For richer, for poorer: mergers, like marriages, start optimistically but often end in disappointment. As confidence returns to the M&A market, Camilla Berens reveals the secrets of corporate conjugal bliss.

When two companies enter into a merger it must feel a bit like falling in love. It's all hearts and flowers at the start, but it's only when they move in with each other that they find out whether they're really compatible. Like many relationships that claim to be equal, a merger implies mutual development. But, when it comes to strategic decision-making, one partner usually ends up trying to impose its will on the other.

According to David Kappler FCMA, chairman of Premier Foods and one of CIMA's highest-flying members, it's rarely a marriage of equals. "There's no such thing as a merger," he laughs. "It's just a polite way of talking about a takeover. In my experience, one company always finishes up on top."

Kappler's experience of mergers and acquisitions is extensive. He was involved in more than 50 deals before and during his time as CFO at Cadbury Schweppes. Like many others, he feels there are clear signs that, alter years in the doldrums, M&A activity is gathering momentum again. Procter & Gamble's recent $57bn (30bn[pounds sterling]) merger with Gillette has reinforced the feeling that the clouds created by the dot-com crash in 2000 are lifting at last. The P&G-Gillette tie-up follows on the heels of mega-deals such as the $36bn merger of mobile giants Sprint and Nextel in the US and the Spanish Banco Santander Central Hispano's acquisition of Abbey National for $15bn.

There are also signs of increasing confidence further down the scale. M&A activity among smaller businesses seems to be gaining momentum steadily. Emma Shipp, an M&A expert at City law firm Sprecher Grier Halberstam, has seen an upturn in takeover action involving unlisted companies, particularly in IT and telecoms.

"There's a feeling that some sectors are being undervalued at the moment. That means there are some good deals out there. But the mood is still some way off M&A mania," she says. "There's an increase in activity, but you're not seeing people splashing money around like you did when the markets were rising before. Then, people wanted to make five or six acquisitions very quickly. This time around, they will do one deal, see how it goes and perhaps go on to another. I'd call it cautious optimism."

But how many companies venturing into the M&A arena will actually prosper? The processes involved in completing a merger are both exciting and exacting. Even when the deal is signed and sealed, the long-term benefits are far from certain. A glance at the success rates of major deals around the world can leave you wondering whether the gain is really worth the pain. In its most recent biennial survey of global M&A activity, KPMG found that only around a third of the 122 major deals recorded during the year 2000 have significantly improved shareholder value.

Carly Fiorina, who'd masterminded Hewlett-Packard's $18bn takeover of Compaq in 2001, recently stepped down as chief executive after a boardroom clash over the company's strategic direction. HP's share price had remained stubbornly low and she was under increasing pressure as a result of missed earnings targets. AstraZeneca has fared even worse since its merger in 1999. Last year the pharmaceutical group's failure to bring new drugs to the market helped to knock 30 per cent off its share value.

For such companies there's little option but to ride out the storm and hope that they'll eventually reach calmer waters. Perhaps they can take heart from the story of AOL's and Time Warner's merger. When the deal was signed in 2000, it was billed as the largest merger in history, creating a company worth 350bn [pounds sterling]. From a distance, the companies seemed well matched but a bitter feud quickly erupted between the executives from the new-media AOL and the old-media Time Warner. For 18 months the company took a hammering, both in the press and on the stock market. The troubled conglomerate's share price collapsed and the US stock market watchdog started investigating its accounting practices. But the media giant has made a dramatic about-turn since the arrival of a new chief executive, Richard Parsons. AOL's internet activities are expected to generate about $1bn in free cash flow this year, while the Lord of the Rings film trilogy has brought in $5bn from the box office and merchandise sales. Five years on, the company's prospects are much more hopeful.

External factors aside, the key requirement for any company considering a merger or acquisition is careful management both before and alter the deal is done. As KPMG's Stephen Smith points out, this is easier said than done. Smith, head of transaction services at the firm, says a strong business strategy is vital.

"There are a great many simple things that you have to get right all at the same time," he says. "You have to get the big picture right and you have to get the detail right simultaneously. In essence, a company needs to know that it has not only a strategy but the confidence to execute it as well."

