The art of the deal: integration strategies that work; Mergers have always been risky business. But in the current M & A mania--fueled in part by a raging private equity market--the buyer must truly beware.Late winter snowstorms aside, February was a particularly cold month on Wall Street. After the former Federal Reserve Chairman Alan Greenspan mused about a coming recession, the Asian markets tanked and panicky investors sent the Dow spiraling.
But not even that frost could dampen the M & A fire that has been raging for well over a year. Worldwide announced M & A activity for first-quarter 2007 topped $1.1 trillion, according to Thomson Financial, which provides information and technology solutions to the financial community. Though that number is slightly down from last quarter, it still represents a 27 percent increase over first-quarter 2006. Last year's worldwide announced M & A deals reached nearly $3.6 trillion, with the U.S. alone accounting for 44 percent, or $1.6 trillion. That represents a 36 percent jump in M & A volume for the U.S. over 2005.
High liquidity levels and strong balance sheets are inspiring both strategic and financial buyers to go in search of the perfect (or good enough) deal. Private equity firms, sitting on huge war chests, are spending billions gobbling up companies they aim to flip for a reasonably swift return. And strategic buyers of all sizes, feeling pressured to spend idle cash or find ways to speed growth, are getting in the game, lest they be left behind as their industries consolidate. Foreign conglomerates have added another dimension, competing with domestic buyers as they go on spending sprees in the U.S. in an attempt to expand their global reach and better compete stateside. According to Thomson figures, M & A volume for announced deals with a U.S. target increased 35.7 percent over 2005.
Of all the compelling facts and figures, however, the most astonishing may well be one that hasn't changed in years: the failure rate of these transactions. The gospel has long been that approximately 70 percent of mergers do not succeed, for a host of reasons, and though the jury is still out on the current crop of megadeals, there is no reason to believe that abysmal success ratio has changed. Research by A.T. Kearney, for example, analyzing deals over the past decade reveals that fewer than 30 percent of all mergers create substantial shareholder value after the first couple of years, and only half create any value at all.
If that sobering statistic holds true, the majority of corporate marriages made in the past year, and this coming one, will sorely disappoint shareholders. They will fail to achieve the cost and revenue synergies envisioned by the two sides and will not deliver the value they promised--and certainly not in the time frame many investors and Wall Street analysts expected. For the CEO, whose performance is now scrutinized on a quarterly basis, missing the mark on such a costly venture could easily mean an untimely exit.
And yet, despite the high stakes, CEOs are still putting their money on the long shot and pressing forward with big deals. Many don't have a choice. With their companies sitting on cash, internal growth rates slowing and relatively high stock values, the noise from critical shareholders can be very persuasive. "It's the discipline and focus the market brings, the reality really," says David Wood, managing director of Standard & Poor's Ratings Services, "which makes it much more difficult for the CEO and board to ignore these pressures, turn a blind eye and say, 'We're comfortable for the time being.'"
Unfortunately, this pressure to buy doesn't improve an acquirer's chances of success. When a company decides to adopt an acquisition strategy solely to allay criticism from irate shareholders, they often put the cart before the horse, Wood explains. "They're overly quick to pull the trigger, and they wind up buying the wrong candidate."
Or they buy a company without doing sufficient due diligence. Too many CEOs fall victim to "shiny object syndrome," says Jon Hughes, head of the U.S. business transformation team at London-based PA Consulting Group. "The acquiring business sees something bright and shiny in a potential target and gets so focused on that that they don't look at the surrounding infrastructure." As a result, they miss key flaws in the company for sale or fail to do the kind of pro forma calculations that would keep them from shelling out too much.
Getting overly emotional about acquisitions is one of the biggest mistakes CEOs make, says Gerald Nowak, corporate partner in the Chicago office of international law firm Kirkland & Ellis, who says he sees more and more corporate leaders feeling compelled to do the deal, either because of shareholder pressure or because everyone else is doing it. "If you walk into an auto showroom and you must have that BMW 330, and you're not willing to walk away from it, that is a prescription for overpaying," he says.
