Summing Up
In the end, M&A is about buying more volume. It is a flawed process, invented by brokers, lawyers, and super-sized, ego-based CEOs." With this comment, Ellis Baxter summed up the thinking of the majority of those responding to the April column. Edward Hare put it in more graphic terms: "Acquisitions are a macho exercise, not an intellectual one. Think World Wrestling Federation, not a chess tournament." Stephen Alexander adds: "Those promoting an acquisition are often dealmakers whose interest in the transaction often stops when the deal is closed." Jean-Marc Frion opined that, "Only in certain circles, such as family…where both parties sincerely want the good of the other and are not motivated by greed, can there be deals in which neither of the two loses."
Does it have to be this way? Several respondents pointed out reasons why mergers and acquisitions fail to achieve their objectives, suggesting possible remedies to this "flawed process." Kathryn Yates, for example, cited three primary reasons for M&A failure: "1) Forgetting to plan for the cost of integration… 2) Side deals. Putting the best manager (no matter the company source) in charge is always the best plan ... 3) ... thinking that a top-down communication, sent once, is sufficient." Marcus Dancer blamed some of the problem on the way that executives are compensated. In his words, "Because executives are frequently compensated in an asymmetrical fashion (for example, through stock options), it is in their financial best interest to do M&A to add volatility to their business."
Is M&A part of the natural Darwinian process of business, or is it rigged to produce inferior species of companies, as measured in terms of value created for customers, employees, and shareholders? If the latter, is it the natural result of a system of incentives geared to short-term financial rather than longer-term business benefits? And what does it say about the overall future strength of industries caught up in consolidation? Or, as some critics claim, are we caught up in research that fails to adequately measure the benefits of M&A (particularly in situations where one of the partners is especially weak) while concentrating on the disadvantages? What do you think?
Original Article
The recent return of higher enterprise market values as well as greater disparities between them suggests that an upturn in mergers and acquisitions can't be far behind. Unfortunately, if research is any guide, the operative question is whether more or less value will be destroyed in this cycle than the last, from which many investors (for example, those in the former Time Warner) are just recovering. In pondering this, it is appropriate to give some attention to a recent book, The Human Side of M&A, by Dennis Carey and Dayton Ogden.
Research tells us that the short-term value in an acquisition accrues primarily to shareholders of acquired companies. On the other hand, short-term value is more often destroyed than created for shareholders of acquiring organizations. There are conflicting conclusions about whether mergers and acquisitions contribute directly to long-term value for the surviving organization. What is generally agreed upon is that perhaps as many as two-thirds of all acquirers fail to achieve the benefits planned at the outset of an acquisition. In part, this is thought to be due to the fact that too many acquirers are more concerned about size and top-line growth than value creation. Others approach an acquisition like a conquering hoard, focusing on the numbers while remaining insensitive to the qualities and needs of the human resources being acquired.
Carey and Ogden set out to examine the methods for integrating an acquisition that were employed by a subset of acquirers experiencing significant long-term, post-acquisition value increases. They found that these acquirers: (1) performed careful due diligence not only on the easy-to-obtain financial numbers but also the sensitive and difficult-to-obtain information about people and culture, (2) avoided acquiring organizations with distinctly different cultures than their own, (3) created a third strategic vision based on a combination of those of the two merging organizations, (4) quickly identified, motivated, and retained key managers in the acquired company, (5) integrated the two organizations deliberately and swiftly, promoting the best managers from each organization, (6) timed their integration activities to avoid significant disclosure prior to regulatory approval of the acquisition while doing whatever necessary to "survive" a sometimes prolonged regulatory process, and (7) strengthened their board by selectively drawing members from the boards of both organizations.
There is nothing here that is earth shaking, although it is clearly harder and more complex than it sounds. But if the roadmap is clear, why do so few mergers and acquisitions meet expectations? Are so many supposed benefits factored into the acquisition price that it is difficult to realize value for the acquirers? Is the information regarding human resources just too difficult to obtain during a sensitive acquisition process? Or do acquirers talk a good game about the importance of targeting and retaining talent without really believing it or making the effort to follow through? Should we get ready for another era of M&A value destruction? What do you think?
The news that two-thirds of acquirers fail to reach their financial performance targets is not new, nor are the reasons. The continuing consternation is that companies fail to learn from the mistakes of others, believing that "our numbers" are more well-founded and therefore not subject to the elements of integration that crashed someone else's ship on the rocks.
Basic fact: Those promoting an acquisition are often dealmakers whose interest in the transaction often stops when the deal is closed. Basic fact: Most companies don't have the management fortitude to take the time needed to do the due diligence of all the organizational factors (people and culture) that are the mark of successful integrations.
Until companies adopt this approach, we will continue to see the same pattern of results and the accompanying dismay by shareholders.
Yes, on average, M&A will be value destroyers because of compensation structures and human needs factors. Because executives are frequently compensated in an asymmetrical fashion (for example, through stock options), it is in their financial best interest to do M&A to add volatility to their business. For example, let's say a company is trading at $10. It can do an acquisition that will either be a great success (stock will go to $18) or will severely hurt the company (stock goes to $2). Say the net value of the deal is -$2. If the CEO were paid in options, he would have a financial incentive to do this deal even if it were destructive on average. As to human needs: We need to grow and we--on average--expect greater outcomes than the actual outcomes.
Value realization is obtained not by capitalizing on managerial knowledge and socializing job loss, but by integrating tacit and codified knowledge at all levels to make a viable operating entity.