Smith argues that, although the success rate measured on KPMG's survey is low, it's an improvement on previous years and there are signs that companies are taking merger management more seriously these days. "In the past, people weren't clear how much the business was going to earn and hadn't validated their assumptions," he says. "Today, companies are generally much clearer about the business case and are doing proper due diligence."

Larger companies have even gone to the trouble of creating specialist M&A business development departments. "If you like, it's an insourcing of financial advice," Smith explains. "They started off doing some smaller transactions on their own and are now moving on to bigger things. It's been a steady evolution over the past few years."

As buyers become more adept at finding ways of reducing their bids during negotiations, vendors need to cover themselves accordingly. "They must ensure that they professionalise the sell side in terms of what information they give so that the buyer can fully value the business," he says. "If the vendor gives the buyer a chance to quibble, things start to slip and that's when the price goes down."

Although pre-sale processes are tightening up, Smith believes that a lot of work still needs to be done on post-acquisition activities. "There has to be more rigorous integration," he says. "Companies need to be clear what the synergies will be, where they come from and how they will be realised. All this has to be in place from day one. It's not easy to walk into a business and set up a process that delivers savings and benefits swiftly. It needs thorough planning."

From a management accountant's perspective, M&As pose many hazards. Kappler believes that one of the most common problems is overenthusiasm. "When you are evaluating a deal, there is a tendency to be too optimistic about the growth you are going to add to the business," he says. "Some companies are very successful in securing a good-value deal, but then they find they can't generate the anticipated growth."

A finance director must have nerves of steel in such situations. "M&As are very stimulating processes and it's quite easy for one side to get carried away in the heat of the moment," Kappler says. "You need a very strong FD to keep a close eye on the value that's being created and ensure that the company isn't paying too much. However exciting the deal, you require cold, rational analysis back at the ranch. It's really important to get the implementation and integration right at the start. In my experience, problems have always come up when the FD isn't brought in from day one."

But no merger is going to work if the companies involved have incompatible approaches to business. "You need to have some alignment of culture," Kappler says. "Otherwise, you get so many internal wars that the focus shifts away from running the business properly."

One example of a corporate culture clash was highlighted by the US merger of the Wells Fargo and First International banks in the late Nineties. Wells Fargo tried to impose its electronic banking culture on the new alliance and made two-thirds of First International's senior managers redundant, losing a lot of IT know-how in the process. As a result, records were lost, ATM services suffered technical faults and thousands of customers voted with their feet.

The success of a merger often hinges on whether the new partners get on with each other in the boardroom. Phil Adams, managing director of investment bank Altium Capital, says it's vital to agree a board structure at the outset. "You have two sets of people and it's important that everybody agrees who does what," he says. "Often there are quite a few egos to deal with, so you need to ensure that this issue has been resolved quickly and the directors are ready and willing to work together."

Now that China is welcoming western trade alliances, global expansion through M&As seems more attractive than ever. But surely finding a compatible corporate culture is hard enough without having to take into account national differences as well? KPMG's Stephen Smith believes that cross-border transactions have a surprisingly good success rate. "You'll find that they often work out better because management has put a lot more effort into making sure the deal sticks," he says.

Some of the newer issues that companies seeking M&A deals must face include pension fund shortfalls, increasing investor activism and ever-changing competition laws. Some of the shrewdest players have been thwarted by the threat of regulatory intervention. US defence giants Lockheed Martin and Northrop Grumman abandoned their planned merger amid government concerns that it would make the armaments industry less competitive. And Ernst & Young and KPMG shelved plans to create the world's largest accounting and consulting firm after directors decided that opposition from anti-trust regulators in Europe, Australia and Canada would make the deal unworkable. Industry watchdogs are certain to become more vigilant as the number of mergers increases.

The Sarbanes-Oxley Act 2002 has personalised corporate responsibility to such an extent that you have to wonder how US chief executives can confidently sign off their firms' accounts as they engage in ever more complex financial dealings abroad. Their counterparts in Europe are considering the effects that the new international financial reporting standards (IFRS) will have on merger activity. KPMG's Stephen Smith says that in theory they shouldn't complicate the process, but there are areas of potential frustration.

