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Winning the Merger Game

A new wave of consolidation is coming. To succeed, a company must understand where its strengths are.

Fortnightly Magazine - March 2006

fail to create meaningful shareholder value.” Thomas J. Flaherty, another industry expert, has said that utility mergers typically generate rather moderate synergies relative to the price paid for the target.

Indeed, previous McKinsey research came to a similar conclusion. An analysis of 193 deals that took place between January 1996 and September 1998 showed that 58 percent of acquiring companies destroy value. This conclusion was based on an analysis of the beta-adjusted change in stock price, relative to an index, from one week prior to the announcement of each deal to one week after the announcement was made.

Value Created Over Long Term

However, much of this analysis is misleading because it focuses exclusively on the short-term impact of M&A on share price. Our new research refutes the notion that M&A fails to generate value. While we agree that acquisitions in the power industry generally have destroyed short-term value for acquirers, our analysis shows that companies that pursue M&A-intensive strategies generate a majority of the industry’s value over the long-term.

We analyzed short- and long-term outcomes between September 1995 and September 2005, focusing on 22 acquirers that announced corporate deals during this period. For the short-term analysis we determined the change in their stock prices relative to the S&P 500 over a 10-day period that began five days before their announcements and ended five days after them. We then multiplied this figure by the acquirer’s starting equity capitalization. We found that acquirers destroyed almost $1 billion in market value in the short term.

However, our analysis of market value-added for these companies over the full 10-year period showed that together they generated about $102 billion in industry value. 3

We then looked at the value created in the industry as a whole over this period (see Figure 1) . We found that companies that pursued M&A strategies generated 55 percent ($102 billion) of the total value generated in the industry ($185 billion). 4 Moreover, just four companies generated $64 billion of that $102 billion: Dominion, Energy East, Exelon, and FirstEnergy. We call these companies “M&A winners” because they not only pursued M&A-intensive strategies 5 but also enjoyed an annual TSR of 10 percent or more during this period.

Companies that pursued organic growth opportunities and not M&A generated 45 percent of the value in the industry as a whole. However, most of this organic growth was generated by companies ( e.g., Entergy, Kinder Morgan) occupying privileged positions that could not be occupied by other companies or replicated in other regions.

How the Winners Prevailed

Companies that profited from M&A in the 10 years we examined had an ability to understand their strengths and use them to their advantage when conducting mergers and acquisitions. These winners leveraged one or more of five distinctive competencies that are key to unlocking hundreds of billions of dollars industry-wide (see Figure 2).

Operational excellence is the ability to run efficiently at low cost. Companies that excel in this area continuously cut variable and fixed costs while increasing the flexibility of their resources to capitalize on new