“To grow to be an organization operating on a global scale, it is almost impossible to do so quickly enough through organic growth alone. Mergers and acquisitions have in many ways become necessary. Interestingly, evidence is now mounting that the deals conducted in the current merger wave may be different. Across a broad range of industries throughout the world, lessons learned are being applied.” ~Marco Boschetti
Most economists agree that mergers offer no sure solution to the troubles or shortcomings of a company. Nor do they guarantee growth and a big rise in earnings. But they can often help a bright and growing firm to grow even faster. The global business environment dictates that companies have to grow to consolidate their footprint in the market place.
If they cannot do this organically they have to look to acquisition to broaden their perspective through; new products and technologies, new markets, reduced costs through economies of scale, or simply eliminating competition. While executives may dream about a merger made in heaven, however, analysts report that up to 75 percent of acquisitions fail, but the statistics seem not to put anybody off.
The British 19th century politician Benjamin Disraeli said there are three kinds of lies; “lies, damned lies, and statistics.” So do the statistics lie? If the majority of mergers and acquisitions are alleged to fail, there must be more than statistics behind the drive to keep on doing it. It may well be that analysts who judge the success of an acquisition look no further than to compare the revenues of the merged company with the cost of its union. However, Is there more to the success of a merger than numbers?
In the article “The Urge To Merge” by Max Fawcett writes: There are some clear trends emerging that can be reliably counted on to define the course of M&A activity in 2011. Here’s a snapshot of what lies ahead for buyers, sellers and everyone in between:
- Hoarders: Public companies worldwide are sitting on $3 trillion in cash, with private-equity funds armed with an estimated $500 billion more. All told, it’s the biggest so-called “cash hoard” in 50 years, according to Bloomberg…
- Widening the Yield Field: When it comes to financing acquisitions, cash will always be king, but right now debt is nearly as attractive, given that interest rates are still hovering near once-in-a-generation lows.
- Go With The (Cash) Flow: Free cash-flow has always been an important metric for investors. At any given time, it provides more predictability and certainty to acquirers, knowing that they can pay off their debt and continue to have cash for other strategic initiatives.
In the article “The Desire To Acquire & The Urge To Merge” by Cliff Kurtzman writes: I’ve put together some of the more common reasons companies enter into M&A activity:
- Need for speed: In a world where everything is moving fast, making an acquisition can instantly open the door to new markets, new geographic locations, and new business models, as well as new customer and business relationships.
- Avenues for revenues: Companies with publicly traded stock, or private companies that find themselves cash rich but revenue poor, can buy companies with solid revenue streams that will instantly boost their earnings.
- Dash for cash: Public companies can use their stock to acquire cash rich companies, thereby trading their stock for cash without having to make a new stock offering.
- Expand the brand: Companies may seek to acquire people with unique capabilities, relationships, and positions of leadership, unique assets such as domain names and web sites, or brands.
- Prepare to gain market share: Sometimes companies see an acquisition as simply a way to get more of a good thing and capitalize on the economies of scale.
- Reduce costs and control quality: Companies acquire other businesses within their supply chain to reduce costs, control quality, and increase profits.
- Preempt unwanted competition: Sometimes companies acquire other companies to prevent a potential competitor from deeply entering their market.
- Add critical value to an under-performing organization: Sometimes a company will be floundering by itself but in the hands of an acquirer with the right resources and connections, it can be turned into a much more profitable venture.
- Diversify and reduce risks: In the online world, we sometimes see companies diversifying by making acquisitions in related offline businesses that offer synergistic business models with less inherent risk.
Okay, these are the “official reasons.” Yet you probably won’t be surprised to find out that the reality is that deals get put together in some very strange ways and are motivated by some very odd reasons. Here are some that undoubtedly also take place:
- Our stock is floundering and we’ve got to do something about it, FAST: Making acquisitions can seem a straightforward way to show that management is working hard to make deals and take the company to a new level.
- Competitor envy: Seeing that a competitor is making acquisitions and wanting to not get left out of the game. This is the “lemming suicide syndrome” and it is a poor reason to make an acquisition.
