2009While we wait patiently for our winter of financial discontent to be made glorious summer, searching eagerly for credible signs of green shoots and wondering which letter of the economic alphabet – V, W,U or, horror upon horrors, L – will most aptly describe the shape of the current recession, we know that Merger & Acquisition (M&A) activity will not pick up until business confidence does, as the two move in lockstep.
But is that a bad thing, or is this the pause that refreshes, giving us time to form new insights into what makes mergers and acquisitions fail, and therefore what we can do better in the next upswing? How can we harness growth by acquisition as a means of delivering that elusive shareholder value?
Studies on M&A success/failure almost universally conclude that the majority of M&A deals either destroy shareholder value or fail to create incremental value that could not have been generated in some other way, such as from organic growth. The reportage is so gloomy that it sometimes seems that the popularity of M&A activity, particularly in economic upswings, is a tribute to human resilience and obstinacy, rather than the product of a carefully thought out strategy.
One academic – Professor Robert F Bruner of Darden Graduate School of Business, University of Virginia – provides a ray of light in an otherwise gloomy scenario, however. In his book Deals from Hell1 he points out that the thinking around M&A failure can be badly flawed. Specifically he points out that:
• risks of M&A failure are no greater than the risk of failure of any major capital project, such as a new mining venture. Risk is an inherent part of business, and knowing how to manage it, rather than eradicate it, is a key challenge of management. This sentiment finds an echo in the remarks made by Whitey Basson, the CEO of Shoprite Checkers, on his company’s experience in Africa. Shoprite’s management believes it understands the risks of operating in Africa, and as a result of their ability to manage them, they are able to generate commensurately higher returns than are available in more developed economies;
• our perceptions can be skewed by a few high-profile failures, as a result of which we tend to generalise these failures across the broad spectrum of M&A activity. Prof Bruner points out that most of the losses from M&A activity incurred between 1980 and 2001 were generated by 87 deals out of 12 023 studied. For some reason the spectacular examples of shareholder value destruction, such as Time Warner/AOL and Daimler/Chrysler, linger on in our consciousness; and
• M&A failure is often reported out of context. Sure, a great deal of shareholder value was lost by Time Warner shareholders, but the acquisition was made immediately before a major economic downturn, and the shareholders would have had a great deal of their value wiped out even if the acquisition had not taken place.
That said, there is also no doubt there are dos and don’ts about how to conclude acquisitions successfully. Oft-cited reasons for M&A failure include the following:
• Key talent leaves
Sometimes the key objective of an acquisition is to gain talent, creativity or management. But people are notorious for their ability to up and off. This happened to IBM many years ago when it acquired Lotus Corporation in an attempt to bolster its PC capabilities. The Lotus people didn’t relate to IBM’s way of doing things, and a number of key employees left, diluting the value of the deal.
• Ignoring the culture fit
The culture of a company can be a subtle thing, but it can be very important in determining organisational fit. Culture comprises the assumptions, norms, shared values and practices –‘the way we do things around here’ – that define a company. It is almost certainly true that the influence of culture is not taken into account sufficiently before a deal is concluded.
• Overpaying for the company
There is no one right price for a company. One company might be a better owner of a target than another as a result of the ability to generate synergies, and therefore the right price is the intrinsic value of the target plus a premium that does not exceed the value of those synergies. The authors of an informative article, “Are you paying too much for that acquisition?”, published in the Harvard Business Review2 point out that as a buyer you must be able to justify the price you are willing to pay on economic grounds, even if many judgments are required in your calculations. The notion of ‘strategic value’ can be a trap for the unwary.
• Not paying enough attention to implementation
There can be a disconnect between the acquiring team and the implementation team. Somewhere along the line there can be a dilution of the vision underpinning the deal. Companies that are most successful at M&As understand the need to commit senior resources to ensuring that the deal achieves the objectives for which it is intended by managing the implementation process.
• Ignoring existing customers while the acquisition is being bedded down
A great deal of work goes into the implementation aspects of major deals. This may spread management of the acquiring company very thinly. A lack of attention to the needs of existing customers will be quickly picked up by those customers, and they will move to a competitor. This possibility needs to be planned for and guarded against.
