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4 July 2015

Mergers and Acquisitions

Tag(s): Business, Marketing
Merger and acquisition (M&A) activity is very nearly back to 2007’s record levels. Globally, there has been almost $2trn worth of deals so far this year, 36% up from a year ago. In the US, overall deal activity has reached $841bn, also the highest since 2007. An M&A upswing always accompanies buoyant economies and stock markets. Companies that have rebuilt their cash position become more confident and try to increase size by merging with or acquiring competitors. This time round an added ingredient is that of record-low interest rates, encouraging firms to borrow in order to buy rivals. [i]

However, M&A activity is also a good leading indicator of bull market peaks in the stock market. Cash financed M&A provides nearly a third of the corporate demand for equities. Once M&A activity reaches its peak, the stock market peaks on average about eight months later although this lag varies as the following shows[ii]:
M&A deals, % market cap peak S&P peak Lag (months)
18 November 1988 16 July 1990 20.2
25 February 2000 24 March 2000 0.9
3 August 2007 9 October 2007 2.2
Average   7.8
I wrote on the subject of Mergers and Acquisitions in my book The 20 Ps of Marketing as follows:

 ‘Mergers might be thought to be the ultimate example of Partnership and some have been very successful. However, in researching this chapter I looked at several pieces of analysis conducted over the last 15 years or so that showed this not to be the case. Here are some quotes about different pieces of research:
  • However, approximately two out of every three M&As fail to achieve the intended goals which were the stated reasons for the business deal."
  • "At the same time, the success rate of M&As has been poor. Some estimates put failure rates as high as 60/70%."
  • "Some studies show that 50 to 70 percent of mergers fail, in that they don't live up to their financial promise." 
  • "The stats on M&A failure, in fact, might be gloomier than the American divorce rate. Depending on whether success is defined by shareholder value, customer satisfaction, or some other measure, most research places the merger failure rate somewhere between 50% and 80%."
 One piece of research by KPMG International, the accounting, tax and consulting firm, found that 83% of corporate mergers and acquisitions fail to enhance shareholder value. In the report, Unlocking shareholder value: the keys to success, KPMG analysed the 700 most valuable international deals in the years 1996 to 1998. "More than 8 in 10 deals fail to enhance shareholder value because of poor Planning or execution or both, yet, by contrast, most of the executives interviewed (82%) believed their deals were successful," said Donald C. Spitzer, the U.S. national partner in charge of the Global Financial Strategies(SM) practice of KPMG. "This is an extraordinary finding, and noteworthy because transactions remain the most dynamic driver for growth among corporate executives."

 It is particularly interesting that firms like KPMG made such findings because they also have a pecuniary interest in promoting M&A. M&A is stimulated not only by the ambitions of overly optimistic senior executives but also the armies of accountants, the battalions of bankers, the legions of lawyers, and the platoons of Public Relations advisers who earn vast fees advising both sides of the transaction. Of course, the transaction that failed to enhance shareholder value to the acquiring company may well have added shareholder value to the benefit of the acquired company's shareholders. In other words the common failure is to pay too much.
 The KPMG research conducted interviews with 107 executives of the subject firms and identified a combination of six "keys", three hard keys and three soft keys, that were necessary for a deal to succeed. The three "hard keys", pre-deal business activities that had a tangible impact on the ability to deliver financial benefits, were
  1. synergy evaluation (business fit),
  2. integration Planning, and
  3. due diligence.
 The three "soft keys", human resources issues that must be examined even before a deal is announced, were:
  1. management team selection,
  2. cultural issues, and
  3. communications with employees, shareholders and vendors.
 I have not found any research indicating that a majority of M&A transactions were successful. All the research points to at least 50% failure and much of the analysis points to much higher levels of failure. What is not clear from the research is whether this applies equally to mergers and to acquisitions. They are not the same.  A merger takes place when two companies agree to go forward as a single new company rather than remain separately owned and operated. This is more likely to take place when the firms are about the same size. Both companies' stocks are surrendered and new company stock is issued in its place. For example, in the 1999 merger of Glaxo Wellcome and SmithKline Beecham, both companies ceased to exist at the time of merger, and a new company, GlaxoSmithKline, was created.

 However, this kind of transaction is quite rare. Usually, one company will buy another but to save the face of the acquired party it will be announced that a merger has taken place. This may be desirable in helping to address one of KPMG’s soft keys but unless the other keys are also addressed it won’t be enough to guarantee the success of the merger. An example of a transaction that was described to the world as a merger was the takeover of Chrysler by Daimler-Benz in 1999 which went on to fail several of the KPMG success criteria.

 A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is hostile - that is, when the target company does not want to be purchased - it should always be regarded as an acquisition.

 Over the years strategies have changed in building large firms by acquisition. There was a fashion to grow companies by acquisition in different industries as a way of diversifying risk. It was thought that companies could ensure that they were not exposed to cyclical downturns if they had assets in different cycles. However, this also ensured that they were more likely to be exposed to some downturn and so were at best offering mediocre returns. While they had expertise in financial engineering there was no other common expertise in the business and so added little value to the component firms. Hanson Trust was a well-known example of such a firm which grew by acquiring firms with interests in basic commodities that it was thought would always be in demand, such as bricks.

 More common today is the consolidation of companies operating in the same Markets but even here executives should be looking for more than just loose references to synergy, in my experience a highly elusive benefit. I would recommend that the following characteristics should be present for a merger to be likely to succeed in adding shareholder value.
  • Compatibility of direction. Compare the two companies’ mission statements, business Plans and purpose and if they are compatible then the first building block of a successful merger may be in place.
  • Growth. The merger should be directed from a desire to grow more quickly than would be possible organically. If the other party offers entry into a new Market or removes a barrier to growth then a merger may make good sense.
  • Economies of scale. Some larger firms lose their flexibility and the ability to adapt and respond to changes in market conditions. Economies of scale are not always beneficial. It is salutary for example to see how often customer service has suffered when merged companies merge the back office function and so reduce their ability to respond to customer demands.
  • Common culture. Compare the two companies' cultural styles. If one party is highly competitive with a strong hire and fire element and the other is more sympathetic with a no lay off policy it will be difficult to create a happy marriage.
  • Geography. Cultures also vary greatly by geography. If the headquarters of the two entities are close it will be much easier to maximize the return on investment, finding the best employees from either side. If they are remote the communication problems will be particularly challenging. This is particularly true if the two parties are based in different countries.
 It should be possible to articulate the Positive effect of a merger clearly and concisely and in such a way that most employees will welcome it. Remember that the majority of M&A fail to achieve the objectives set and attempts to merge the number 2 player with the number 3 or 4 to create a new number 1 instead finish with a new number 3. All too often mergers are driven by a philosophy of doing something for the sake of it. Growth comes from hiring good People, building a consensus for growth based on integrity and openness and emPowering them to release their creativity and innovation.  If a merger will enhance this process then go for it. If it will distract your People then forget it.’

This comes from Chapter 13 on Partnership in my book The 20 Ps of Marketing published by Kogan Page. There is a link on the home page of this website to order it.

[i] Why companies are eyeing each other up MoneyWeek 26th June 2015
[ii] Credit Suisse
Copyright David C Pearson 2015 All rights reserved

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