Based on the many customer engagement I work with in the field of Mergers and Acquisitions, I would like to write about some of the ideas, benefits, critical success factors and pitfalls. However let me start with saying that M&A is not strategy in and of itself, but a vehicle for executing a strategy and delivering shareholder value. A Merger and Acquisition is a tool used by companies for the purpose of expanding their operations often aiming at an increase of their long term profitability. There are 15 different types of actions that a company can take when deciding to move forward using M&A. Usually mergers occur in a consensual (occurring by mutual consent) setting where executives from the target company help those from the purchaser in a due diligence process to ensure that the deal is beneficial to both parties. Acquisitions can also happen through a hostile takeover by purchasing the majority of outstanding shares of a company in the open market against the wishes of the target's board. In the United States, business laws vary from state to state whereby some companies have limited protection against hostile takeovers. One form of protection against a hostile takeover is the shareholder rights plan, otherwise known as the "poison pill". Historically, mergers have often failed (Straub, 2007) to add significantly to the value of the acquiring firm's shares (King, et al., 2004). Corporate mergers may be aimed at reducing market competition, cutting costs (for example, laying off employees, operating at a more technologically efficient scale, etc.), reducing taxes, removing management, "empire building" by the acquiring managers, or other purposes which may or may not be consistent with public policy or public welfare.
M&A is buying smart and integrating successfully. Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded. In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals". Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.
In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal euphemistically as a merger, deal makers and top managers try to make the takeover more palatable.
M&A is challenging and requires focused and sustained effort. The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:
Synergies: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
Increased revenue/Increased Market Share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.
Cross selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
Economies of Scale: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts.
Taxes: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company.
Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below).
Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.
Vertical integration: Vertical Integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.
However, on average and across the most commonly studied variables, acquiring firms’ financial performance does not positively change as a function of their acquisition activity.Therefore, additional motives for merger and acquisiiton that may not add shareholder value include:
Diversification: While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger.
Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.
Empire building: Managers have larger companies to manage and hence more power.
Manager's compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders); although some empirical studies show that compensation is linked to profitability rather than mere profits of the company.
The failure rate among M&A deals is very high:
· 58% of mergers failed to reach goals set by top management (Survey by AT Kearney)
· Deal costs were recovered within 10 years in only 23% of all transactions (The Economist Survey)
· In almost 60% of all cross-border transactions, the acquiring company did not earn back its cost of capital (Business Week Research)
· 50% of transactions result in same or lower profits (Business Week Research)
· Of 150 recent deals about half destroyed shareholders wealth (Business Week Research)
I have looked over the numerable M&A projects I have worked with and have come to the overall conclusion that M & A failure occur during different stages of the transaction:
· About 30% Strategy development, candidate screening, and due diligence
· About 20% Negotiation and closing
· About 50% Post-merger integration
The classic M&A challenges:
Rewards:
- Produces rapid growth
- Adds capabilities
- Builds scale
- Expands geographic markets
Regrets
- Adds significant risk
- High probability of failure
- Very expensive
- Effects on management
Effects on management:
A study published in the July/August 2008 (Mergers and Acquisitions Lead to Long-Term Management Turmoil Newswise) issue of the Journal of Business Strategy suggests that mergers and acquisitions destroy leadership continuity in target companies’ top management teams for at least a decade following a deal. The study found that target companies lose 21 percent of their executives each year for at least 10 years following an acquisition – more than double the turnover experienced in non-merged firms. In order to change that, three major assumptions determine the content of the change management work streams:
1. Strategic rationale behind a merger has to determine the focus of the post-merger transition and integration tasks
2. Merger is never one merger, but made up of tens of hundred of mini-mergers. Each mini-merger needs its own reconciliation process
3. Cultural clashes and differences in management processes and styles reflect different mind-sets of two organizations. Recognition of this fact and the necessity of professional expertise in addressing these problems is blocked by perception of their vagueness and invisibility
However often forgotten is that there has to be a link between change management and the critical value drivers (critical success factors). E.g. here are six critical success factors to make a Merger and Acquisition a success:
1. Wisdom of the deal - as seen by the marketplace and the merger partners
2. Soundness of the due diligence - understanding what you face
3. Preoccupation with driving the value of the deal
4. Moving as fast as possible
5. Thoroughness of the post merger integration programme and its implementation
6. Utilisation of scarce leadership talent: effecting the merger while leading the existing businesses
In order to get these and other important critical success factors throughout the M&A lifecycle in place, real success demands a value-creating approach. I have over the years developed such a M&A value-creating approach/method and if you need help in better understanding and exploiting such a value-creating approach. Let’s talk about how I can help you explore the levels of value creation you are looking for in your merger and/or acquisition.
If you have any questions please feel free to contact me via email: mvr@rosenteam.com
Regards your moderator
Mark von Rosing
