Although the M&A market declined in the early part of this year, it has still remained strong, especially among healthcare companies and defensives. But what makes a company appeal to potential suitors? And since we are still near the post-crisis peak, is the mergers and acquisitions market set to cool down? Morgan Stanley strategist Adam Parker and team don’t think so.
M&A activity remains robust
In a “U.S. Equity Strategy” report dated September 19, Parker outlined why he still thinks there’s a “long runway for more M&A.” He highlighted that activity as measured by the percentage of stocks that received tender offers over a 12-month timeframe stands at 5.1%, which is only slightly lower than the highest level we’ve seen since the financial crisis, which is 5.2%. That post-crisis peak came two quarters ago. The current percentage is an increase from the reading observed last quarter, however.
Parker noted the sharp market decline earlier this year and the time of volatility the markets experienced a year ago, which would suggest that M&A activity would decline more sharply. But Parker sees several reasons the current pace of mergers and acquisitions will continue. For example, he has observed macro tailwinds such as the rising and flattening yield curves, which history has shown usually support greater activity in the mergers and acquisitions market.
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Various levels of M&A activity
The Morgan Stanley strategist also observed a divergence in trends of intensity across various sectors and cohorts and even within sectors. He reported that intensity among large-cap stocks declined from 4.8% to 3.6% in the second quarter, but mid-cap activity picked up and neared its post-crisis peak.
He also observed that growth stocks were particularly strong as 5.8% received tender offers during the quarter, marking the highest level since 2008.
Value stocks also recorded robust M&A activity at 5.2%, the highest intensity since 2001.
Within the healthcare sector, mergers and acquisitions in the equipment and services subsector soared to a new high of 12.1%, while pharmaceutical and biotech offers just rebounded off their post-crisis lows.
What makes an attractive M&A target?
After Sarepta Therapeutics announced that it had been granted accelerated approval status for its drug eteplirsen, analysts at RBC pronounced it one of the most attractive M&A targets in the biopharma sector, but is there anything more there than just anecdote? Possibly.
Parker found that acquirers don’t appear to be focused on valuations, as cheaper stocks were no more likely to receive a tender offer than expensive ones. He found that suitors’ preference instead was for stocks that have high yields compared to those of their sector peers.
The Morgan Stanley strategist also found a preference for stocks that had been underperforming their sector peers or had high gross margins compared to their own histories.
Some findings on M&As backed up
This week Intralinks also released its own findings on what makes for an attractive M&A target in a study conducted in association with the M&A Research Centre at Cass Business School in London. For one thing, the study titled “Attractive M&A Targets: Part 1 – What do buyers look for?”
The study backed up some of what Parker found, such as that growth companies have a greater likelihood of being targeted for an acquisition, and this isn’t a new trend. Intralinks and the M&A Research Centre found that over the 23-year period they studied, the growth of target companies is 2.4 percentage points higher than the growth of non-target. Further, the researchers found that the premium given to growth targets increased during types of economic and market downturns and uncertainty.
Differences between the studies
However, there were some differences between the studies. For example, while Parker said valuation doesn’t matter right now, Intralinks reports that public M&A targets tend to have lower valuation multiples than public-non-targets.
Specifically, the firm reports: “Public companies in the bottom three deciles for valuation are on average 30% more likely to become acquisition targets in any given year than public companies overall.”
Intralinks and Cass also found that private targets tend to be more profitable than private non-targets (by 1.2 percentage points since 2000), whereas public M&A targets tend to be less profitable than their non-target public peers (by 3.3 percentage points since 2008 or 1.7 points since 2000). Liquidity was also a factor, with companies in the bottom two deciles for liquidity being an average of 35% more likely to become M&A targets than companies overall.
Intralinks said that high leverage and large size are the two most statistically significant predictors of a private company becoming an acquisition target, whereas small size and low profitability are the two most statistically significant predictors of a public company becoming an acquisition target.
“Since 2008, acquirers have been particularly targeting underperforming public firms, because underperforming public companies are more likely candidates for operational improvements and cost savings through merger synergies,” said Philip Whitchelo, Vice President of Strategy and Product Marketing at Intralinks.” Buyers also take advantage of public companies whose valuations have fallen the most during market downturns.”
Whereas Morgan Stanley called out the healthcare sector as the recent M&A standout, Intralinks and Cass found that energy companies have the highest likelihood of being acquired. As part of their report, Intralinks and Cass Business School released a calculator to help companies determine their likelihood of becoming an acquisition target.