The book s central focus is on the challenges of using mergers and acquisitions (M&A) as an instrument to create shareholder value.

Transcription

1 Creating Value from Mergers and Acquisitions: The Challenges Sudi Sudarsanam FT Prentice Hall 2003 ISBN: , 616 pages Theme of the Book The book s central focus is on the challenges of using mergers and acquisitions (M&A) as an instrument to create shareholder value. An extensive review of the value-creating Mergers and acquisitions, however, more often appear performance of acquisitions reported in to destroy, rather than numerous studies from the US, the UK and enhance, value for the some continental European countries acquirer shareholders. provides clear evidence that, whilst shareholders of target companies are better off with abnormal returns in the order of 20% to 40%, shareholders of acquirers experience value losses on average, or at best, breakeven. Since the odds of positive and significant value creation may be less than 50%, mergers and acquisitions are clearly high-risk transactions for acquirer shareholders. In some cases, the feverish atmosphere, the inexorable momentum and thrill of the chase of a hostile bid may drive managers to foolish excess in the bid premium they pay. The causes of failure may, in other cases, stem from the fragmented perspective that managers and other players in the acquisition game have of the M&A process. The book seeks to signpost risks and potential problems and improve the odds of successful M&A activity.

2 Key Learning Points M&A must be viewed not as a transaction but as a process. A business model whose sources of value creation are poorly understood will fail to create the organisational conditions or external conditions necessary for realising that value. A firm that lacks an effective organisation for making acquisitions may make acquisitions whose rationale is poorly understood and communicated to the key constituencies within and outside the firm and lead to sloppy deal structuring and negotiation. A deal negotiation process that is not well informed about the underlying business model and the source of expected value creation may result in a deal that inhibits smooth post-acquisition integration. This failure may have arisen not merely at the deal-making stage but may be traced to the lack of an effective organisation for acquisitionmaking. Over-optimistic forecasts of acquisition benefits and under-estimation of potential risks are both enemies of good acquisition. Bad strategy and bad acquisition integration cannot be offset by clever calculus and smart financial engineering. Post-acquisition integration is not a compartmentalised activity that picks up when the deal has been closed and signed. It must be informed by the events that occurred in the previous three stages and must have regard to the performance criteria against which integration success will be judged in the fifth stage. Integration should be a creative process of transformation to a better and stronger firm with resources and capabilities that either of the merging firms on its own would have difficulty creating. It should leads to value creation and not value destruction. Knowledge Interchange Book Summaries Page 2

3 The Five Stage Model Postacquisition Corporate Strategy audit Postacquisition integration Five stages in M & A Organising for acquisitions Deal structuring To examine the issues that possibly contribute to acquisition failure and value destruction, the author develops a five stage model of mergers and acquisitions, which advocates a view of M&A as a process rather than a transaction. The process is regarded as a multi-stage one and a holistic view of the process is necessary to appreciate the inter-stage links and develop effective value creating M&A strategies. The five stages comprise: Corporate strategy Organising for acquisitions Deal structuring and negotiations Post-acquisition integration; and Post-acquisition audit and organisational learning. The stages are obviously inter-linked in that one stage follows another in a There is often a decision-making and chronological sequence. disconnect between the But the stages are also linked in a more different stages of the important evolutionary sense. Without M&A process and successful implementation of the following managers lose the plot stages the earlier stages will stand unfulfilled. about what the merger or acquisition is about and One, therefore, needs to understand the interconnectedness of the stages and how how it is to be executed. weaknesses in prosecuting one stage can feed into subsequent stages and erode the chances of overall success. Knowledge Interchange Book Summaries Page 3

4 The implication of the inter-stage linkages is that, at each stage of the process, the consequence of the actions at that stage and their impact on the following stages need to be given explicit consideration and be carefully evaluated. Stage 1: Corporate Strategy Development M&A is a means to an end and is an instrument for achieving corporate and business strategic objectives. Corporate strategy is concerned with ways of optimising the portfolio of businesses that a firm currently owns and with how that portfolio can be changed in the interests of the shareholders. Business strategy aims to enhance the firm s competitive positioning in its chosen markets on a sustainable basis. M&A can serve the objectives of both corporate and business strategy but is only one of several alternative solutions including, for instance, strategic alliances, organic growth, outsourcing, etc. In general, companies tend to make acquisitions with the strategic intent of gaining market power, achieving economies of scale and scope or internalising vertically linked operations to save on the cost of dealing with markets or alternatively to acquire complementary resources and capabilities which can be leveraged with those of the acquirer to the enhanced competitive advantage of both firms post-merger. M&A generally seeks to create value from one of the following sources viz. Revenue enhancement while maintaining the existing cost base Cost reduction while maintaining the existing revenue level Generation of new resources and capabilities that lead to revenue growth or cost reduction or both. Knowledge Interchange Book Summaries Page 4

