M&A trends are often described in terms of waves or cycles, which naturally seems like a reference to underlying economic conditions. However, a recent article published by The Economist looks deeper into what drives M&A trends and asserts that other dynamics are also at play.
The article, which relies on a book published by Peter Clark and Roger Mills, argues that M&A waves are composed of four phases, with a driving factor being changing business confidence:
- In the first phase, the economy is weak, deal flow is poor and buyers typically have the upper hand during negotiations. Historical bid premiums average between 10-18% in this phase.
- In the second phase, the economy is strengthening and deal flow increases, but buyers are still quite weary of perceived risks. Historical bid premiums average between 20-35% in this phase.
- In the third phase, deal flow increases dramatically because executives feel confident that going ahead with a transaction will not draw criticism. Historical bid premiums average over 50% in this phase.
- In the fourth phase, deal flow is booming and companies are the most willing to take significant risks. Those who have not participated in the M&A surge may feel the pressure to get involved. Historical bid premiums average over 100% in this phase.
As the article notes, when companies’ risk appetite and willingness to pay a significant premium increases in the third and fourth phases, so too do the chances of failure. If a failure is big enough, it can significantly slow down the M&A boom.
One of the book’s authors argues that we have entered the third phase and should “expect the number of deals to rise fast”. It remains to be seen whether this will occur.