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(originally published by Booz & Company)


Why Corporate Buyers Are Dominating M&A

Amid the tightest credit conditions in decades, the market for corporate control is favoring low-leverage, growth-oriented transactions.

Storage systems provider EqualLogic Inc. was all set to go public in November 2007. The traditional road show, during which the company would present itself to the investment banking houses, was scheduled to begin the next day when Dell Inc. swooped in and bought EqualLogic for US$1.4 billion, the largest all-cash purchase ever for a venture-backed company. In keeping with Dell’s long-standing strategy of buying businesses that might provide healthier margins than its core line of PCs, EqualLogic offered a fast-growing entry into storage, allowing Dell to compete at the low end of the market with such giants as EMC Corporation.

Strategic M&A transactions such as Dell’s, funded with some combination of cash and stock, remain one of the few bright spots in a very depressed M&A market. The data tells the story: Globally, the number of M&A transactions completed by financial sponsors such as private equity firms dropped by 22 percent in the first half of 2008, compared with the same period in 2007, while the dollar value of those deals dropped by a startling 76 percent, from $571 billion to $140 billion, according to researchers Dealogic. For the U.S. alone, the number of deals fell by 31 percent, and total deal value declined by 87 percent, from $338 billion to $45 billion.

In comparison with the weak numbers for buyouts led by private equity firms, strategic M&A is having a relatively strong year. Globally, the number of deals is up 12 percent, though the total value of such deals is down 18 percent, from $2.2 trillion to $1.8 trillion. The U.S. is even stronger, with the number of deals up 9 percent, and total deal value up 3 percent, from $649 billion to $671 billion. The contrast between the poor market for large, highly leveraged buyouts and the continued strength of strategic deals suggests the overall direction the M&A industry is likely to take, not just in the near term but for the foreseeable future. Is this just another one of Wall Street’s boom-and-bust cycles, or is the recent shift in power from financial to strategic buying a truly structural change?

The relative strength of the corporate M&A market reflects the strength of corporate balance sheets: Companies still have plenty of cash, despite the sluggish growth in corporate profits overall. Because they typically use mostly cash or stock to make their strategic acquisitions and avoid the use of extreme leverage or the financial engineering schemes of the financial buyers, corporations looking to make deals haven’t been significantly affected by the difficulty of getting debt financing. Dell’s profits, for instance, have remained strong, and as of May the company had $8.3 billion in cash on its balance sheet. So although the $1.4 billion in cash it paid for EqualLogic is not exactly a drop in the bucket, Dell could easily afford the acquisition. Moreover, corporate buyers are facing much less competition for the deals they want to do, because private equity buyers are having so much difficulty finding financing.

These dynamics have driven a wide range of large strategic deals this year. In April 2008, for instance, candy maker Mars Inc. bought the William Wrigley Jr. Company for $23 billion; a month later, Hewlett-Packard Company bought out EDS for $13 billion. In June came a far bigger deal, when Belgium’s InBev agreed to purchase Anheuser-Busch Companies Inc. for $55 billion. This year’s private equity deals pale in comparison: The largest buyout by a financial sponsor thus far was Avista Capital Partners’ acquisition of ConvaTec Inc., a maker of wound therapeutics owned by Bristol-Myers Squibb Company, for $4.1 billion.

The upside for strategic buyers is straightforward. Before the summer of 2007, financial buyers were using sky-high leverage ratios to buy everything in sight, driving valuations far past what strategic buyers were willing to pay. But now companies looking to make strategic acquisitions aren’t facing that level of competition from financial buyers hungry for deals, and that means lower valuations and more simply structured deals.

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  1. Gerald Adolph, Simon Gillies, and Joerg Krings, “Strategic Due Diligence: A Foundation for M&A Success,” strategy+business enews, 9/28/2006: Offers a valuable approach to determining the strategic fit of a potential acquisition.
  2. Michael Sisk and Andrew Sambrook, eds., The Whole Deal: Fulfilling the Promise of Acquisitions and Mergers (strategy+business Books, 2006): Good advice on the entire scope of M&A transactions, from initial strategic considerations to postmerger integration.
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