5 Effectiveness of M&A in achieving strategic objectives will depend on both the conceptual and empirical validity of the strategy and also the clarity of understanding and commitment of managers within the acquiring company to the objectives and critical success factors of the chosen strategy. The evidence suggests that revenue enhancement is generally harder to achieve than cost reduction as a strategic objective of M&A and that acquisitions driven by a business model of conglomerate diversification seem to destroy more shareholder value than others. This is the critical foundational stage of the M&A process involving development of the value creation logic, evaluation of the choice of M&A as a means of achieving the firm s strategic objectives and leading to the selection criteria for screening potential targets for acquisition or merger. Stage 2: Organising for Acquisitions An understanding of the acquisition decision process is important since it has a bearing not only on the quality of the acquisition decision and its value creation logic but also on the ultimate success of the post-merger integration. There are two primary perspectives on decision-making viz. The rational perspective is based on hard economic, strategic and financial evaluation of the acquisition proposal and the potential value creation. The acquisition is essentially a matter of quantification of expected costs and benefits and the acquisition decision is assumed to be a unified view commanding the commitment of all managers within the firm. The process perspective adds a soft human dimension to the rationalist approach. In this view the acquisition decision-making process is more politically complex and has to be carefully managed to Knowledge Interchange Book Summaries Page 5

6 achieve the required clarity and commitment of managers which the rationalist approach tends to take for granted. The author posits a framework for the effective A pre-condition for organisation of the M&A function particularly within a successful acquisition is that acquisition-active firms. The aim of the framework is the firm organises to develop the acquisition function, i.e. the A-Team, itself for effective as an important organisational capability and as a acquisition making. core competence of the firm. Such a function serves as a repository of the firm s M&A related skills, knowledge and capabilities. It also serves as a gatekeeper for ideas for M&A generated by the different parts of the firm and by external advisers In the context of specific acquisitions, the acquisition function provides the strategic direction, organises the resources for teams responsible for deal making, directs those teams and ensures that deal making leads to acquisitions that deliver the firm s strategic objectives and shareholder value. The A team can also regulate the acquisition decision process to minimise the impact of the potential dysfunctional attributes of that process. They can play the devil s advocate so that over-optimistic acquisition proposals are not accepted or the acquisition process is not driven by the grandiose vision or overweening ambitions of the CEO, reducing acquisitions to a one man show. The author contends that the five stage model of the M&A process envisages that the risk of value destruction can be substantially organisational in origin and active management of that risk is part of an effective organisation for acquisition. Knowledge Interchange Book Summaries Page 6

7 Stage 3: Deal Structuring and Negotiations The outcome of the processes described in Stages 1 and 2 is the specific target selection. Once the firm has made this selection, it has to negotiate the merger transaction or make a takeover bid. The aim is to make a deal that will satisfy the strategic objectives of the firm and create value. The deal structuring and negotiation process is very complex and involves various interconnected steps including: Valuing target companies Choosing advisors to the deal such as investment bankers, lawyers, accountants etc Obtaining and evaluating as much intelligence as possible about the target Performing due diligence Negotiating the positions of senior management of both firms in the post-merger context Developing the appropriate bid and defence strategies and tactics within the parameters set by the regulatory regime etc. There are various risks associated with this phase of the M&A process, not Information least the information asymmetry between acquirer and is the key to target. Due diligence, as a formal information gathering successful exercise, has traditionally focused on accounting, tax, deal-making contractual liability issues and the like However, in recent years the need to extend the scope of due diligence has become widely recognised. Due diligence is no longer just concerned with reducing risk but also with contributing to effective management of the acquisition and the postacquisition leveraging of the acquirer and acquired firms resources and capabilities so that the goals of the acquisition can be realised. Knowledge Interchange Book Summaries Page 7

8 In order to be useful in valuing and negotiating deals and thereafter in effectively integrating and managing the acquired businesses, due diligence needs to cover, apart from accounting and legal matters, the following aspects of the target company: Commercial e.g. competitive position, customer relations, patents; Operational e.g. production, technology, processes and systems; Human resource e.g. compensation, training, employee relations Organisational e.g. structure, management style, power distribution Information systems e.g. performance, cost, complexity, compatibility. That said, while mapping the areas that due diligence should focus on is relatively simple, gaining access to the required information is a formidable challenge and in hostile deals and in deals with companies listed on the stock market in particular due diligence is likely to be deficient. Another significant risk is associated with the valuation of the target. All valuation models suffer from varying degrees of imprecision and unreliability. Many of the assumptions underlying these models are subjective and somewhat arbitrary. Thus, using a range of value from alternative models for target valuation is prudent and sensible. Given that any such valuation will not be precise, the bidder is exposed to valuation risk. It is particularly important for the acquirer s negotiating team to be very clear as to what is the walk away price. Companies contemplating mergers must also carefully evaluate their anti-trust implications and the regulatory risk and cost to those deals. They need to evolve strategies to minimise the risk and the cost of a deal being blocked on anti-trust grounds. Regulatory uncertainty, often extending over years, increases the risk to deal execution and to the expected value creation from a merger. There is also a significant element of uncertainty about the eventual outcome of anti-trust investigations and the remedies that may have to be Knowledge Interchange Book Summaries Page 8

