Why Some M&A Underperforms
Do mergers and acquisitions create or destroy value?
Academics and industry practitioners often give different answers. Industry practitioner’s have principal-agent conflicts and incentive structures that encourage them to down-play the risks and failure rates of M&A. Investment Bankers receive transaction fees and aren’t responsible for failed integration. Corp Dev employees want to close deals that they can point to in their next job interview. And, CEOs who receive large stock option packages are incentivized to engage in risky M&A when stock options limit their downside risk.
For a public stock investor, a company’s M&A activity can make or break a good investment. In other articles I wrote about ways companies can allocate capital and when to invest in spinoffs, rounding-out the series, here are a few cases when M&A can destroy value.
1. Low Return Synergies: For example, combining back-offices functions (e.g. accounting and legal departments) might be straightforward but the yield could be relatively low.
2. Synergies Take Too Long: Synergies take time to develop (often longer than expected), and the discounted present value of savings years from now might not be worth the premium paid.
3. Synergies Have a Cost Too: Synergies cost money to implement — downsizing, integration, training and relocation of employees have real costs.
4. Negative Synergies: You messed up, more than duplicated functions, and now it costs you more to run the business
5. Getting the Strategy Wrong: For example, a savings and loan bank acquiring smaller savings and loan banks to roll them up to increase geographic footprint and improve efficiency is not the same as acquiring a chain of home insurers which requires developing a competency in cross-selling.
6. Mistaking an Acquisition Target for Being the Same as a Previously Successful Acquisition: The synergy opportunities will be different too.
7. Lack Entry Barriers: Buying companies that are believed to have entry barriers, but actually don’t.
8. Copying Competitor Strategy / Rationale: Does the strategy actually make sense, and has it been tested? For example, after the pharmaceutical company Merck acquired a pharmacy benefit manager, Merck’s competitors Eli Lilly and SmithKline Beecham did so too without fully planning or testing the strategy. A few years later they all spun-out these businesses.
9. For the Sake of Size: Is not a good enough reason.
10. An Overvalued Company Acquires Targets for Multiple Expansion: Multiple expansion occurs when a public company’s stock price trades at a higher multiple to earnings than that of a target. Overvaluation doesn’t last forever, and the impact of any excess premium paid will appear more harmful when the company’s multiple does compress.
11. Diversifying Revenue Streams and Industry Exposure: Investors could do this on their own by diversifying their portfolios.
12. Poor Due-diligence: Examples include, not identifying issues in target company such as lack of rigorous processes (e.g. customer data security and accounting), credit quality, or audit controls. Not identifying customer or account conflicts that will reduce combined revenue (e.g. advertising firms that merge may lose clients to conflicts). Or, not identifying significant recent erosion in market demand for target company’s products.
13. Not Accounting for Technical Debt: Acquiring companies to speed development of a service offering, without realizing that technical debt might require the technology architecture to be rebuilt to a new standard and thereby losing the advantage of speed to market.
14. Poor Integration Planning Before Acquisition
15. Poor Integration Management: Leading to planned synergies never being realized.
16. No Integration Champion Designated
17. No Resources to Deal with Unexpected Hurdles
18. Alienating Customers in the Process
19. Key Management Leaves: After cashing out.
20. Employees Lose Incentive: When employees were significant owners and got paid out.
21. Reducing Employee Compensation: Leads to negative manager impact.
22. Hostile Takeovers: Can lead to target employees thinking, “I will kill you rather than join you”.
23. Disbanding the Wrong Teams: If they were responsible for success (E.g. R&D teams).
24. Disregarding Culture: That contributed to the target’s success (e.g. Entrepreneurial environment).
25. Cross-Border Transactions: Are harder to manage from overseas, too much “hands-off” management can lead to misbehavior, and corporate cultures are more likely to be conflicting.
Sources:
· Finkelstein, S., Why Smart Executives Fail
