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  Bain & Company’s new 2004 M&A; Deal Success Research concludes that the initial stock market reaction to a merger announcement is a reliable predictor of share price performance of the acquiring company two years forward.
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Bain's M&A; experts Dave Harding and Sam Rovit found that three quarters of the companies who received an immediate “Thumbs Down” — a negative shareholder return more than 10% worse than their peer index– when they announced plans to acquire another company continued to under-perform their market index two years after the deal was announced.

Conversely, half the companies to which investors gave a “Thumbs Up” — outperforming their peer index by 10% or more — on the news of a deal maintained their premium performance two years forward.

“The stock market is a creature of uncertainty, and companies' share prices are subject to lots of extraneous influences,” said Bain partner David Harding. “But our new data validates 'efficient market theory' in a way that is highly predictive for companies involved in M&A; activity. Our 'Thumbs Up/Thumbs Down' research found that an acquirers' initial impression on the financial markets provides a highly efficient and reliable level of predictability to assessing the long term prospects for M&A; deals.”

Bain examined 790 merger and acquisitions transactions announced between 1995 and 2001 by US public companies measuring the total shareholder return (including price appreciation and dividends) of the acquirer compared to the performance of its peers. They found that:

1. In the 20-day window before and after deal announcement, 23% of acquirers beat their index by 10% or more, while 27% of companies under-performed by 10% or more. In 50% of the deals, the markets did not take a significant position with regards to the validity of the transaction.

2. Stepping out two years, three quarters of the companies whose announcement generated an immediate negative share price move relative to its peers continued to under-perform their market index two years after the deal news.

3. But nearly half of those companies whose news was greeted favorably still were out-performing their relevant index at the end of that two-year time frame.

4. Excess returns are generally poor across all industries but technology companies suffered a median excess return of -40% over that two-year time frame, while utilities was the only sector whose sector generated positive returns at 12%.

Harding and Rovit are co-authors of an upcoming book, Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, November 2004).
 
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