• A joint venture or alliance might have been a better option
Setting a growth strategy should always involve an evaluation of the relative merits of organic growth, growth by acquisition and growth by alliance/JV. In another HBR article, ‘When to ally and when to acquire’3, the authors point out that when the objective is to acquire skills and talent, an alliance may be a better option, so as to avoid culture clashes that will lead to people leaving the combined entity.
A great deal has been written about improving the chances of success in M&A, but as with any other field of human endeavour, there is no substitute for experience, as opposed to text-book learning. In fact it can be observed that the companies with the highest record of M&A success are those that have turned growth through acquisition into a core skill: they make many smaller acquisitions and thus are able to devote a small, well-trained team to the task. Steel company Mittal used this approach in starting out on its path to becoming the largest steel company in the world.
The ingredients of success in M&A include the following:
• Operate strategically, and not opportunistically
Bain & Co, the consultancy, produced a surprising finding based on interviewing the CEOs of 250 companies a few years back. The surprise was that 40% of the CEOs interviewed did not have an investment thesis, and 50% of those that did found their investment thesis to be incorrect within three years. In other words, CEOs could not articulate precisely why they had considered or made a particular acquisition, and many acquisitions were made for the wrong reasons. Given the implication of the time, money and other resources that need to be invested in an M&A programme, it’s important that you get the best bang for your back by carefully honing your acquisition strategy.
• Stick with the industry you know
McKinsey and Co, another consultancy, warn against the temptation to move into other industries with which you are less familiar, particularly in times of economic downturn. It can be tempting to respond to the Siren call of investing in an industry that is adjacent to the one in which you already operate, on the basis that you already know something about it. But in their article entitled ‘The granularity of growth’ 4 McKinsey warns that you may not know enough about the industry to be competitive, and it may be more fruitful to look for pockets of growth in your own industry. In other words, do not regard your industry as being homogenous, but rather one in which elements will be ebbing and flowing all the time, and look to take advantage of those cycles.
• Understand your basis of competition, and build on that
Bain & Co, in a Harvard Business Review article entitled ‘Building deals on bedrock’5 offer the opinion that understanding what makes your own company tick is a good starting point for identifying which companies might make suitable acquisition targets. Sometimes the basis of competition is more subtle than it appears at first glance, and companies only rarely operate off one basis of competition but, if your company has low cost as a basis of competition, it may have a very uncomfortable fit with a company that sells branded goods, for which cost control is less of an imperative.
• Implement internal procedures to make sure that you get the deal at the right price
It is sometimes said that financial buyers, such as Private Equity companies, make better buyers than trade buyers, as their investment decisions are based entirely on financial considerations, whereas trade buyers can be swayed by invalid thinking, such as ‘this could be our last opportunity to acquire such an asset’, leading to overpaying.
Whichever sort of buyer you are, you need to implement internal disciplines to lower the risk of overpaying. For example, empower the negotiating team to operate only within a specified range. Pressure to exceed this range needs to be referred up to an executive that is not as close to the deal.
One of the hardest things to do is to walk away from a deal in which you have invested considerable time and money, and yet this may be the key to M&A success. Anglo Gold walked away from the potential acquisition of Australian miner Normandy when management could find no economic justification for increasing their bid price higher, thus earning the market’s respect.
Mergers and acquisitions may not be a lost cause in terms of value creation, but it is clear from the above that they need to be thought through very carefully and that it is essential to build up a track record of success on smaller acquisitions before launching into something bigger. Maintaining a strategic perspective on mergers and acquisitions is vital for success.
1. ‘Deals from Hell’, by Robert F Bruner, John Wiley and Sons, 2005
2. ‘Are you paying too much for that acquisition?’, by Robert G Eccles, Kersten l Lanes and Thomas C Wilson, Harvard Business Review, July/August 1999
3. ‘When to ally and when to acquire’, by Jeffrey H Dyer, Prashant Kale and Harbir Singh, Harvard Business Review, 2004
4. ‘The granularity of growth, by Mehrdad Baghai, Sven Smit and S Patrick Viguerie, The McKinsey Quarterly, 2007
5. ‘Building deals on bedrock’, by David Harding and Sam Rovit, Harvard Business Review, September 2004
Dave Thyser CA(SA), MBA, FCMA is Director: Transaction Advisory Services at Ernst & Young.