A few weeks ago, I argued here that mergers were immoral: so few of them create value, and it’s so hard to predict which ones will, that I don’t think you can justify the risk they pose to shareholder value, or, more importantly, the anguish they put employees through.
Now, though, Myoung Cha and Theresa Lorriman have published an article in the McKinsey Quarterly that looks at the notoriously merger-happy pharma industry, arguing that there, at least, “megamergers have created significant value for shareholders.”
Let’s unpick that. The authors write that the median excess return was 5% above the pharma industry index. (In other industries, they helpfully add, megamergers create negligible value at best.) Since their pharma figure is a median number, it means that half the deals created less than 5% in excess value.
The authors don’t say how many created no value, or destroyed value, though they do say that ‘consolidation deals’ have positive total shareholder return (TSR) at the three-year mark, but that TSR turns negative after five years. In a consolidation deal, two companies overlap considerably (for example, each may have a neuropathic pain research programme at opposite ends of the country), and one swallows another. The acquirer then does one of several things to increase profit, most of which involve firing people: “accelerating revenue, improving the cost of goods sold, reducing overhead, promoting R&D rationalisation and consolidation, or improving working capital.” By contrast, a growth-oriented merger is one where a new company is created, or new markets are explored.
Where does that leave us? I’d argued that the unpredictability of mergers, and the pain they cause, meant you couldn’t justify the bet.
McKinsey tells us that half of all pharma mergers do create at least 5% excess value for shareholders, but that the proportion of those that are consolidation deals (and McKinsey doesn’t tell us what proportion that was) have negative TSR in 5 years. In my book, those are still unconscionable: no one profits, and the acquired company is plucked to the bones (McKinsey says an acquired company contributes just 10% of new-product revenue at the five-year mark, versus 24% for the minority company in a growth merger).
What if you’re planning a growth merger? You still face a conundrum, and McKinsey hasn’t given us enough data to tell us how well the dice are loaded. You have an x% chance - let’s call it a 50% chance - of generating an additional 5% in TSR, relative to your industry’s index. Is half a shot at shareholder payback worth the human cost to staff? That’s something CEOs - and shareholders - need to decide for themselves.
Disclosure: I worked on several pharma cases (though none related to mergers) as a consultant at The Boston Consulting Group (BCG). BCG is McKinsey's principal competitor.