Commentary - Brian Harding

formerly of James Capel Stockbrokers

Total shareholder Returns from acquisition growth contrasted with those from organic growth based on R&D investment


In recent years UK companies in the quoted engineering, automotive and aerospace sectors have spent more on acquisitions than on research and development and capital investment combined. In view of the benefits associated with increased R&D investment intensity highlighted in this and previous Scoreboards, it is important to gain some insight into the success or failure of acquisition-led growth in general, and to compare this with the total shareholder returns (TSR) generated by high investment intensity companies. In carrying out this comparison, it is helpful to make some international comparison with respect to the propensity to grow by acquisition. This has been done via a direct comparison with a large group of quoted, US companies in the same sectors. This article addresses these two related issues.

The analysis that follows is based on a sample of 46 quoted UK companies in the engineering, automotive and aerospace sectors and, for the international comparison, on 184 quoted US companies in the same sectors. Both samples account for a very high proportion of total sector market capitalisation. The research on the relationship between TSR and levels of investment, and the work on the TSR effects of large acquisitions relates primarily to the ten year period 1988 to 1997 when all 46 UK companies were operating independently throughout the entire period. There is some extension to cover later years, although several of the original companies disappeared from the sample as a result of M&A activity. The comparison between the UK and the US has been based on the period 1997 to 2000 because of earlier discontinuities in the US data. The underlying source documents for the US were the IRI Industrial R&D Scoreboards and US Mergers and Acquisitions published by Thomson Financial. The UK data was derived from the R&D Scoreboards, company accounts, Datastream and Acquisitions Monthly.

The relationship between total shareholder returns and investment in research and development and capital spending

As the 2001 Capex Scoreboard *1 showed, there is a high degree of variability between companies with respect to TSR, particularly over longer periods of time. Over the period 1988-97 total shareholder returns vary from +839% (Bodycote), to –71% (ASW). Full details for all companies in the broad engineering sector are found in the Capex Scoreboard*1.

It is, however, short run share price volatility which poses the greatest difficulty in procuring satisfactory measurements of the success or failure of particular investment strategies. This difficulty can be circumvented to some extent by using ranking techniques. Rather than working in terms of share prices per se, companies are ranked by total shareholder return and by investment intensity, (research and development plus capital spending as a percentage of sales). The correlations between these two rankings are then calculated. This approach has the advantage that it effectively removes systematic share price variation arising from changes in investor fashion (eg, a switch from engineering to ‘dot-com’ stocks), broad changes in investor sentiment (eg, a switch from equities to cash), and sectoral rotation (switching into or out of defensive or cyclical stocks). Ranking therefore focuses on outperformance or underperformance within sector in terms of TSR.

On this basis it is possible to discern highly significant positive correlations between within-sector rankings for TSR and investment intensity. The correlation coefficient for the ten-year period 1988-1997 for example, is Rs = 0.55. The chances of observing a coefficient of this magnitude if no real relationship existed are about 2000 to 1 against. Similarly high Rs values can be observed for almost every period of four years or more, (and most periods of three years or more). To put these findings another way, most high investment intensity companies will be found in the top half of the TSR ranking table most of the time if the measurements are taken over a period of three years or more.

* Brian Harding has a fellowship at Warwick Business School and was previously with James Capel for a period of some 20 years. Before this, he held senior management positions in UK engineering companies.

*1 Brian Harding in 2001 Capex Scoreboard, DTI & Company Reporting Ltd

The relationship between total shareholder returns and major acquisitions

The argument for acquisitions advanced most frequently by acquiring companies is that of synergy. It is argued that the enlarged group will achieve improved manufacturing efficiencies via plant closure or consolidation or economies of scale. Alternatively, or additionally, better marketing efficiency is sought through the completion of product ranges, the introduction of existing products into new markets where the acquired company has an established presence, or the introduction of the acquired company’s products into markets controlled by the acquirer. This is undoubtedly a popular argument amongst companies. We have identified a total of 540 acquisitions made by the 46 companies in our data set over the period 1988-97, rising to 667 over the period 1998-2000. It should be added that integrating an acquired company involves much management time and attention leaving less for issues of organic growth through investment.

The aggregate expenditure on acquisitions, by year, for the 46 UK companies involved in the study is set out in table 1 below.

figure 1

It is fairly obvious that this data is intensely cyclical in nature with very little acquisition activity occurring in periods of economic decline when prices would tend to be lower. Maximum expenditure tends to occur when the economy is buoyant and the price of making an acquisition is relatively high. This phenomenon relates to the frequent desire of predator companies to use their own paper in the acquisition process and/or, to the desire of sellers to deal only when prices are relatively buoyant.

