Acquirers these days may be strategy-driven, but they are still making classic mistakes.
With mergers as with marriage: a high proportion fail, but people keep trying. According to Acquisitions Monthly, UK companies struck 319 deals worth a cool £10.7 billion in the first three months of the year (up from £8.8 billion during the same period the year before). The second quarter kicked off with BT's £13.7 billion takeover of MCI, and then saw drinks groups Guinness and GrandMet plan a £24 billion merger. But how many of these corporate marriages will succeed in creating value for shareholders?
At first glance, the auguries seem promising. A recent study by Mercer Management Consulting points out that acquisitions in the 1990s are more likely to be driven by strategy and restructuring than by the 'sheer financial hubris or conglomerititis that fuelled the M&A binge' of the greedy 1980s. This suggests a triumph of reason over mad ambition. But the Mercer research also showed that the more strategically motivated the acquisition, the higher the premium paid, which obviously affects the net value created. It showed further that 'almost half' the mergers of the 1990s are still failing to create shareholder value.
Other researchers have found a similar failure rate. Richard Schoenberg, lecturer in international business strategy at the Imperial College School of Management, studied 129 British companies that had made acquisitions in Europe. He measured their performance on a weighted scale of factors (including the impact on share price and earnings, profit margin, sales growth, market position, skills and technology transfer) against their own hopes and intentions in making the acquisitions: 54% admitted that their performance had been 'neutral to very poor' compared with their initial objectives. It seems that not much has changed since the first research done on the subject back in 1973, when John Kitching found that only 46%-50% of acquisitions could be judged a success.
But why is it that so many acquisitions fail? Tony Grundy, senior lecturer in strategic management at Cranfield, sums it up under three headings.
Either the acquiring company mistakes the inherent value of the company it is buying - misunderstanding the attractiveness of the market, for example, or the competitive position of the target company. Or the acquirer destroys value by paying too much, making it impossible to achieve an adequate return. Or poor implementation of the merger similarly destroys value or fails to unlock it. Grundy adds as a fourth, overarching error, the tendency to underestimate the investment, both capital and non-capital, involved in the merger process. He cites BMW's acquisition of Rover, which supposedly cost £800 million but has since been followed by capital investment of £3.5 billion over five years. 'Returns won't be seen until the next century,' he comments. Of course, the BMW investment could be seen in a different perspective, as an example of thinking and investing for the long term; but it is best to be aware of this 'iceberg factor'.
Companies can, of course, fail on more than one count. Think of Boots, paying £900 million for Ward White in 1989 and declaring as its strategic aim the 'entry into new, large consumer markets with a company already substantial but also offering good growth prospects'. But Boots overestimated both the potential of the market and Ward White's capabilities: A G Stanley, the Ward White home improvements business, slumped along with the housing market; the Payless position in the DIY market was too weak to compete with the major players (leading to the disastrous joint venture with WH Smith's Do It All); and car parts and servicing at Halfords, suppposedly the jewel in the Ward White crown, revealed, as turnover declined, an unexpected dependence on new car sales. Next, apart from the brand names (themselves hardly glittering prizes), the Ward White buy was largely property-based - and the date was 1989, the very peak of the property market as well as the retail cycle. By 1995, chief executive Lord Blyth was admitting publicly that it was going to be 'a very hard uphill struggle' to get Stanley and Do It All back into profit, and that 'we paid too much with the benefit of hindsight'. Third, Boots the Chemist itself is acknowledged as a well-managed retailing operation, successful at maintaining its brands and very effective in its use of merchandising management and technology (with high net profit margins as a result). But the Boots management clearly failed to inject these qualities into the acquired businesses. In other words, the acquisition made all three classic merger mistakes.
Of course hindsight is wonderfully easy. But what clouds managerial vision at the time? In the case of paying too much, comments Piers Whitehead, vice-president at Mercer, it is often because 'management falls in love with the deal'. Others, less delicately, call this the 'testosterone factor', and point, for example, to Tomkins' acquisition of Rank Hovis McDougall in 1992 for a hearty £925 million. As the Telegraph pointed out in January, it took four years to haul the food and milling group's returns up to Tomkins' cost of capital; and the generous price may well have owed something to the fact that Tomkins was bidding against Hanson, former employer of Tomkins' chief executive Greg Hutchings.
Be that as it may, senior management clearly likes to run bigger companies; egos (not to mention salaries, bonuses and share options) are boosted as their domain expands. Such spirits are susceptible, too, to the thrilling arguments of the corporate finance people, when what is really needed is 'dispassionate assessment', says Whitehead. 'Remember that most advisers are transaction-driven, and don't get paid unless the deal is done.' Paying too much is especially tempting when, as now, the stock market is high: raising equity is easy, and it looks as if the deal is not costing real money. 'But it is!' Finally, he adds another useful bit of advice: 'Pay for the company; don't pay for the synergies you are hoping for.'
This wishful thinking also frequently leads to over-estimating the potential of the target company. 'We see synergies where none exist,' says Whitehead, 'or benefits that prove to be fleeting.' Remember too that when cost savings are made as a result of merger synergies, it may be the customers, rather than the shareholders, who reap the benefits, particularly where the merger takes place under competitive pressure - as in the European steel industry, for example.
