider the overall medium-run impact of M&A on firm values. We find a 3 year medium-run decline in EV/EBITDA of about 10% and a negative and statistically significant effect for the Communication and Technology sectors.

Finally, we revisit the hypothesis that M&A potentially has a positive short-run impact ("bump") on firm values. We specifically test the hypothesis of an M&A "bump" that pushes firm values higher in the year of the M&A compared to values either before or after that year. The potential outcome mean of EV/EBITDA for firms being experiencing M&A is higher than those having no M&A activity during that year, this difference is statistically significant and represents a rough 8% gain relative to the outcome sample average. The effect is also positive and significant and relatively large for the Communication sector, but not others. Overall, therefore, we find evidence that a firm generally does experience an M&A "bump" (especially one in the Communication sector); i.e., it has a higher instantaneous EV/EBITDA ratio during the year that M&A takes place.

In contrasting our results for the medium-run with those that also consider the instantaneous impact of M&A, we find that the medium-run effect of M&A activity on firms' EV/EBITDA is different from the instantaneous effect. The enterprise value ratio multiple is defined as ratio of enterprise value to the earning. In general EV and EBITDA increase over time, but the ratio may go up, down or even stay flat depending on the relative changes. In the medium-run analysis, the impact on the enterprise multiple is negative, which means the ratio EV/EBITDA falls after M&A. While both the numerator and denominator may rise, when the ratio falls one possible explanation is that EBITDA in the denominator increases faster than EV in the numerator. In other words, during the three years after M&A activity, earnings grow farther than the corresponding enterprise value. This result may be valid in technology-related firms, but not in energy-related companies. From the perspective of high-tech business, including communication, the motivation of mergers and acquisitions are clear, to seek innovation in technology and acquire intellectual property. Acquirer firms could apply the new technology immediately and become more productive resulting in the raise of total revenue and profit in a short time period. Concurrently, firms are not required to largely expand total assets and market capitalization. Thus, the increase of enterprise value could be less than that of firm's earnings during the three years after the M&A deal, which results in a fall of EV/EBITDA. Therefore, M&A may be good for technology-intensive companies because of the enhancement in firms' development.

However, Energy and Utilities firms may show a different pattern. The main incentive for M&A in those sectors should be tangible advantage. Firms get geographic expansion and occupy more resources after a deal, especially in a cross-border deal. Firm's earnings increase at the same pace as enterprise value or even slower, thus the EV/EBITDA ratio fluctuates much less during the post-merger three-year period. The payoff from M&A may take longer than three years in resource-intensive firms. Therefore, the EV/EBITDA of Energy and Utilities sector does not dramatically change during that period.

In summary, our findings suggest that the medium-run and instantaneous effects on the EV/EBITDA are much different. In the medium-run, three years pre- and post- the deal, M&A gives a net decrease in EV/EBITDA. By contrast, the instantaneous effect of M&A on firm value is more uniform in all four sectors. The firm value gets an instantaneous increase ("bump") in the year of the M&A deal, since the EV via the stock market moves much faster in response to the M&A activity while the enhancement in firms' earnings is slow moving.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.