A boom in company takeovers has been gathering pace for a number of years. But the party may have only have just begun. The conditions are perfect for a further surge in M&A activity: many companies are flush with cash, private equity “dry powder” is close to a record high (money raised but not yet invested) and borrowing costs are historically low.

But who is doing the buying? And what does the data tell us about how these deals affect the performance of the buyers and the bought?

Our research on the US stock market has found that it has been public companies, not private equity, behind most of the activity, jarring with the wider media narrative. However, we also found that private equity is in position to play a bigger role in future. Understanding this takeover trend is going to become ever more important.

Our research found that:

• 38% of companies that were listed on the US stock market at the end of 2010 had de-listed before the decade was out. 23% were bought by another public company, 9% by a private entity, and 6% de-listed for another reason (such as bankruptcy or a breach of stock exchange rules).
• Stock market investors retained an ongoing share in the prospects of most of these companies, only as part of another public company, not on a stand-alone basis. “De-equitisation” – the disappearance of companies from the public market – may not be as worrisome as previously thought.
• The need for buyers to offer a takeover premium drove 76% of targets to outperform their industry group in the 12-months before being bought. Median outperformance was 19%.
• A majority (57%) of public acquirors went on to underperform their industry group after buying another public company. Median three-year underperformance was 6%. But those that outperformed did so handsomely (median 23%). That temptation is one reason why M&A is so popular among executives.
• Better outcomes have been associated with smaller, bolt-on deals, larger, better-resourced buyers, and more experienced buyers of public companies.
• Most companies to be bought were relatively small, and their outperformance made little dent in broad market returns. Only more active stock pickers, and predominantly those investing in smaller companies, would have been able to take advantage of the takeover boom – perhaps one reason, among many, why active small cap managers have a better track record then their large cap equivalents

Gone but not forgotten

There were 2,590 companies spread across the large, mid and small-cap sectors of the US stock market at the end of 2010 (MSCI USA Investible Market Index). Over the next ten years, 977 of them (38%) de-listed. Against a backdrop of soaring US stock prices, many investors have been unaware of this significant development in the corporate sector. But, for the companies involved, its impact has been dramatic.

Most have been bought by other public companies

Of the 977 companies that delisted, 84% did so because they were bought by or merged with another company (Figure 1). Over three quarters of these were small cap stocks (similar to the proportion of US public companies that were small caps at the start of the period). The IT and health care sectors have been most popular.

Importantly, the vast majority were bought by another public company (Figure 1). They did not exit the stock market when they delisted. They continued to remain part of it, only as part of another public company, not on a stand-alone basis.

Yes, some were bought by private equity or private companies, but these have been in the minority – so far, at least. Even fewer have delisted voluntarily or because they have breached stock market rules (e.g. on minimum size or trading volumes), or gone bankrupt. M&A by other public companies has been the dominant influence.

A transfer of value from buyer to target shareholders                  

Most M&A has involved a transfer of value from buyer to target shareholders. The need to pay a takeover premium has boosted the performance of targets relative to their peers. 76% of acquired companies outperformed their industry group (as defined by GICS) in the 12 months before being bought (a period which would typically capture the bid announcement and hence any impact on the target’s share price). The median level of outperformance was 19% (mean 31%). Even bottom quartile performing acquisition targets managed to outperform:

On the flip-side, almost 60% of public acquirors went on to underperform their industry group in the one to three years after buying another public company. The margin of underperformance was much lower than that of targets’ outperformance (3% in the year after a deal, rising to 6% in the three years after, for the median acquiror). However, as the median target was only about a quarter of the size of the acquiror, this isn’t surprising.

That still means a large proportion of acquirors did go on to outperform. And the median level of outperformance among that group is 14% one-year post-acquisition, rising to 23% over three years. Although most struggle, successful M&A can be highly value-additive, one reason why it is so popular among executives.

Small bolt on deals have a better track record than large transformational deals, likely due to them being easier to digest and less disruptive to overall corporate strategy and culture. Larger, better resourced, acquirors also have better track records. And there is some evidence that those who have completed several public company takeovers go on to do better – evidence of the benefits of experience.

Nuanced investment implications

Although takeover premiums boosted the share prices of target companies, in aggregate, this had little impact on overall stock market returns. The median target made up 0.01% of the MSCI USA IMI index 12 months before being bought. And even within the small cap market, the largest company to be bought was only 0.25% of the market. The median was 0.04%. It doesn’t really matter how good their individual performance was. Their small weights mean their impact at the overall market level was small.

Only more active stock pickers, and predominantly those investing in smaller companies,  would have been able to take advantage – perhaps one reason, among many, why active small cap managers have a better track record then their large cap equivalents.

On the acquiror side, investors should not reject M&A out of hand as being value-destructive. But they should be more wary of smaller, more inexperienced buyers who go down this route. And blockbuster deals should come with a clear health warning. As with most investing, selectivity is key.

The future

Public companies are sitting on near-record amounts of cash (in both nominal and real terms), private equity has close to a record dry powder war chest to spend (money raised but not yet invested), and borrowing costs are historically cheap. The ingredients are in place for an M&A boom which could blow what occurred in the 2011-2020 period out of the water. Stock market investors are likely to witness many companies in their portfolios on the receiving end of a takeover approach.

One important development is that private equity is likely to play a more prominent role in the current decade than in the last. Average private equity fund sizes and, consequently, deal sizes, have been on the increase. A record 54% of money raised by US private equity funds in the first half of 2021 was raised by mega-funds, those with assets of over $5 billion (Figure 3). A decade ago, this proportion stood at only 9%. This trend towards increasingly large funds is occurring in North America, Europe and Asia.

This results in a gravitational pull towards larger deals, as this is the most efficient way for these very large funds to deploy capital. Public companies are likely to be more easily digestible and on their radar than in the past.

M&A is likely to play an even more powerful role in shaping our capital markets than it did in the past decade. Investors can benefit from this, but adding value from this insight is only really a plausible outcome for actively managed strategies, particularly those investing in small companies.