Understanding Mergers and Acquisitions
Mergers and acquisitions (grouped under the single expression M&A) are by far the most common way to seek inorganic growth since they usually provide the quickest way to enter new markets, obtain key capabilities or improve a competitive position.
Acquisitions are by definition very simple: a company buys another company and makes it part of itself. But in reality, acquisitions rarely go as smoothly as expected and most of them destroy value for shareholders.
In fact, Harvard Business Review estimates that at least 60 percent of all acquisition attempts fail, and that number could be up to 83 percent according to KPMG.
At least in theory, the general rule for any acquisition is that the value it produces for the buyer should exceed the cost paid for it.
This may sound like common sense, but we all know that’s not always the case. In fact, most times it is actually very hard to even try to measure that.
The first challenge with an acquisition is that to put a price tag on a target you must consider the strategic benefit of the target for you, but that value is pretty much in the eye of the beholder, so it will be different for different companies.
In the eyes of Microsoft, the kind of synergies that Skype could create with its other professional tools justified the high price.
The price that a company puts on a target then is a combination of financial factors (e.g. measured by the target’s cash flow) and strategic factors (measured by how the target’s assets, both tangible and intangible, could create value for the buyer), where things like key contracts, exclusivity agreements and intellectual property among other things can help improve the target’s position in the negotiation.
The second challenge is that the buyer’s strategic interests change over time. When Cisco Systems (NASDAQ: CSCO) bought Pure Digital, the company that made the popular Flip video cameras in 2009 for $590 million, it did so with the intention of expanding its product offering and showing the market that it was making the right moves in the consumer electronics space.
But success in the consumer market turned out to be harder than Cisco expected and two years later in 2011 it decided to close the business and stop selling the Flip products to “refocus on their network-centric platform strategy”.
Nice way of sugarcoating a half a billion dollar mistake.
When evaluating an acquisition, in addition to the price of buying the shares, you should take into account the cost of integrating the new unit into the mothership, which in some cases has turned out to be higher (and way more expensive) than expected.
The costs of terminating people, integrating software platforms, training for acquired employees, public relations, lobbying to get the transaction approved by regulators, re-branding, advertising
The most common downside that comes out of an acquisition is that as the acquirer you will, in many cases, overpay for the target. That obviously sucks, but sometimes you just have to accept it as the cost of making the transaction happen.
The truth is that unless you’re the only buyer and the seller is desperately trying to get out of the business, it would very difficult to get a “fair” valuation.
We see acquisitions happening these days at 80 percent or even 100 percent goodwill (overpayment), but as we said earlier, the details are not in the face numbers but in the strategic value that the target creates for the buyer.
A not-so-common type of acquisition that I found while reviewing some of Jack Welch’s transactions as part of the research for this book is companies “trading” businesses, that is, giving one of your business units to another company in exchange for one of theirs.
For example, in the late 1980s, France’s government-owned electronic company Thomson and GE made a trade where GE gave its TV manufacturing business to Thomson, in exchange for Thomson’s medical device division and $1 billion in cash.
At the time, it was a win-win for both companies. On the one hand Thomson had a subscale TV operation which would get better if merged with GE’s TV business, and on the other GE had no participation in France, a market it wanted to enter and where it could create synergies by integrating Thomson’s medical device unit into its own.
Wu, Sun. Strategy for Executives, this book can now be downloaded for free here.
Lewis, Alan; McKone, Dan. So Many M&A Deals Fail Because Companies Overlook This Simple Strategy. Harvard Business Review blog. May 2016. URL: https://hbr.org/2016/05/so-many-ma-deals-fail-because-companies-overlook-this-simple-strategy
Heffernan, Margaret; Why Mergers Fail. CBS MoneyWatch. April 2012. URL: https://www.cbsnews.com/news/why-mergers-fail/
Skype Wikipedia page. URL: https://en.wikipedia.org/wiki/Skype
Reardon, Marguerite. Why Cisco killed the Flip mini camcorder. CNET. April 2011. URL: https://www.cnet.com/news/why-cisco-killed-the-flip-mini-camcorder/
Welch, Jack; Byrne, John A. Jack: Straight from the Gut. Business Plus. Kindle Edition.