Attention was focused on the changes in TSR ranking which followed major acquisition events to see whether or not companies which completed major acquisitions outperformed those which did not. A ‘major’ acquisition is arbitrarily defined as one where the consideration is equal to at least 15% of the annual sales of the acquirer at the time of acquisition. On the basis of this definition a total of 18 companies completed 25 ‘major’ acquisitions between 1988 and 1997. For each of these acquisitions total shareholder return was tracked on a monthly basis for four years after each takeover.

This revealed that a major acquisition was followed by under-performance against the sector average on 16 occasions out of 25 (64%). Additionally, and just after the end of our arbitrary four year period, a further three companies (Wagon, Invensys and Baynes) suffered a collapse in share price and total shareholder return; on this basis 76% of all major acquisitions were followed by underperformance. However the period is defined, share price underperformance after a major acquisition is significantly more likely than outperformance. It is important to note that some major acquisitions appeared to be successful with 7 of the 25 associated with relative TSR outperformance of over 20% after 4 years. However, three of these 7 were made by Wagon, Invensys and Baynes whose share prices collapsed just after the period studied. The point is that significant outperformance is just a much less likely outcome with two to four times as many acquisitions associated with underperformance against average shareholder returns for the sector.

Research in the US by Sirower*2, which was based on an examination of all major acquisitions (excluding regulated sectors such as banks, utilities) completed between 1979 and 1990, found that about 66% of all deals were followed by reduced shareholder value. The similarity between our figures for the UK engineering, aerospace and automotive sectors and the more broadly based US data is striking. It is suggested that the reasons for this relatively high failure rate include overpayment for the target company, (particularly likely in the case of contested takeovers), overestimation of the synergy benefits, and underestimation of the time taken to realise these benefits. Such under-performance could, of course, result from a variety of factors and it might be unwise to attribute it solely to ill-judged acquisition strategies. Nevertheless, the contrast between high investment intensity companies with their sustained and frequent appearance at the top of the TSR rankings, (reference 1), and the frequent under-performance which follows major acquisitions is very marked.

*2 Sirower: The Synergy Trap, 1997

A comparison between the UK and the US with respect to acquisition-led growth in the engineering, automotive and aerospace sectors This comparison relates to the four-year period 1997 to 2000 and is based on the behaviour of two groups of quoted companies, 184 in America and 46 in the UK, all of which operated in the engineering, automotive and aerospace sectors. Aggregate expenditure on acquisitions is displayed in tables 2 and 3 below:

figure 2

Table 4 contains a comparison of acquisition intensities, (aggregate expenditure on acquisitions as a percentage of aggregate sales), for the UK and the US.

figure 3

A number of interpretive comments have to be made about the data in table 4:

  • Acquisition spend in the US is not lower because the sector was more fully consolidated before 1997. In 1999, about 89% of the 184 US companies included in the sample contributed less than 1% to total sector sales. The corresponding figure for the UK is 56%. If anything, the UK is in a more advanced state of consolidation than the US so that the US has greater potential for acquisitions and might have been expected to show a higher acquisition intensity. The majority of UK companies in this broad sector are international in scope so UK domestic market considerations should not predominate.
  • The UK engineering, automotive and aerospace industries spent about five times as much on acquisitions per £ of sales as the US over the period 1997 to 2000. If the particularly large acquisitions noted beneath tables 2 and 3 are arbitrarily removed (the turnover figures remaining unchanged), the UK still spends over four times as much per £ of sales as the US.
  • There is an argument for excluding Ford and GM from the American data on the grounds that these companies are so large, (Ford $163bn of sales, GM $173bn of sales in 1999) that they can no longer make meaningful acquisitions. Also, there are no broadly comparable companies in the UK. Exclusion of these two companies does, of course, raise US acquisition intensity – but only to an average of 3.28% over the period 1997 to 2000. This still leaves UK acquisition intensity about 3.5 times higher than that seen in the US.
  • Even the entirely arbitrary removal of Ford and GM on the grounds of size and lack of comparability (removing both acquisition expenditure and turnover), plus the removal of all other major acquisitions noted under tables 2 and 3, leaves the residual acquisition intensity in the UK close to three times that seen in the US.

While table 4 establishes the difference in acquisition intensities between the US and the UK, it does not relate the expenditure on acquisitions to organic investment in R&D and Capex. This is done in table 5 below.

figure 4

Table 5 demonstrates that UK companies invested only 60% as much in R&D plus Capex as they spent on acquisitions. US companies, on the other hand invested between four and five times as much on R&D plus Capex as they spent on acquisitions. If GM and Ford are arbitrarily removed from the US data, the remaining US companies still spent 2.4 times as much as on R&D and capital investment as they did on acquisitions. This ratio thus remains well in excess of the UK figure of 0.6.


