Mergers and acquisitions (M&A) in the listed equity markets have a chequered past, particularly when one publicly quoted company takes over another listed company, with investors enduring a long history of M&A failures. The flood of deals in 2018 in the equity market has been mirrored by corporate acquisitions in the listed real estate sector. Analysis of deals generally reveals that buyers typically struggle to deliver share price outperformance despite stated plans for the post-merger entity to achieve greater market share, economies of scale and synergies.
When a chief executive wants to boost their company’s performance, the thought of acquiring another company can be extraordinarily seductive. As Warren Buffet noted in his annual letter to Berkshire Hathaway shareholders in February 2018, “After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed.” Buffett had expected a further surge in M&A in his investors’ newsletter earlier this year after signs of increased activity in 2017.
Indeed, the overall volume of deals remains on track to beat the post-crisis high of 2015 with deals totalling USD 2.8 trillion in value to date as US tax reform and faster global economic growth have stimulated companies’ deal-making instincts (Bloomberg data as of 26 June 2018).
Private equity, real estate managers and REITs are buying
As said, the real estate sector has experienced a similar surge in deals involving real estate investment trusts (REITs) acquiring or being acquired, notably in the US. REIT M&A accelerated in 2018, with seven deals totalling more than USD 54 billion in equity value so far. That compares with eight deals for USD 18 billion in 2017 and six for USD 13 billion in 2016. Private equity and real estate managers are buying REITs and taking them private in a popular pre-crisis investment strategy, while REITs themselves have also been buying up their listed competitors.
Exhibit 1: The growth of M&A in the US REIT sector from 2004 to 2018
Note: dotted line shows moving average. Source: National Association of Real Estate Investment Trusts, as at 26/06/2018
The listed real estate sector has been seen as undervalued in the US, which has fuelled the growth in M&A. But REITs have been reluctant to be sold at a discount to the private market. A privatisation, or a takeover by a public company, is only likely to be accepted at a premium to a valuation.
M&A does little for equity performance
M&A activity may help companies grow their earnings, but in the global equity markets, deals have been accompanied by disappointing share price performance for dealmakers. Acquirers, on average, underperformed the MSCI World index by 6.2 percentage points during Q2 2018, according to a Willis Towers Watson study.This was the third consecutive quarter of underperformance by purchasing companies.
As said, US REITs have been involved in seven M&A-like deals already this year. An eighth has been signalled at the time of writing. Shares in US REITs involved in the largest public-to-public deals over the last 12 months have broadly underperformed their peers in the month after a deal was announced, with the size of underperformance varying significantly.
Table 1: Public-to-public M&A deals involving listed real estate companies
Note: Performance is total returns relative to the country FTSE EPRA NAREIT index, in local currency, in the month following the deal announcement. Source: BAML, Bloomberg, FTSE EPRA NAREIT, as at 26/06/2018.
Two-thirds of buying companies have underperformed the FTSE EPRA NAREIT US index in the month after announcing they were pursuing a company. These findings tally with a much larger study by US research firm Green Street Advisors of 50 REIT M&A deals in the US between 1990 and 2013. It found that REITs making an acquisition underperformed the broader RMZ index in the month after the takeover announcement.
Some M&A scepticism is warranted
The abundance of cheap debt has clearly fuelled purchase activity across the corporate world. Some investors may be tempted to invest in potential acquisition targets in the hope of an M&A windfall after a bid. But waiting for a takeover can be tricky. For investors, it is usually more prudent to put money into good companies that create value for shareholders over the long run. Moreover, if a company is attractive enough, a public or private investor may try and buy it at a later stage.
Globally, private equity has access to considerable capital – as much as EUR 287 billion, according to the most recent Preqin data – so interest in REITs is likely to persist from the private sector at least.
However, what is salutary about the experience of the broader equity market and also the history of public-to-public takeovers is that buying companies may be a good strategy for leveraged private buyers, but the reality of M&A is often more complex and not always clear-cut for public companies in general and REITs in particular.