- Empire building: Often coupled with competitor envy, this is a CEO’s desire to build as big an empire with as many employees as quickly as possible…
- Convenience: Making a deal to acquire an organization that you know and have worked with can in fact reduce risks and ease the transition. Familiarity with an organization does not necessarily imply that they will provide the good ROI.
- The FOR SALE sign is out: Sometimes an organization actively looking to be acquired can offer valuable assets at fire-sale prices, while other times all they are doing is trying to find a way to make their problems someone else’s.
Sound M&A practice involves:
- Defining clear objective: The acquirer needs to have a plan for where they are going and then design pathways and alternatives, along with associated costs and timetables, for achieving their goals.
- Investigating and researching multiple alternatives for achieving success: The acquirer should never allow themselves to be held hostage to the closing of any one particular deal. If the cost of “Plan A” gets too expensive or the risks start appearing too great, then the organization should have other alternatives to pursue.
- Knowing when to walk away from the table: If the deal isn’t making sense, then it is important to be able to walk away without regret because there are better alternatives to pursue to reach an objective.
- Developing a detailed plan for post-acquisition governance and cultural integration: Acquisitions rarely fail because one or both parties didn’t perform adequate due diligence. Acquisitions tend to fail due to inadequate leadership, governance, and difficulties in integrating disparate cultures.
- Getting outside help: An organization should consider support from consultants with deep expertise in selecting and evaluating the business models of potential acquisitions, and in putting together effective post-acquisition management and integration plans that will allow the investment to achieve its potential.
In a paper titled “Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction”, the researchers found that ‘overconfident’ CEOs were most likely to make acquisitions and mergers, and often destroy value for shareholders. The authors, Tate & Malmendier, measured overconfidence by assessing how CEOs, in a sample of Forbes 500 companies, handled their stock options.
If a CEO held options in his company until the year they expired, he was classified as overconfident. Why? “Previous literature in corporate finance shows that risk adverse CEOs should exercise stock options well before expiration,” the authors write. “Holding an option until its final year, even when it’s highly in the money, indicates that the CEO has been consistently ‘bullish’ about the company’s prospects, and that could cloud their judgment.”
When the authors compare the behavior of these CEOs with the more cautious ones in their sample – they call them ‘rational CEOs’ – they find that ‘overconfident’ CEOs are more likely to conduct mergers than ‘rational CEOs’ at any point in time. Tate and Malmendier also found that overconfident CEOs were most likely to make acquisitions when they could avoid selling new stock to finance them, and that they were more likely to do deals that diversified their firm’s lines of business. Prior research has shown that ‘diversifying’ mergers are the least likely to create value…
According to Jeffrey Pfeffer, research consistently shows that most mergers fail, from falling stock prices to lower profitability. Yet, even with suffering capital markets, a recent Hewitt Associates study found that more than half of the 70 senior executives and board members surveyed planned to step-up merger activity during the next three years. Why? Call it executive hubris.
One study, by business school professors Matthew Hayward and Donald Hambrick, showed that the greater the hubris of the chief executive, the more a company tends to overpay for acquisitions. The aphorism “Pride goeth before a fall” seems to hold true in business too. When executives are confronted with the appalling statistics, their first response goes something like this: “That may happen to other companies, but not ours. This acquisition will be more successful. We have learned.”
The next CEO challenge is persuading a possibly recalcitrant board of directors to let you pursue your ‘urge to merge’. Hubris, again, returns to center stage. Here’s how to avoid hubris-fueled merger mania. First, follow the adage: “Forgive and remember”. ‘
Go back and evaluate past merger decisions, admit when you were wrong, figure out why, and learn from it. Second, beware of too much agreement in the board room. Find, even encourage, people to disagree with you, so that all sides of the decision are examined.’ The ‘urge to merge’ is an addiction in many companies: Doing deals is much more fun and interesting than fixing fundamental problems…
“Great deeds are usually wrought at great risks.” But too many companies are unprepared for dealing with the complexities of M&A risk. World-class capabilities are not built overnight; they are developed and refined over several years and multiple transactions”.