That's why CEOs with a successful track record in dealmaking say the buyer must be willing to walk away if the price isn't right. Miles White, CEO of Abbott Laboratories, has been growing the company steadily by acquisition, complementing its existing portfolio of products and taking it from drug company to diversified health care business. Ten deals over the past eight years, ranging in size from $58 million to $7.2 billion, have helped bump sales from $8.7 billion in 1999 to $19.7 billion in 2006, or growth of 126 percent. Abbott has been able to make the purchases profitable in short order partly due to a highly disciplined approach and a concerted effort to stay unemotional about transactions. "Once you get into the heat of the deal, particularly in an auction or competitive situation, you don't want emotion and the desire to simply win the deal to carry you past the boundaries of your financial modeling or your expectations," says White. "You need to understand in advance your absolute limits. Then it's very simple black and white."
During one negotiation, White recalls, Abbott was getting ready to acquire a company in Europe, but when the team went over to finalize the contracts, they found their acquisition target had received a higher bid from another player. Tempting though it was to try to outbid the competitor, White knew Abbott could not earn a sufficient return at the new price point to make the transaction worthwhile. "It was beyond what we could do, so we walked out, and that was the end of it," he says. "If you don't do that, you're never going to have a coldly analytical and objective organization that makes good deals on behalf of investors. You're going to make too many exceptions for the wrong reasons."
White also attributes his success to plenty of advance preparation, noting that Abbott will track potential targets months or years before making a bid. "And if we don't know the market well, we'll supplement with some consulting help from the outside to do a deep dive on learning the industry or business," he says. His shrewd preparedness proved most useful in the spring of last year, when Johnson & Johnson and Boston Scientific tussled over the right to buy cardiovascular medical products maker Guidant. White made a deal with Boston and was able to secure Guidant's vascular business, and its coveted stent products, in exchange for financing to help Boston raise their bid. Though many agreed Boston overpaid, Abbott emerged as the one clear winner in the deal. "We were very well prepared, well in advance," says White. "We were fortunate the opportunity occurred--we couldn't have predicted that--but we were certainly extremely well prepared when it arose."
White's team also knew exactly how they planned to handle the newly acquired assets once the ink was dry on the deal--a key factor in his ability to make it work. Many CEOs focus too much on the upfront negotiation, neglecting planning for the post-merger integration where many deals fall apart, says Hughes. "It's a kind of post-deal blindness that sets in," he says. "There's a temptation to say, 'The deal is it and once the deal is done, it will all happen by magic.' Then the poor folks on the other side of the wall get thrown this beast and have to try to make it work."
Ed Kaplan, CEO of Zebra Technologies, agrees. He won't even bid on a deal without knowing in advance how the integration will work and without having run a pro forma of what the company will look like post-merger. That means an analysis of what management will look like, what will happen to the two companies' product lines, how the merged entity will be positioned, how the distribution channels will be affected, and how the addition will affect the company's global footprint, he says. "It amazes me how often big companies that should know better don't do that," he adds. "They say, 'Oh, well, we'll integrate it.' And the question is--how?"
Indeed, a deal's fate often lies in what happens to the merged entity after the contract is signed and sealed, and often in the first 100 days. The softer, cultural issues can sabotage the best-laid plans for a smooth integration, particularly in the beginning when employees are feeling the most insecure about their future with the company. "That's when people leave," says Gunilla Sandgren, director of Celemi Learning Change, a Sweden-based consulting firm that advises companies on handling the human side of change management. "And it tends to be the good ones leaving as well." Keeping that talent, and keeping up morale in general, means creating a forum for constant dialogue up and down the org chart. "Many companies, if they do a communication effort, tend to do it once--a big event or program for all employees for two to three hours to discuss what the merger will mean," says Sandgren. In fact, the CEO needs to set a tone of openness from the top and establish a fluid communication channel throughout both the merger and the integration.
When Paris-based Axway, a provider of business-to-business integration software, bought Phoenix-based Cyclone Commerce, the two faced even greater potential culture shock, yet they managed to suffer no more turnover than usual in the wake of the merger. Christophe Fabre, Axway's CEO, chalks that up to careful communication with employees. "You have to take the same care of your people inside as the new employees," he says. "If you put someone in a position that is unacceptable to him in the first six months, that's where a lot of acquisitions are failing. And if you hurt someone because you don't understand his wishes and how he understands himself, that's where you fail. You have to listen." Even in the case of a Phoenix-Paris odd couple pairing, communication was able to go a long way to keeping the two sides happy. The combined entity exceeded pre-merger expectations, generating revenues of $152 million in 2006, and Axway grew 54 percent in the U.S.
