UNZIPPING THE MERGER MYTH

UNZIPPING THE MERGER MYTH - Big-ticket mergers are the society weddings of the business world. But the honeymoon is usually soon over. Anthony Hilton examines landmark deals of the past decade to find out why so many corporate tie-ups destroy shareholder value.

by ANTHONY HILTON
Last Updated: 31 Aug 2010

Big-ticket mergers are the society weddings of the business world. But the honeymoon is usually soon over. Anthony Hilton examines landmark deals of the past decade to find out why so many corporate tie-ups destroy shareholder value.

One lunchtime back in 1986, Sir Michael Richardson was in expansive mood. He was then at the height of his powers and influence - the head of corporate finance at NM Rothschild in the days when British merchant banks still ruled the Square Mile; architect of much of the Thatcher government's privatisation programme; Boxing Day guest at Chequers - a true City grandee. 'You know,' he said leaning back and drawing on his cigar, 'there is no deal in the City which I have done, which could not be undone ...' he paused for effect ... 'and hopefully will be.'

Investment bankers think differently about takeovers from ordinary people. As far as the banker is concerned - and particularly these days, now that long-term relationships between banker and client have crumbled - they are just a transaction on which a fee will be earned.

If the merged business doesn't work, it does not matter - simply split it up again. For the industrialist doing the deal, in contrast, it is probably the defining moment of his career, and for the employees too, although in a harshly different way. For both groups, it's a disaster when a merger deal goes sour.

And they usually do. From the perspective of the bidder, between half and three-quarters of all mergers (depending on which management consultant you believe) destroy rather than create value. Nor is this just a phenomenon of our times. Similar studies in the 1980s produced broadly similar results.

Look at the disasters of that time in America - the age of the Barbarians at the Gate.

So in a sane and rational world, almost no-one would opt for a takeover, other than a small infilling acquisition, unless special circumstances made the target company self-evidently a screaming buy. Such occasions are so rare they need not concern us here.

Yet mergers happen all the time - more often in bull markets, where egos rise faster than share prices, but also in the bears. In hard times, troubled businesses can look like a bargain to potential bidders - witness the potential Carlton/Granada merger. Despite the chill economic climate, there was pounds 160 billion of M&A activity in Britain last year, and 2003 got off to a flying start. Sir Ken Morrison's pounds 2.9 billion offer for ailing supermarket chain Safeway has set off a bidding war, with rivals J Sainsbury and Asda (owned by maga-retailer Wal-Mart) also set to throw their hats into the ring.

Many deals are simply a result of the merchant bankers' seductive patter. If a business underperforms, sell it off. If the main product is mature, buy into a new, fast-growing market. If the UK market is saturated, try your luck in America. If the main competitor is tough to dislodge, massage up your share price and slap in an offer. Too often the bosses succumb.

Then the trouble starts - usually because the existing management is not very good, but the proud new owners' under- standing of their acquisition's business is so poor they don't know who else to appoint. So they let it drift, and a drifting company goes only one way. As the CEO of one FTSE 100 company put it: 'When you are only number three in a market and it turns down, then numbers one and two skin you alive.'

So why do the deals keep getting done? Well, Britain's businessmen don't have much fun. We don't have many Bill Gates-style celebrity bosses and the day-to-day running of a business is difficult, grindingly hard work and often very boring. By contrast, a takeover is exciting and glamorous, promising even the dullest managers their brief moment in The Sun, or preferably the Financial Times. It gives them recognition beyond their own boardroom. It makes them someone for 15 minutes. It's easy to see why they are so easily seduced by the whispering investment banker.

Few big businessmen are entrepreneurs; they are corporate animals motivated to rise ever higher in the organisation, and once at the top, their ambition is to leave their mark and make the corporation bigger - not, you will note, more profitable, but bigger. Takeovers are not the only way to do that, but they are certainly the quickest. But there's a simple defence against these dark arts. Paulo Scaroni, the Italian who until last year ran Pilkington, has a surefire way of seeing off people who come to him with ideas for acquisitions. 'I ask them how they will improve the business.

I say: 'If you are not going to improve it, why do you want to buy it?''

He found they rarely had an answer.

ROYAL BANK OF SCOTLAND

NATIONAL WESTMINSTER BANK

Value at merger: dollars 38.5 billion

Of all the big deals in recent years, this seems the only one to have clearly benefited both sets of shareholders - but because it was a management buy-in rather than a takeover. NatWest had scale, resources, history and political clout. What it did not have was leadership, the ability to sort out its own problems and a board that inspired confidence. It also had a penchant for own goals - none bigger than when it tried to buy Legal & General and let slip that its real interest was to secure the services of L&G's boss, David Prosser. Having exposed its weakness, it was a matter of time before predators swooped. The only issue was who would get it.

Either Bank of Scotland or Royal Bank of Scotland would have done well, but on balance RBS was probably the more committed and in Fred 'The Shred' Goodwin it has one of the best CEOs in UK banking. Since the deal, Goodwin has shown how much leaner NatWest could be made, and the combined bank has become a high street force again.

