Is shareholder value the only way to evaluate the success or failure of a takeover or merger?

It is a statistic that is widely supported by research and is also likely to be used by 000’s of students as they write about the likely success or failure of a takeover or merger:

“70% + of takeovers and mergers destroy value…”

In other words – most takeovers and mergers fail. But is this the only way to measure success or failure?

A good starting point for evaluating the success or failure of a takeover or merger is to consider the objectives for the deal. After all, if a deal achieves its objectives, then by definition it could be said to have been successful.

The creation of shareholder value is just one, albeit an important, objective for a takeover.

The concept of shareholder value is a tricky one to understand, but it is important.

Shareholder value is all about return on investment. If you have £10,000 invested in shares in a company, then you expect to earn a return from that investment – i.e. your shareholder return. Shareholders typically require a greater rate of return compared with, say, investing in savings accounts, to compensate them for the greater risk involved.

It is the firm’s management that make those investment decisions on behalf of shareholders. Importantly, a takeover is just like any other investment – it has to earn a return; otherwise why bother? The problem is that takeovers are usually much more complicated and therefore risky than other kinds of business investment.

So, if a firm has a corporate objective of earning a target rate of return for shareholders (most quoted firms do), then the classic way to evaluate a takeover is in terms of financial returns.

Sometimes, it’s relatively easy to work this out. Take these two examples:

In March 2008, Tata Motors bought Jaguar Land Rover from Ford for around £1bn. In 2011, JLR reported a significant improvement in profitability and is now estimated to be worth at least £9-10bn. A substantial improvement in shareholder value for Tata shareholders, without doubt.

In 2007 Royal Bank of Scotland (RBS) was part of a consortium of three banks which paid £49bn for ABN AMRO. RBS’s share of the investment was £10bn. It was subsequently discovered that RBS’s part of ABN AMRO was worthless and that an additional £5bn of liabilities had been bought. This led to a loss of shareholder value of £15bn. By any measure - a disastrous takeover

In both the above examples, the success or failure of a takeover (as measured by the effect on shareholder value) is clear-cut. Tata buying JLR – a big success; RBS buying ABN AMRO – a huge failure.

But sometimes the use of shareholder value as the measure of success or failure is less clear-cut.

Take the example of Google’s acquisition of YouTube for $1.7bn in 2006. What return have Google shareholder’s received from that deal? It’s hard to tell – since no separate financial information is provide about the YouTube. There is no doubt that YouTube has grown dramatically since Google’s takeover and that it has generated substantial advertising revenues – but Google will also have incurred significant costs in scaling up and developing the YouTube service. Has the deal been a success? Most would say yes, since it has enabled Google to establish a strong leadership position in a key online market (and to further the achievement of its other corporate objectives). But using shareholder value as the measure is a little trickier.

The use of shareholder value to evaluate the success of a takeover is much easier if the target business continues to be operated on a standalone basis, with financial performance readily identifiable. However, this shouldn’t prevent a buyer from integrating the target business and extracting potentially significant cost synergies – since these are usually the things that generate the required shareholder return in the first place!