Worldwide merger and acquisition activity totaled $4.7 trillion last year (a 42% increase over 2014 levels) making 2015 the strongest year for deal-making on record. Therefore in a sellers’ market, many buyers that were previously reluctant to take on pension and post-retirement medical obligations are accepting this additional risk to stay in the game.
Chuck Moritt is Mercer’s North American multinational client leader and co-author of the company’s 2016 report “People Risks in M&A Transactions.” He believes that the fundamental driver of this high level of M&A activity is low economic growth of 2% or 3%. “M&As are one way organizations can demonstrate growth to their shareholders in a low growth environment because they can improve top line revenue and find ways to reduce expenses,” he says.
Buyers face a host of new complexities as they enter unfamiliar geographies and industries, often enticed by the promise of lower costs in emerging markets. Study findings show that nearly 25% of buyers are more inclined to consider multi-country transactions than they were prior to 2014. Also, almost 50% of buyers are willing to consider taking on pension and post-retiree medical obligations, with one in four transactions analyzed including single or multi-employer pension plans.
In addition, 41% of participating buyers report having less time to complete their due diligence before making a binding bid compared to previous years, and 33% say that sellers are providing less information about the asset for sale.
Moritt notes that understanding the pension and benefits plans of seller organizations is an important part of buyer due diligence. “Buyers need to know whether there are significant differences between the benefit plans of the two organizations in order to effectively integrate the programs after the deal closes,” he says.
Furthermore, understanding the pay and benefits practices relative to industry benchmarks for all rewards components is another crucial element of due diligence. This includes base pay and total cash; internal equity; incentive metrics/targets and non-cash rewards. Study results reveal that the top rewards-related issue is medical benefits, which was a key area of focus in 91.7% of the 450 randomly-selected transactions studied.
Compensation and benefits are of particular interest for private equity buyers with more than a quarter of respondents citing this as a significant area of focus in future transactions. But because the timeline between when company actually decides to sell and the deal closes can be anywhere from six months to a year, there can be considerable volatility in the value of defined benefit pension plans and other long-term obligations during the auction period.
“For example, there have been swings of as much as 10% over the last several months. If there is a 10% market swing, the value of a $500 million pension plan drops by $50 million creating a problem for both the buyer and the seller,” he says.
To help manage market volatility, Mercer offers M&A vendors a pension debt product Moritt describes as “an approach that allows investment managers to implement hedging strategies in the seller’s pension fund that can mitigate the effects of market lows using various types of options and synthetic instruments to take out the effects of volatility.”
He continues, “Where there is enough scale in the plan and depending on the investment portfolio and the time line, there will generally be hedging strategies available that will provide risk mitigation for both sellers and buyers. But to say this solution is always available would be misleading,”
Representations and warranty insurance are another way to preserve deal value. These insurance policies offer protection against financial loss suffered as a result of breach of representations and warranties contained in the purchase and sale agreement. For 2015 in North America, Mercer’s sister company Marsh saw an increase of 20% in the number of policies issued and an increase of 50% in the amount of insurance placed.
While nailing down the financial details of an M&A is extremely important, the survey suggests strategies that help buyers retain employee talent during organizational transition are also critical to the success of the transaction. In fact, 64% of respondents indicated that talent-related issues are typically the most significant focus of their due diligence.
That’s why programs targeted at employee groups that influence important customer relationships or operating initiatives can maximize the purchase price and minimize any pre-closing disruptions that would typically occur if key people exit.
But Moritt says if the purpose of the deal is to buy product and know-how that will be integrated into existing systems retaining key talent may be important, but the duration or how long you need them to stay is a different matter. “Ultimately the acquirer must determine whether incumbents from the target [acquired company] are the best people to achieve the organization’s objectives,” he says.
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