We have argued that, in terms of within sector total shareholder return, growth by acquisition is frequently inferior to that achieved by ‘organic’ investment in R&D and capital spending. Despite this, vast sums continue to be spent on acquisition-led growth and there is some evidence which suggests that, in the late 1990s, it was becoming increasingly important relative to R&D and capital spending.

The argument is not against acquisitions per se. A process of acquisition and consolidation is probably the only way of dealing with any industry which is facing a long term contraction in demand or substantial overcapacity. The hostile takeover, or mere threat of such a takeover, has an important place in the general disciplinary function of the Financial Market. Nor are we criticising individual acquisitions. We are merely pointing out that, as a group, those companies which spend heavily on research and development and new plant outperform, on average, those which undertake large acquisitions. The disparity between the frequent out-performance of high investment intensity companies, and the under-performance which too often follows major acquisitions, is too great to be dismissed as mere chance.


The position in the US appears to be fundamentally different from that in the UK in that major acquisitions are, somewhat surprisingly, less frequent.

In the US, expenditure on acquisitions over the period 1997-2000 was less than one third of that seen in the UK on a per £ of sales basis. This lower incidence of acquisition activity would not appear to be related to lack of opportunity since the US sectors remain less consolidated than their UK counterparts. Additionally, there is a fundamentally different relationship between research and development plus capital spending and acquisition spending in the US vis-a-vis the UK. In 1999 and 2000 American companies in the above sectors spent only 22% as much on acquisitions as they invested in R&D plus Capex whereas UK companies spent 160% of organic investment on acquisitions. Even the arbitrary removal of BAe with its huge acquisition of the Marconi defence interests from the samples leaves this ratio at 110% and, hence, with acquisition spend still larger than organic investment; if, in addition, GM and Ford are removed from the US data, the US ratio of R&D plus Capex to acquisitions is still three times the UK figure.

Although some acquisitions are undoubtedly successful, the question remains as to why UK CEOs should continue heavily to favour strategies of investing in major acquisitions. The answers could include the desire for quick results, a desire to compensate for previous underinvestment in R&D and Capex and, perhaps, the prospect of enhanced rewards and security thought to be associated with a larger and expanding company *3,4. There could also be a tacit coincidence of interest between investment bankers (with their interest in M&A fees), plc directors (with concern for their personal position and income) and fund managers (who are likely to choose an immediate and substantial premium on the shares they hold in the target company rather than voting against a takeover on grounds of insufficient industrial logic).

The key factual conclusions are therefore:

  • A study following a large group of UK companies over 10 years shows that high levels of R&D and capital investment (essential components of organic growth) are positively correlated with increased relative shareholder returns over periods of 3 to 4 or more years.
  • Major acquisitions (in the broad engineering industry and also across industries) are associated with a reduction in relative shareholder returns over the succeeding four years in some twothirds of cases.
  • US companies in the broad engineering sector invest more heavily in R&D and Capex than do their UK counterparts.
  • The result is that the broad engineering sector in the US spent on acquisitions just over 20% of the sum invested in R&D and capital equipment, while the equivalent sector in the UK spent on acquisitions a sum which was over 150% of their R&D and capital investment. These percentages remain very substantially different even if the largest UK acquisition and the largest US companies are arbitrarily excluded.

This evidence on long-term shareholder returns shows that, in formulating their strategy for future growth and success, companies need to consider carefully the merits of organic growth based on high R&D and capital investment against the generally less successful outcomes associated with major acquisitions.

*3 Charkham ‘Keeping Good Company’ OUP 1992(p311-5)
*4 Marsh ‘Short Termism on Trial’ Booklet for Institutional Fund Managers Association. 1990


Brian Harding wishes to acknowledge the valuable assistance given by Mark Whittington of the Warwick University Business school.


The basic methodology used was as follows. We calculate, for each acquisition event, the cumulative post acquisition total shareholder return and subtract from this the average cumulative total shareholder return achieved by the entire group of companies over the same period. A negative result indicates under-performance against the group average, a positive result indicates out-performance. This data was computed on a monthly basis for four years after the completion of each acquisition. This approach possesses the advantage that it effectively removes systematic share price variation arising from changes in investor fashion, investor sentiment and sectoral rotation. It therefore focuses on outperformance or underperformance within sector in terms of total shareholder return. The results of this analysis are summarised in the table below.