Can consolidation create sustainable long-term value, or will it prove seductive but, ultimately, disappointing to shareholders, employees, customers, and management alike?
Fulfilling the Value Proposition
The Next M&A Wave: If mergers are once again a potential strategy for accomplishing growth objectives, the previous round of transactions offer several lessons.
- risk trade-offs.
- Regulatory creativity. Fighting with regulators is recognized as a counterproductive and expensive exercise. Companies will work with regulators to fashion solutions that offer meaningful outcomes to concerns over potential market power, RTO participation, supply sourcing, or savings sharing.
Companies pursuing combinations in the near term can synthesize a variety of lessons from their predecessors:
- It all starts with strategy. The rationale drives the outcome, not the reverse;
- The simpler, the better. The objective is closing, not elegance in design;
- Protect the shareholder. Astute financial engineering can pay off;
- Pick a business model. Blending two gives you two, not one;
- Stretch the targets. Aggressive people + aggressive targets = full benefits;
- Spend the money. Synergies are not free. Don't starve the cash cow;
- Transform later. Focus first on Day 1, then the trip to the final destination;
- Discipline matters. Develop a plan, then stick to it;
- Offer regulators a choice. There is more than one way, not only your way; and
- Expect to succeed. The history is there, let it be a guide.
The industry is poised and positioned to enter the next stage of consolidation. Managements would be well-served to remember that transaction success is not just about having a good story. Merger success depends on both a strong strategic rationale and a demonstrated capability to execute flawlessly.
Finding ways to produce new earnings sources may include mergers as a primary vehicle for capturing economies in operating costs.
As the industry emerges from its entrenchment, the time for renewed growth has arrived. Smart companies did more than just weather the market credibility and financial liquidity storms of the past three-and-a-half years. These companies recognized the unique circumstances in the market and bet that seizing the available opportunities for growth would pay off when the overall market turned.
However, most companies did not have the luxury of thinking about growth when besieged by rating agencies, analysts, stockholders and debt holders. Now these companies are once again faced with positioning themselves to grow-except this time they have little momentum, lower balance sheet capacity, and less margin for error.
Are current values indicative of utilities breaking-out against the market, or has the environment of low interest rates and steady yields simply made the sector a temporary safe harbor? The tight range of multiples given the wide estimates for 2005 earnings growth suggests that the market is focused more on near-term company fundamentals than long-term growth stories. Nonetheless, it is unlikely that financial markets will continue to award high valuations to companies with both low growth rates and low yields. Investors will demand more from those companies where they place their capital. Yet, the industry has not been the beneficiary of strong organic growth paths over time.
Figure 1 captures recent multiple levels relative to expected earnings growth for 2005. As the figure shows, little correlation is apparent between valuations and planned expansion of the business. In fact, one might question whether the pursuit and delivery of growth is adequately recognized and rewarded. Nonetheless, as the profits of other sectors