SMITHKLINE BEECHAM

GLAXO WELLCOME

Value at merger: dollars 77.3 billion

The trouble that engulfed GlaxoSmithKline in November 2002 was, on the face of it, a row about the pay and perks of chief executive Jean Pierre Garnier. It was remarkable for the scale of the battle, the near unanimity of investor outrage and the insensitivity of the firm's board. But the argument had its roots in disillusion with the two-year old Glaxo Wellcome/SmithKline Beecham merger, which had seemingly failed to deliver anything tangible.

The merged shares went down as hard as any blue-chip in the bear market, profits were under pressure, and it was hard to see where the business was going. Glaxo had built its reputation as a research company and its earlier mergers in the 1990s - notably with Wellcome - were designed to consolidate its research position. The deal with SKB was different: its appeal lay in the opportunity to exploit sales and marketing synergy and it implied that Glaxo's future would be in building maximum sales and distribution muscle. It could both develop its own drugs and distribute those of others. It hasn't worked yet for two reasons. First, investors still focus on the drugs pipeline - and its emptiness - so they continue to see the firm as a drugs developer. Second, it is often a lot harder than it looks to bring together two salesforces that have been groomed to think of each other as the enemy. A classic case of two plus two making three.

GUINNESS

GRAND METROPOLITAN

Value at merger: dollars 18.3 billion

The merger of Guinness and Grand Met to create Diageo was a defeat for both. Guinness was just a brewer till Ernest Saunders bought Bells and Distillers in quick succession in the mid-80s. Under Sir Anthony Tennant - who as chairman of Christie's recently figured in investigations by the US authorities into cartel arrangements with rival auction house Sotheby's - the Guinness group made rapid progress, capturing better margins by buying out its distributors around the world. Grand Met meanwhile addressed its problems by diversifying into food as well as drink, creating a branded business by buying the likes of Burger King and Haagen-Daaz. When both strategies were running out of steam, the two firms merged, the claim being that the combined group would be able to demand shelf space and maintain margins globally with its unrivalled portfolio of leading brands.

The deal has demonstrated how unwieldy Diageo is. The liquor market is young and fashion-driven - fads such as alcopops and Bacardi Breezers may rise fast but they fall faster. Whether the Diageo juggernaut is producing enough winners to keep up is a moot point. More fundamentally - as argued by LVMH at the time - Guinness was the wrong partner because too much of its range duplicated Distillers products. Merging with the French firm would have widened its range, securing Hennessey cognacs and Moet champagnes.

Instead, cost-cutting and brand rationalisation were the aims, and the sterility of this policy shows in the subsequent stagnation.

VODAFONE

MANNESMANN

Value at merger: dollars 202.8 billion

The biggest deal of all time - on paper at least - was Vodafone's acquisition of Mannesmann. It set many firsts: a contested bid, by a non-German company, for a first class-business. Given that Germany disliked hostile bids and selling to foreigners, and considered takeovers as a way of rationalising bad companies rather than good ones, this deal broke new ground. It did so because of globalisation: so many Mannesmann shares were held outside Germany that the government had no say in the outcome. If Vodafone had paid in cash it would be bust by now. As it is, each year it writes off pounds 9 billion of goodwill - by the end of the decade it will have written off more than the annual GNP of Ireland. None of which helps to make this deal look like a success, but if the market was stupid enough to give Vodafone that kind of money, you cannot blame its boss Sir Chris Gent for taking it. If one ignores the balance sheet and looks at the cashflows, the sheer power of Vodafone in almost all the major markets makes itself felt. The more commoditised the mobile phone business becomes, the more this will matter. A fact understood well by Orange, which is a long way ahead on its branding and has taken a bite out of Vodafone's markets big enough to suggest either that the Newbury boys weren't paying attention, or did not understand that they were in the lifestyle business. But if Mannesmann seems to have worked, it is harder to be enthusiastic about Vodafone's parallel American deal - the acquisition of a major slice of Airtouch. Vodafone may control the company, but the Americans are showing no great enthusiasm for taking orders from the Limeys. When Gent retires in July they will no longer have to - his successor is the former Airtouch boss Arun Sarin.

BP

AMOCO

Value at merger: dollars 55 billion

BP has proved with its takeovers of Amoco and Arco that the key to merger success is to buy cheap and buy what you know. Too many firms use mergers to get out of the business they know and into something more attractive.

In their excitement (or desperation), they pay too much and struggle to understand the new business. You couldn't level such charges at BP. It came out of the 1980s prosperous but bloated and spent the early '90s under David Simon and then John Browne (both now life peers) re-structuring so that it could survive long term with oil at dollars 13 a barrel. None of its competitors managed this so well - when in the late '90s the Crude price fell even lower, BP was alone among the big oil firms in smiling through the pain. BP's good health gave it highly rated shares and access to cheap capital, advantages it used to grab Arco, Amoco and other smaller companies on the ropes. Having bought them for a song, BP used its re-engineering skills to take out costs and drive the mergers through. The timing was brilliant, the execution faultless and the game of hardball with the US regulatory authorities played to perfection. BP became one of the permanent big three of the oil business alongside Mobil and Shell.

Find this article useful?

Get more great articles like this in your inbox every lunchtime

Subscribe

Get your essential reading delivered. Subscribe to Management Today