The strategy itself may be misguided. Consider Pepsi Cola, buying its bottlers around the world, when it should have been developing the brand, not pouring money into manufacturing. Or Daimler-Benz, with its concept of the integrated transport company, which now lies in the dust along with the Fokker acquisition. Or AT&T, advised by the 'experts' that the future lay in the convergence of telecommunications services and computer equipment, but discovering otherwise through its disastrous acquisition of NCR.
Or BT's equally disastrous acquisition of Mitel, made on the similar assumption that telecoms service companies and equipment manufacturers would converge, whereas the reality proved to be that it was better for service companies to be able to pick and choose their suppliers.
Admittedly, predicting the future is difficult. But sometimes research into the present capabilities of the target is poor. AT&T was unaware of NCR's particular strengths and weaknesses in the computer market - strong in retailing and banking, but not in mainframes and PCs, as it supposed. Likewise BT overestimated Mitel's technological capabilities.
Managers are frequently guilty of underestimating the effect of differences in culture and management style. Schoenberg found a 'statistically significant' negative relationship between differences in management style (formality, attitudes to risk, systematised decision-making, participation, managerial self-reliance, attitudes towards funding and gearing) and inferior performance.
'The greater the difference in management style, the greater the impact,' he says, adding that the impact was most significant in the service sector, where the motivation and commitment of employees is critical. Success was more likely when the former management of the target company, who would have clung to the old ways, left and, after a brief period of conflict, a status quo was reached. Comments Schoenberg: 'Machiavelli was right. You may need a period of sharp turmoil ... before you integrate fully, and things settle down.' His main advice is: 'Be aware. Where you see very different styles, think carefully about whether you should go ahead. You must consider the soft human factors as well as the strategic business ones: they are not more important, but they are also important.'
All of which brings one ineluctably to the third critical area - implementing the merger, a fertile ground for making mistakes. As Nick Viner, vice-president at Boston Consulting Group (BCG) in London, points out, there is the danger that the transaction itself becomes such a demanding process, particularly when there are different regulatory regimes to contend with, that managers forget that the deal itself does not create value: 'Value comes from the strategic fit and from how well the companies are put together.'
So what goes wrong? Probably the most common mistake is to proceed too slowly. ABB, an undoubted master of growth by acquisition, will put new management in place on day one, and reporting systems in place within three weeks. Most companies, however, make only the occasional acquisition, and managers find themselves overwhelmed by the myriads of decisions to be made, ranging from 'the sublime to the ridiculous', as Viner says, from whom to appoint to the integration team to how to put together information systems and the style of the new letterhead. So they sink into paralysis, arranging meetings, setting up task forces, but taking no real action.
Morale suffers, rumour thrives, the best employees get poached, and customers get forgotten.
Crucially, 'companies don't make the people decisions early enough on - things like the choice of chief executive, where headquarters will be,' says Joanne Lawrence, now a consultant, who as vice-president of corporate communications played a key role in the (successful) SmithKline Beecham merger. They also neglect the importance of communication, which should be used strategically - internally and externally - to blazon forth the integration message, making clear the purpose of the merger, the people in charge, the goals, the achievements as they unfold. As Lawrence says, this is a time when 'the functions of human resources and communications, traditionally kept in the background, have to be brought forward'.
At Lloyds-TSB, another successful merger, group director of central services Mike Fairey agrees on the need for speed and upfront communications. He also stresses the importance of a structured approach.Thus, he says, the top 1,000 managers of the merged bank had been appointed within three months (having all had to re-apply for their jobs against at least one other candidate, which 'caused some upheaval,' he says, 'but everyone knew the rules precisely, it was all upfront and open'). In parallel with this process, the company brought in BCG consultants, who provided a framework for bringing the organisations together, through cross-functional teams and extensive sharing of information.
However, moving swiftly does not mean tackling everything at once: the trick is to identify high pay-off actions, and to act on those. Nor is the point of a merger to integrate all aspects of the business at any cost. According to a McKinsey study, successful acquirers focus resources on a few critical elements of the target's business system, especially those that are global. 'The critical elements in the business system are often company-specific rather than industry-specific. In many cases a company develops a "tweak" in its business system that gives it competitive advantage.' They also integrate critical systems by 'patching' them together initially, resisting the urge to spend heavily.
Thus, for example, Lloyds-TSB is still reviewing branding - 'a critical issue, which needs a lot of customer research': discarding or downgrading brands can be a quick route to destroying rather than creating value.
The bank's computer systems programme, meanwhile, will take a number of years to complete. 'We have converted where we can: for example, we now have one treasury system but the mainframe computer systems are more problematic,' says Fairey. 'And we didn't rush to do anything with the branch networks, although in the fullness of time we will need to. We're still looking at how the branches operate, and have identified a great number of potential benefits which we didn't see before.'
The McKinsey consultants also found that successful acquirers carry out a good deal of skills transfer. This does not happen by osmosis but by moving a few senior managers to key positions. ABB has a particularly sophisticated approach, using special squads of 'roving global managers', who are sent in to coach local managers in the acquired company in whatever skills might need upgrading, and then move on. And of course the transfer of skills and knowledge can take place in reverse.
Finally, Whitehead has an interesting suggestion on the relative significance of the three key merger mistakes. Overpaying becomes obvious, he says, but the other two, more subtle factors could be linked. If the strategic rationale behind the acquisition is right, but integration is slow - or if the strategy is flawed but implementation is good - then the merger could turn out well. 'But if the deal is wrong, and you don't do the right things, the result will be a disaster.' Be warned.