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Almost every significant research study argues that acquiring companies lose value for their shareholders when they attempt takeovers. The pain associated with merger activity is well-documented: acquirers see their share prices fall when deals are announced, whereas target company shares rise in value through the purchase premium; and “strategic synergies” mean lost jobs in both companies.
But is this yesterday’s news? Have dealmakers finally learned the lessons of past mistakes? And if so, what are those lessons?
Deals conducted in the current merger cycle (those that have closed since 2003) are different. Our research has revealed an unequivocal change in short-term deal success. Obviously, the long-term results will not be known for several years, but the leading financial indicators are positive. Our analysis focused on companies which have made only one acquisition during each of the merger cycles. This has enabled us to isolate the impact of those single deals on each company’s performance. Naturally, it would be better to look at these deals after a longer period of time and to consider numerous non-financial factors as well. However, in order to get a sense of the current market, across a broad range of companies globally, short-term financial factors are the only option that offer any consistency.
In a worldwide study of more than 1,400 merger transactions worth over $400m each, we found that deals in the current cycle are creating shareholder value, at least in the short term (the only time period currently measurable for deals conducted in 2004 and 2005). By contrast, over the same period of time in the two previous merger cycles (the late 1980s and the late 1990s), our analysis showed that shareholder value was destroyed.
The success is global, although deals in Asia are more successful than in Europe, and the US trails the pack. We also found that success increases over time, with 18-month performance exceeding that over six months. And, not unsurprisingly, domestic acquisitions are more successful than cross-border transactions.
We did not focus on share price alone. Other key financial measures, such as return on equity, leverage, earnings per share and operating profit margin, supported these findings as well. In fact, on every single financial and share performance factor we analysed, deal success was better in this merger cycle than in the two previous cycles.
The big change is that companies are seeking advice from both inside and outside on how to do deals better. Organisational learning has taken place: codification of institutional knowledge about what works for each company. Companies are now making a conscious effort to learn from past experience, from internal and external sources. As the director of the M&A division of a European-based technology company told us: “The combination of thorough due diligence and good deal assessment using the knowledge gained previously is very important in order to achieve better deal terms and to pay lower or at least fair price for the target.”
The risk of failure can be severe in a world where corporate governance issues are now more firmly enshrined in law and when non-compliance can put senior executives and their advisers in jail. We have identified improvements in three areas of corporate behaviour.
■ Better deal governance Senior management has aligned itself more closely with shareholders. Executive compensation is more directly linked to shareholder value and this makes senior managers focus more on delivering targeted synergies, profitability and share price performance. M&A deals are one place where this focus is evident. Our survey revealed less upfront irrational behaviour driven by emotions, and more rational behaviour driven by financials.
■ Better deal selection There is a more rigorous due diligence process. Investment banks and companies have learned from the venture capital and private equity industries. For many companies, due diligence now includes assessment and quantification of the financial impact of factors that were never before given proper consideration. One example is pension liabilities, an issue which has taken centre stage in a number of high-profile deals in the UK, such as the attempted takeovers of retailers Marks & Spencer and WH Smith.
Better due diligence leads to greater confidence in pricing deals. Another effect is that people, system and product problems are found before the deals close. In some cases, this means that an acquisition is called off; in others, that the problem can start being addressed even before deal closure.
■ Better focus on integration It is no longer sufficient merely to find the right company and purchase it at the right price with the optimal mix of equity and debt. Post-deal cultural issues are critical, too. Relevance of the deal to the company’s mission is paramount. Risk management is everyone’s responsibility. People matter. Perhaps this is why our study found that smaller deals are also more prevalent in the current merger cycle, as integration is perceived to be easier.
Another example of the improved focus on integration is the early involvement of human resources (HR). Key person identification, retention strategies and cultural issues are all critical to successful takeovers. A Towers Perrin study in 2000 found that HR departments were typically not involved in pre-deal or due diligence activities. Their later study in 2004 found that HR professionals were being brought into the M&A process earlier: in 2000, only 40 per cent had any meaningful involvement in pre-deal or due diligence stages; by 2004, the figure had jumped to 62 per cent.
Achieving transaction success, however, is not easy. Those companies that seem to do deals effortlessly are often serial acquirers who have successfully institutionalised their company’s M&A process. They expend significant effort learning how each deal succeeded or failed to live up to its expectations. The M&A director at the technology company said: “Our company learned that we needed to build professional internal departments where people could learn from their mistakes and apply their knowledge later on.”
But not every company can or would want to be a serial acquirer; most companies do not consider M&As a core competence. They can, however, still benefit from looking back on the few deals that they have done or by observing how others did their deals.
In our interviews with companies that have made acquisitions in the current deal cycle, every senior executive attributed some of their transaction success to a conscious effort to apply lessons learned from experience. “‘Integration skills come with practice,” noted the CFO of a large global bank.
Our study also found that companies are less likely to make frequent acquisitions; instead, more time is being spent making the most of each acquisition. This may explain why the earning power of deals conducted in the past few years has increased following acquisition whereas in the past it declined. Similarly, there are fewer multiple deals being done. Buyers appear to be willing to wait to demonstrate the success of each major deal before they move on to the next target.
Finally, our research revealed that companies have learned a number of other lessons: in the short term, it is better to do smaller deals because they are showing better returns; and it is better to do deals where 100 per cent of the target is purchased rather than a controlling interest only.
Based on our research, there are seven key lessons that companies have learned from the mistakes of the past that can serve as guidelines when considering future acquisitions:
• if you must do a deal, you are more likely to be successful if you acquire a domestic company;
• don’t try to swallow too large a company;
• focus on deal governance;
• don’t do too many deals at the same time;
• pay attention to due diligence issues and the role of HR;
• get well down the integration trail with one acquisition before trying the next one;
• assume complete control of your target.
A paradox has existed for a long time in the world of M&As. In the past, analysts and most studies had found that an overwhelming majority of acquisitions failed. Yet to evolve into a global organisation, it was almost impossible to do so through organic growth alone. M&As were, therefore, necessary.
If the lessons noted above are being utilised this time around, the paradox may soon disappear. It may be possible to have your cake and eat it too: acquire and be successful.
This article is based on research sponsored by Towers Perrin.
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