Why markets don’t anticipate prolific acquirers

Conventional wisdom, backed up by prior studies, holds that as serial acquirers acquire more firms they earn lower and lower returns as the market can spot them a mile away. Yet some acquirers don’t follow this pattern, but instead earn persistently higher returns in subsequent acquisitions. This poses a puzzle: why does the market not anticipate and punish these ‘extraordinary’ acquirers?

Serial acquirers fall into 4 categories

A new study addresses this puzzle by separating acquirers into 4 categories that can help predict future activity:

1. “loners” that make just one or 2 acquisitions
2. “occasional acquirers” that only acquire a few targets
3. “sprinters” that make short-lived bursts of acquisitions
4. “marathoners” that almost never stop acquiring

The study, published in the Review of Corporate Finance Studies, finds in effect that the market is likely to be using a simple ex ante (before-the-fact) classification such as this to predict which acquirer is going to acquire before they actually acquire. So an explanation for declining returns of many serial acquirers is that future acquisition market reactions are lower because expectations of future activity have already been incorporated into acquirer’s market value; many extraordinary acquirers do not make lots of acquisitions so their activity cannot be predicted, and this helps them attain continuing higher returns from their takeover activity.

Predicting behaviour has implications beyond mergers and acquisitions

“The study moves beyond previous academic research that looked at serial acquirers as a homogenous class. It is difficult to believe that markets would treat Microsoft, for example, exactly as they would treat an acquirer who acquires only once,” says study co-author Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School. “Our methodology shows that not all serial acquirers follow the same takeover patterns, and this ex ante information on acquirer types enables our model to predict acquisition activity far more accurately.

“We believe that these results have potential implications beyond M&A activity, including for hedge fund managers who compute acquisition intensity probabilities, share repurchases which often occur regularly and predictably, and mutual fund manager performance yardsticks. If events can be predicted, then the methodologies measuring the returns to the events are understated because the market already discounts the predictable part of the event.

In the USA, just less than a fifth of acquirers made 60% of all acquisitions

The study is based on a large sample of 55,482 acquisitions of US public, private, and subsidiary targets by 8,640 US publicly listed acquirers from 1989 to 2018. While 46% of the sample’s acquirers made just one or 2 acquisitions over the 3-decade study period, 17.5% of acquirers made 60% of all acquisitions.

“Once we adjust for market anticipation, we find little evidence of declining returns for the most frequent serial acquirers,” the study says. “On average, serial acquirers seem to experience a positive benefit-cost trade-off in their serial acquisition dynamics.”

Little movement between the 4 categories – except when publicly listed targets are involved

The four classification groups are very stable over time. “In any given year, 71% of loners, 72% of occasional acquirers, 54% of sprinters, and 85% of marathoners (the most stable type) remain in the same classification type as in the prior year.” Less stable over time, however, was the type of acquirer involved in deals involving publicly listed targets: in the 1990s most of these targets were acquired by loners or occasional acquirers; in the 2000s acquirer types were more balanced; and in the 2010s these deals were “increasingly dominated by marathoners” with loners largely disappearing from view. This is in line with increased concentration levels in many US industries since the late 1990s.