As the CEO of a private entity, Fabre wasn't in the same spotlight that many other CEOs find themselves post-merger, but his strategy of setting realistic goals and managing expectations is a sound one for public company leaders. The market pays particular attention to expectations set during the merger and will hold CEOs accountable to those, says Tim McDonald, a partner with A.T. Kearney. "No one has the expectation that it will be an overnight success," he adds. On the other hand, "overpromising and underdelivering is not a good recipe for continuity as a CEO."
That's always true, but particularly so in the world of M & A. And in the coming year, there will likely be CEO casualties from this current merger wave. Still, despite the odds against a successful merger, Kaplan says, when the deal is done right, the upside is phenomenal. Ultimately, that potential keeps optimistic CEOs in the game. "People go to the racetrack and bet a lot of money on a horse that has a one out of three chance of coming into the winner's circle. Why? Same reason--big payoff," he says. "If you fail, you might be out the door, but if you succeed, you may be very rich."
RELATED ARTICLE: Seven Reasons Divestitures Are Harder Than You Think
In today's seller's market, divesting noncore businesses makes good strategic sense. But before moving to cash in on businesses you think will be attractive, it is worth taking a hard look at the process of divestiture. Whether you aim for an outright sale or a spin-off to shareholders, in today's business environment splitting off pieces of a business is much harder than it appears. It can impact not only the divested entity, but the seller as well. Our analysis has found seven key hurdles to successful divestitures.
1. IT integration efforts make divestitures difficult. ERP (enterprise resource planning) applications like SAP, which wire businesses together, make them far more difficult to separate.
2. Support services and facilities are hard to unravel. The more successful a company has been at achieving scale through shared support services and joint facilities, the greater difficulty it will face unwinding these collaborations.
3. Outsourcing adds third-party issues to divestitures. Outsourcing can add additional--perhaps hundreds of--vendor relationships as well as involve processes that are critical to a company's core businesses.
4. The divested business may require long-term support from the former parent. Thus, establishing clear service level agreements (SLAs) between buyer and seller is critical.
5. Disruption threatens both seller and divested entity. Getting a separation plan done often requires a three-way collaboration between the seller and its remaining businesses, the divested unit itself and, in some cases, the buyer--absorbing valuable management resources.
6. The divestiture can impact the seller's cost structure. In some cases, there can be loss of scale in areas where work was combined with the divested business.
7. Regulatory requirements can force your hand. Regulatory requirements, on both local and global levels, often create additional complexities.
This doesn't mean divestitures are a bad idea, of course. In many cases, they are absolutely the right thing to do. The trick is to be aware of the challenges in advance, and use that knowledge when assessing any proposed transaction. Truly understanding the issues can help a seller get the very best deal--in the broadest sense of the term.
Gerald Adolph is a senior vice president at Booz Allen Hamilton and the head of its merger and restructuring group. J. Neely is a vice president at Booz Allen specializing in growth strategy and transformation.