An upside in M&A with increased values seems to be most definitely on the horizon, but it needs to be seen if this time around M&A skills have advanced to levels of accurately determining value creation and not just unstable market capitalization.
It is very hard to forecast whether an M&A creates or destroys value. I know that in an M&A between two companies, the sum 1 plus 1 does not always give 2: it can be 3 or 1 depending on the value created for the shareholders, stakeholder, employees, and customers. An Italian saying is "Homo homini lupus": everybody tries to take advantage from a deal. And so the companies do during an M&A process.
I've worked on more than a hundred transactions, both on the corporate side and as a consultant, and here are three of the many things that stop senior management from reaching the goals they set.
1. Forgetting to plan for the cost of integration. A year later, results often show that the destruction of intended value can be traced to this issue.
2. Side deals. Putting the best manager (no matter the company source) in charge is always the best plan ... but reality is more likely a "good guy" side deal where longtime managers protect their own. This not only hurts long-term productivity, it also weakens the process and destroys trust.
3. "I already told them." This is the issue of thinking that a top-down communication, sent once, is sufficient. It's closely related to "Why are they so resistant to change?"
Until the soft stuff of communication and HR process are managed with the same kind of discipline as the financial details, value will always be at risk.
This will probably sound trivial, but experience strongly suggests that in today's world, buying usually means being the loser in the deal. One party has to lose; otherwise the deal would not happen, right? Why would it be different between corporations? Only in certain circles, such as family or close-knit tribes, where both parties sincerely want the good of the other and are not motivated by greed, can there be deals in which neither of the two loses.
Like all decisions based on the money side of the page, M&As are never what they appear. The huge cost in terms of time and legal fees is an outrage. Can anyone name one M&A in which the service to the end user got better? Shareholders do worse in almost all cases. Employee talent is lost to some competing company.
Growth should come from the ground up. If you cannot grow the company ground up, how do you manage a major takeover? The only exception is the takeover of a failed company. Here the core value is obtained at a low cost, the workers who are retained are happy to have a job, and the locations and or plants have low-cost, real value.
In the end, M&A is about buying more volume. It is a flawed process, invented by brokers, lawyers, and super-sized, ego-based CEOs. I prefer being like a farmer and growing the business. In my industry, every attempted M&A beyond a single model has failed.
I was an investment banker who specialized in M&A for ten years in Europe with a bulge bracket firm. There is an urban legend that "most mergers and acquisitions fail." This is simply untrue. They nearly all succeed, if succeed means increase revenues, margins, and the bottom line over time. As for the other benefits, be careful of the window dressing versus the real rationale for a deal.
Carey and Ogden need to study M&A transactions adjusted for market cycles, which I don't think they did. Furthermore, there is effectively no such thing as a pure "merger" (some corporate freaks such as ABB and a couple of others notwithstanding). One company is always dominant and one management clique nearly always prevails. I don't think taking the "best" employees from both organizations and the "best" directors from both boards makes sense or is even possible. Who is going to determine who the best directors are? How?
It is precisely that kind of warm and fuzzy approach that gives Carey and Ogden their ammunition. M&A doesn't destroy value just because the pre-deal list of benefits isn't met. Look at the ten or twenty largest companies in America by market cap or revenue. Nearly every one of them got there through a combination of organic growth and systematic acquisitions. Even Microsoft is a voracious consumer of smaller technology companies (and potential competitors). Wal-Mart buys supermarkets, oil companies buy each other, Ford bought Land Rover and a bunch of other companies.
In every single case, acquisitions brought key technologies, revenues, customers, market share, and market access. These led to higher sales, better purchasing power (higher margins), and ultimately, higher net income. Acquisitions are proof of corporate Darwinism.
As part of my MBA project, I have done a simple analysis on whether M&A among the banks in Malaysia creates or destroys value. My analysis revealed that it destroys value. The question then, is, "Why do these banks embark on this frenzied M&A exercise?" It is simply to align to the call of the government to be perceived as bigger in size and, hence, stronger in order to counter competition from foreign banks. Does size really matter when it comes to value creation?
Now most merged banks have, in a way, stabilized operationally in Malaysia. It will not be long before the banks will undergo another round of M&A, as the government previously indicated that the bank count would be reduced further. This time around, I believe not only the banks, but even the telecoms will not be spared.
In short, yes: Whether we like it or not, the era of M&A value destruction will take place unless research can negate the correlation between size and value, and re-emphasize that "small is beautiful."
I've been involved in a number of acquisitions over a period of twenty years, and my experience has been that little real thought is given to the effects on people on both sides of the deal. Pronouncements are made about the importance of human talent and morale, but the facts are that executives are driven by the white heat of getting what they want. Often, the strategy/purpose behind the combination gets left behind or is flawed from the beginning. "Winning" the deal is all that matters. And when one wakes up to the lack of synergies to be found and the politics that drove the deal, one finds that the only way to offset the premium paid for the acquisition is to dispose of a lot of people who made the acquired property work in the first place. Acquisitions are a macho exercise, not an intellectual one. Think World Wrestling Federation, not a chess tournament.
M&A value destruction continues until executive and board decisions factor return on individual, social capital, and long-term individual equity growth into their acquisition investment equations. Executives using emotional intelligence and sharing leadership vision throughout the new organization permit "value growth" to begin when the M&A approval is given. Clarity of communication during these cultural integrations is essential to rebuilding a stronger organization.