"If a buyer pays a goodwill premium for a company, IFRS states that you have to allocate this to an intangible and then amortise this intangible over the useful life of the asset. This has the capacity to muck up the comments FDs like to make about not having earnings-diluted transactions," he explains. "Moreover, if the deal doesn't deliver the anticipated benefits, you have to write down that goodwill in a way that publicly says that the deal isn't working. It increases transparency but also the potential for executive embarrassment."

Apart from the administrative problems, companies seeking growth through acquisition face the danger of a political backlash. In a recent FT article, Jeffrey Garten, dean of Yale School of Management, warned that multinationals needed to become exemplars of corporate governance and social and environmental responsibility if they were to avoid censure. "In the gilded age of J P Morgan and J D Rockefeller big companies were seen as having unchecked power. This led to a dramatic increase in government regulation. Unless the new corporate Goliaths are smart about redefining their own role in the global society, that could easily happen again."

Faced with such a range of obstacles, it suddenly seems impressive that any company manages to overcome them and improve its shareholder value. Is there a winning formula? Smith reckons there are three crucial ingredients: have a clear business strategy that both management teams support; introduce a clear process to execute that strategy; and recognise the need to manage the integration of the two cultures right through the new entity.

"It's essential to be clear what the risks attached to the deal are and how you will manage them." he says. "This is opposed to the old idea of going with the flow companies did that in Russia and got absolutely stuffed."

Smith's colleague Rebecca Shalom, partner in KPMG's integration advisory team, says it's vital to strike a balance between delivering the promised benefits and keeping an eye on operations. "It is easy to say, but challenging to do," she says. "You have to think about how to integrate without losing the value of the company. Systems change slowly and you must stick to the programme without jeopardising day-to-day business. You have to continue with it even when everyone else has got bored."

TRENDS IN M&A VALUE CREATION

Enhance
2003      34%
2001      30%
1999      17%

Neutral
2003      34%
2001      39%
1999      30%

Reduce
2003      31%
2001      31%
1999      53%

Source: KPMG Transaction Services survey 2003

Note: Table made from bar graph.

THE OBJECTIVES OF M&A ACTIVITY

2003
Economies of scale                6%
Diversification                  15%
New/greater geographic markets   20%
Other/no overriding goal         22%
Increase/protect market share    37%

2001
Increase/protect market share    25%
Other/no overriding goal         29%
New/greater geographic markets   25%
Diversification                  13%
Economies of scale                8%

Source: KPMG Transaction Services survey 2003

Note: Table made from pie chart.

M&A RESARCH FINDINGS

The most common reasons for doing a merger are to protect or increase market share, or to diversify into new markets or products.

34% of deals enhance value for shareholders--this is the first time that this research has showed that more mergers enhance value than reduce it (research in 1999 showed that just 17 per cent enhanced value).

65% believe their deal has been successful, compared with 75 per cent in the last survey (2001). This indicates that the gap between objective assessment of the deals and respondents' perception of success has narrowed.

67% of the deals that enhanced value have come about as a result of management identifying a suitable target in advance, compared with 28 per cent that were opportunistic or where the strategy was unclear. Companies with a documented and approved strategy for the deal are more likely to enhance value.

According a higher priority to synergies and integration planning appears to have a favourable impact on the outcome of the deal.

16% of respondents say their own M&A team was the most involved in assessing the value of the deal (half the number cited in the last survey). Conversely, the influence of the board and some professionals has increased.

37% of respondents describe due diligence as the most important pre-deal activity (an increase from 25 per cent in 1999).

Management is more likely to succeed in implementing synergies in the deals that have enhanced value. While cost reductions are more readily achieved, it is revenue benefits that are likely to hold the key to creating value from the transaction for the acquirer--ie, cost synergies offset the premium to vendors; revenue synergies create the real value for the acquirer.

Source: KPMG Transaction Services' global survey of 122 companies that completed major M&A deals in 2000-01.