When two companies decide to combine forces in a merger, the papers are shouting about it. Why are companies in industries ranging from telecommunications to financial services to retail looking to merge? And why do mergers and acquisitions sometimes fail to produce anticipated results? What is meant by the term M&A, Mergers and Acquisitions? And is a successful M&A more of a fairy tale than reality? Just take a look at the following video about the 10 most disastrous mergers and acquisitions (M&As): To clarify why M&A can fail, I mainly stress what key points one should keep in mind in order to have better chances of success and why businesses should go green if the want to be successful!
Definitions M&A is a generic term that can be broken down and defined more technically. We talk about a merger if an agreement between equals is made to combine their operations. However consolidation would mean that a new firm is created after a merger, and both acquiring firm and target firm shareholders receive shares in this firm. The merger of Royal Haskoning and DHV in the Netherlands is one of the many examples of the far-reaching consolidation in the engineering sector. The acquisition takes place when one company uses its capital resources (cash and/or shares) to purchase another in order to develop resources and competencies.
Think of the recent buy of Bol.com by Ahold, again in the Netherlands. Now, this would be a typical example of acquisition. Well, the business plans are made in the offices but the leaders themselves, the entrepreneurs behind the companies, take the decisions and they often don't like to make, or even study, the relevant business plans. If one firm acquires the assets of another, through a formal vote by shareholders of the firm being acquired, one would speak of the purchase of assets. And finally, when a firm is acquired by its own management or by a group of investors, we speak of a buyout. After such a transaction, the acquired firm may cease to exist in a publicly traded form and will become a private sort of business. But then again, most successes were preceded by many failures and we've also learned a lot from mistakes made in the past.
The players The buyers of companies can be put into two groups, strategic and financial. As the name already suggests, strategic buyers are usually corporations wanting to acquire some other company for reasons of strategic business planning. Financial buyers, on the other hand, are generally buyers wanting to acquire some other company merely for reasons of financial investment nature. Financial buyers are typically Leveraged Buyout Funds or other private equity funds. Already have an idea who will pay more for a company? Nine times out of ten, a strategic buyer will pay more than a financial buyer. Strategic buyers take into consideration that they generally will be able to increase a company’s cash flows if they reduce overlapping costs, expand into complementary markets, etc.
Also, the new company should have a clear picture of how it can create significant change for sustainable business growth. As a result, the strategic buyer incorporates in his valuation of the company the post-acquisition cash flows, which he hopes will be higher than are currently expected to be, thus ending up valuing company higher. Such a buyer will typically assume faster revenue growth and reduction of certain costs because the acquiring company will be able to derive the strategic efficiencies from the acquired company. In contrast to this, a financial buyer will not pay attention to the possible synergies while valuing the company.
Identification of the potential target To determine whether a company can be a suitable acquisition target, the acquirer will consider the strategic aspects from 5 different motives. It's all in the entrepreneurial DNA and they include firm-specific, industry-specific, strategic, financial or personal motives.
- Achieving economies of scale (Removal of central functions such as HR, finance and IT)
- Reducing transaction costs (Heidelberg and Hanson)
- Attaining economies of scope (Citibank and traveler)
- Managing industry rivalry (Heineken and Gruppo Petropolis)
- Increasing bargain power (car makers)
- Building barriers to enter (IBM and proprietary technology firms)
- Capturing last opportunities (Morrison and Safeway)
- Strategic capabilities:
- Adding new resources (Geely and Volvo)
- Increasing the value of products (Virgin and NTL)
- Entering new markets (DHV and Royal Haskoning)
- Protecting product quality (Ryanair and Aer Lingus)
- Financial advantages:
- Exercising corporate finance (Vodafone and Mannesmann)
- Diversifying risk (Bowater)
- Increasing debt capacity (Carlyle and Virgin Media)
And finally, the last motive, not to be forgotten,
- Personal gains
- Building empire (ITT under CEO Harold Geneen)
- Obtaining better benefits
The reason for M&A to fail
Despite the fact that M&A is widely practiced, it has been found that between 60% and 80% of business combinations ended up as failures. M&A often fail because of the failure of filling the transaction and transition gaps. Transaction gap relates to the fact that most mistakes are made before the deal is closed. Transition gap, on the other hand, relates to the fact that most mistakes are committed after the deal is closed. The fact that today, many offices are manned by Generation Y young managers (indeed, they mostly or usually are men) doesn't really help as well, does it?
The problems with the transaction gap The transaction gap can be addressed by better negotiation and carefully considered valuation.
- Negotiate the right price, and do not overpay
- Apply realistic parameters in valuation
- Use multiples within comparable ranges, (I will elaborate on this in the upcoming third and fourth part of this blog-theme)
- Ensure reasonable synergy expectations
- Go for friendly and not hostile acquisitions
As the investment guru Warren Buffet puts it: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
The problems with the transition gap The business risk to the newly merged entity is particularly high at the beginning of its life. The failure of managing it often results in widening the transition gap. Therefore post-merger integration is key to making the new entity a success. There are many reasons for the poor management of business risk and hence the transition gap. M&A can also fail because of problems within the two merged firms (e.g. poor external communications, the wrong form of financing through angel investors or venture capitalists, systems disconnect, etc.), and changes in the environment and context (e.g. technological change). Post-merger integration is about taking the newly merged company from the transaction through the transition, which leads to the eventual transformation, in other words managing the change. To do so, actions must be taken by the top management and integration teams. Top management:
- Establish clear leadership and vision of where the organization is headed
- Remove the obstacles to the new vision
- Establish a sense of urgency for change
- Create a new identity and a set of core messages
- Communicate clearly to all stakeholders of the firm
- Make tough decisions
- Deal with resistance
- Create a project plan and assign ownership of different workstreams
- Ensure regular contacts with workstream and project leaders
- Attain quick-wins to maintain momentum
- Ensure clarity and frequency of communication with all stakeholders of the firm
- Implement the post-merger integration plan within the first 60 to 100 days
- Respond and amend the post-merger integration plan as a situation develops
- Anticipate problems and risks of integration continuously
- Maintain “business as usual”