BY GERALD ADOLPH AND J. NEELY
Only Half of the Top Mergers of the Last Decade Have Added Value Of the top 25 deals since 1998, only 13 resulted in a share price increase after six months. More recent deals have been no more successful than earlier deals, suggesting that companies are not necessarily getting better at M & A over time. Target Value $ (Bil) Year Target Name Nation Including Debt Acquirer Name 1999 Mannesmann AG Germany 202.7 Vodafone AirTouch PLC 2000 Time Warner U.S. 181.6 America Online 2006 BellSouth U.S. 89.4 AT & T 1999 Warner-Lambert U.S. 88.8 Pfizer 1998 Mobil U.S. 85.1 Exxon 2004 Shell Transport & U.K. 80.3 Royal Dutch Petroleum Trading 2000 SmithKline Beecham U.K. 78.8 Glaxo Wellcome PLC 1998 Citicorp U.S. 72.5 Travelers Group 2001 AT & T Broadband U.S. 72.0 Comcast 1998 GTE U.S. 71.3 Bell Atlantic 1998 Ameritech U.S. 70.3 SBC Communications 1998 Tele- U.S. 69.9 AT & T Communications 1999 AirTouch U.S. 65.7 Vodafone Group PLC 2004 Aventis SA France 65.6 Sanofi-Synthelabo SA 2007 Kraft Foods U.S. 61.7 Shareholders 1998 Bank of America U.S. 61.6 NationsBank 2002 Pharmacia U.S. 60.7 Pfizer 2000 Nortel Networks Canada 60.0 Shareholders 2004 Bank One U.S. 58.7 JPMorgan Chase & Co. 2005 Gillette U.S. 57.2 Procter & Gamble 1999 US West U.S. 56.3 Qwest Communications Intl. 1999 Elf Aquitaine France 55.3 Total Fina SA 1998 Amoco U.S. 52.7 British Petroleum Co PLC 2003 FleetBoston U.S. 49.2 Bank of America Financial 1999 MediaOne Group U.S. 48.9 AT & T Acquirer Closing Price at Year Acquirer Nation Industry Announcement ($) 1999 U.K. Telecommunications 155.8 2000 U.S. Media and Entertainment 71.9 2006 U.S. Telecommunications 27 1999 U.S. Health care 38.6 1998 U.S. Energy and Power 72.7 2004 Netherlands Energy and Power 54.6 2000 U.K. Health care 87.9 1998 U.S. Financials 73 2001 U.S. Media and Entertainment 38.9 1998 U.S. Telecommunications 45.2 1998 U.S. Telecommunications 38.8 1998 U.S. Media and Entertainment 60 1999 U.K. Telecommunications 109.5 2004 France Health care 73.9 2007 U.S. Consumer Staples N/A* 1998 U.S. Financials 80.6 2002 U.S. Health care 28.8 2000 Canada Telecommunications N/A* 2004 U.S. Financials 39.2 2005 U.S. Consumer Products 54.1 1999 U.S. Telecommunications 90.9 1999 France Energy and Power 153.3 1998 U.K. Energy and Power 101.6 2003 U.S. Financials 73.6 1999 U.S. Media and Entertainment 77.7 Acquirer Closing Price % change in Share Year 180 Days Later ($) Price Over 180 Days 1999 144 -8% 2000 55.7 -23% 2006 31.6 17% 1999 41.8 8% 1998 80.2 10% 2004 60.5 11% 2000 93.2 -8% 1998 34.5 -53% 2001 34.9 -10% 1998 57.5 27% 1998 47.6 23% 1998 74.2 24% 1999 134.4 23% 2004 67 -9% 2007 N/A 1998 86.9 8% 2002 30.9 7% 2000 N/A 2004 36.9 -6% 2005 55.4 2% 1999 38.7 -57% 1999 140.2 -9% 1998 110.8 9% 2003 81.2 10% 1999 45 -42% Source: Thomson Financial *share price N/A for spinoffs Credit Ratings Take a Beating in the Top 10 Biggest Global M & A Deals The current environment of hyperliquidity and aggressive leverage has led to a huge wave of leveraged M & A. The downside? A negative impact on credit quality. Effect on Effect on Amount Acquirer's Target's Acquirer Target $(Bil) rating rating AT & T BellSouth $89.4 Watch Neg Watch Neg E.ON AG* Endesa SA 71.4 Watch Neg Watch Neg Suez SA Gaz de France SA 41.0 Watch Pos Watch Neg Mittal Steel Arcelor 39.5 Watch Neg; Watch Dev; downgrade affirmed Banca Intesa Sanpaolo IMI 37.6 Watch Pos; Affirmed upgrade America Movil America Telecom 35.3 None Watch Pos SA de CV SA de CV Blackstone Group Equity Office 32.5 Not rated Watch Neg Properties Trust Investor Group HCA 32.1 Not rated Watch Neg; downgrade Statoil ASA Norsk Hydro 32.0 Watch Pos Watch Neg Airport Development BAA PLC 30.2 Not rated Watch Neg; and Investment downgrade Sources: Thomson Financial, Standard & Poor's *Bid terminated 4/07