Why Acquisitions Fail
A Turnaround Guide to Factors Affecting Acquisitions
By: James S. Still
Managing Director
In the crisis management and turnaround world, one of the common themes that companies in trouble have experienced is a failed acquisition or merger. Corporate America has utilized non-organic, acquisition focused growth as a means of growing market share and shareholder value for decades. From Fortune 100 companies growing through acquisitions of publicly traded entities, to smaller middle market companies acquiring smaller competitors, the acquisition vehicle holds an allure of creating shareholder value that has driven a large segment of corporate America. Even with the recessionary driven decline in M&A volume in 2008 and 2009, M&A activity remains a vibrant part of corporate growth strategies.
The experience at MainStream Management, however, correlates more closely with widely held empirical research that suggests that companies that embark on M&A activity as a means of growth more often than not do not create shareholder value. To the contrary, the overwhelming majority of acquisitions and mergers are rarely accretive in terms of shareholder value creation.
According to McKinsey & Company, half or more of the big mergers, acquisitions, and alliances announced in the popular press fail to create significant shareholder value. “For shareholders,” McKinsey reports, “the sad conclusion is that an average corporate-control transaction puts the market capitalization of their company at risk and delivers little or no value in return.” Wharton School Professor Peter Sikora estimates that one-third of mergers create shareholder value, whereas one-third destroy value and another one-third do not meet expectations. For shareholders, these deals can be “a crapshoot,” a sentiment that echoes the view of his colleague, Robert Holthuasen, who says that researchers estimate the range of failure is between 50% and 80%.
The reasons for the relatively high failure rate are illustrative of mistakes made in both the underwriting process and the post-acquisition integration planning process undertaken by the acquiring company. Examining the reasons for the high failure rate allow workout firms to understand and determine appropriate remedial action while also providing valuable insights for companies looking to utilize acquisitions for growth to take appropriate steps in the future.
A study conducted by Southern Methodist University (“SMU”) suggests that lower than projected revenue growth is the principal driver in poor acquisition performance. According to SMU, only 36% of target companies maintained their revenue growth in the first quarter after the merger announcement as measured against industry peers. By the third quarter, only 11% had avoided a slowdown relative to peers with the median lag being 12%. This data is supported by McKinsey, which reports that over 70% of companies did not achieve revenue synergies.
The importance of this revenue shortfall cannot be underestimated in terms of its impact on the success of an acquisition. The analytical research undertaken by SMU suggests that given a 1% shortfall in revenue growth, a merger or acquisition can stay on track to create value only if a company achieves cost savings that are 25% higher than those it had anticipated. Inversely, exceeding target revenue growth rates by 2% - 3% can offset a 50% failure rate in achieved cost savings. Clearly, achieving revenue growth equal to or greater than what was originally forecasted has an enormous impact on the ultimate success of the acquisition to the acquiring company.
On the cost side of the equation, the data is not dis-similar to what research suggests on the revenue side of the business. McKinsey & Company research estimates that over 30% of acquiring companies overestimated cost savings synergies by at least 25% as part of their underwriting process. In addition, 40% of acquiring companies underestimated one-time costs associated with a merger or acquisition. While the one-time cost factor is not recurring, those additional costs are in essence additional purchase price as they are incurred up-front. This has a major impact on the internal rate of return on acquisitions regardless of how those additional costs are incurred.
With the data bordering on overwhelming in terms of the negative impact of acquisitions and mergers on shareholder value, the obvious question is what acquirers should do to mitigate the risk of failure and increase the probability of success. The research that MainStream Management has undertaken corroborates the views of a number of industry experts in terms of certain key characteristics of successful acquisitions.
A key component of McKinsey’s research on successful M&A is that companies can substantially improve their chances of success by pursuing transactions aimed at expanding the company’s current lines of business and not taking the company into entirely new activities. The Wharton School echoes this sentiment in suggesting that so-called horizontal deals – deals between related as contrasted to unrelated firms – tend to be more successful. The rationale behind this phenomena relates to both the availability of cost synergies between industries in a common industry and because industry knowledge allows for a better understanding of potential revenue growth. It is our view that strategic acquisitions will be the norm going forward in 2010 and 2011, at the very least, due to the increasingly conservative availability of debt funding for acquisitions on the part of the domestic lending community.
Another factor in structuring transactions is that the market tends to value “full deals” e.g. complete acquisitions, as contrasted with other forms of transactions including a merger, sale, or joint venture. McKinsey reports that acquisitions boost the announcement impact of a deal on the acquirer’s stock by 2.7% of market capitalization higher than other forms of announcements. The rationale is relatively easy to understand – a full acquisition allows cost synergies to be realized without the angst associated with similar cost savings through a merger or joint venture arrangement.
One key stakeholder that many researchers need to consider to a greater degree in evaluating an acquisition is the customer. Joanna Serkowski, an executive leader at General Electric, suggests that the degree to which company processes are integrated with customers before the merger is a significant determinant in the ultimate success of an acquisition. According to Sikora from The Wharton School, the customer should be viewed as the biggest stakeholder and treated as such. He cited a merger between two Silicon Valley based technology firms, both of whom had IBM as a leading customer. IBM dropped both companies after the merger because it felt that it had not been informed of the merger in an appropriate way before it was consummated.
Many organizations are good at financial modeling and transaction structuring but spend an insufficient amount of time undertaking post-acquisition integration planning before transactions are consummated. It is the view of MainStream that undertaking extensive post-acquisition planning beforehand allows not only for better integration but more effective underwriting. Increased knowledge of what an organization will look like after a transaction is completed allows for a better understanding of cost and revenue projections.
A final factor that many experts in the M&A industry contend is essential that is employees be dealt with appropriately, however loosely that might be defined. Consistent communication regarding the process of integration as well as the goals of organizational change is a theme that many successful acquisitions have. In this day and age of enhanced communications, the use of email updates, newsletters, and face-to-face dialogue is invaluable in ensuring that employees of both the acquiring company and the acquirer have a clear understanding of the integration process and the long-term objectives of the acquisition. This communication can occur through either senior management or an integration-focused transition team that is responsible on a day-to-day basis for the acquisition. Such communication is an essential tool in ensuring effective integration.
MainStream Management believes that acquisition as a corporate tool for generating shareholder value is an attractive and viable option, despite the long odds that history suggests exist for the use of this tool. It will occur, however, only with companies that take a hard, objective view of the costs and benefits of the acquisition, and which follow many of the guidelines for success – and failure – that corporate America has historically experienced.
For more information about MainStream Management, LLC or to discuss this article further please email info@mainstreamllc.com or call 877.785.6888.