9 offered to win clearance. Such remedies may often unscramble the strategic and value creation logic of the deal. Again, multiplicity of jurisdictions increases the transactional risk to firms undertaking cross-border mergers. Stage 4: Post-Acquisition Integration At this important stage the objective is to put into place a merged organisation that can deliver the strategic and value expectations that drove the merger in the first place. Integration of two organisations is not a matter of just changing the There is empirical and organisation structure and establishing a new survey evidence that hierarchy of authority. It involves integration of many acquirers do not systems, processes, strategy, reporting systems etc. successfully integrate Above all, it involves integration of people. It may their acquisitions often involve changing the organisational culture of the merging firms, possibly to evolve a new one to deliver the strategic objectives of the merger. Integrating organisations may require people to change their mindsets, cultures and behaviours. Cultural issues have therefore to be addressed during the integration process. It is also a politically supercharged process since it often involves redistribution of power between the merging firms. Conflicts of interest and loyalty may hinder an effective integration process. This stage of the acquisition process is, therefore, a major determinant of the Value potential in success of the acquisition in creating value. The acquisitions is extent of integration depends upon the degree of realised or destroyed strategic interdependence needed between the two at the implementation firms as a precondition for capability transfer and stage. value creation. The value creation logic behind the acquisition dictates the extent to which the capabilities of the two firms need to Knowledge Interchange Book Summaries Page 9

10 be merged within a single organisational structure or maintained within the boundaries of the firm. The diagram below illustrates the dimensions of strategic interdependence versus autonomy in integration. The taxonomy leads to four types of post-acquisition integration viz. Need for strategic interdependence Low High High Need for Organisational Autonomy Preservation Synergy Low Holding Company Absorption Preservation i.e. great need for autonomy with acquired firm s capabilities being nurtured by the acquirer with judicious and limited intervention such as financial control while allowing the acquired firm to develop and exploit its capabilities to the full. Holding company i.e. involving passive investment by parent more in the nature of a financial portfolio motivated by risk reduction, reduction in capital costs and there is no interaction between portfolio companies Symbiosis i.e. the two firms initially co-existing but gradually becoming interdependent; symbiosis-based acquisitions need simultaneous protection and permeability of the boundary between the two firms Absorption i.e. full consolidation of the operations, organisation and culture of both firms over time. Knowledge Interchange Book Summaries Page 10

11 The goal of integration is to create an organisation capable of achieving the strategic objectives of the acquisition. The two firms need to share those objectives but they must agree on not only the destination but also the roadmap for the journey and the logistical and organisational configuration of the firms undertaking the journey. This requires the hard side of aligning strategy and structure but also the soft side of aligning organisational culture and strategy. The extent to which such alignment needs to be accomplished is determined by the integration type chosen. Stage 5: Post-Acquisition Audit and Organisational Learning Companies that seek to grow through acquisitions need to develop acquisition-making as a core competence and excel in it compared with competitors. Companies that have the right strategy of growth through acquisitions and the necessary organisational capabilities to manage their acquisitions efficiently and effectively can sustain their competitive advantage far longer and create value for their shareholders. For acquisition-making to evolve into a firm s core competence, it must also possess robust organisational learning capabilities. Developing such learning capabilities is thus part of the M&A core competence building effort by multiple or serial acquirers. It is, or ought to be, part of their competitive strategy. Organisational learning can be based on both direct experience i.e. actual acquisitions the firm has made in the past, and indirect or vicarious experience It seems that each acquisition i.e. acquisitions made by other firms. In experience is lost in other words firms can learn not only from organisational amnesia so that their own mistakes but also from the history repeats itself. mistakes of their competitors. How organisational learning is applied to new acquisitions depends on the ability of the firm to create the necessary organisational memory and also diffuse the Knowledge Interchange Book Summaries Page 11

12 learning throughout the organisation. Without such diffusion the learning remains at best an inaccessible archive. Various surveys suggest that in a majority of active acquirers, there are no systems, processes and procedures to ensure organisational learning. This evidence may explain the statistical results that more than half of the acquirers fail to generate value from acquisitions. Without effective organisational learning, the author contends, the five stage acquisition process is incomplete and future acquisitions may not create value. And Finally Given the risks associated with M&A, the firm must always consider the alternatives to acquisitions as a means of achieving its strategic objectives. Knowledge Interchange Book Summaries Page 12

13 Author SUDI SUDARSANAM joined Cranfield as Professor of Finance and Corporate Control in January 2000 from Cass Business School, London where he was Professor of Finance and Accounting. His early career was in banking. Sudi`s main areas of research interest are in corporate restructuring, mergers and acquisitions, valuation of intangible assets, corporate governance and corporate strategy. He is a leading authority on M&A. His previous book, The Essence of Mergers and Acquisitions, was published in 1995 and translated into five European and Asian languages. Sudi has carried out surveys of M&A practices in leading corporations in Europe and the US and taught on MBA and executive programmes. He also acts as a consultant on M&A. He is a member of the UK Competition Commission and a member of its Expert Committee on Cost of Capital. Knowledge Interchange Book Summaries Page 13

14 Produced by the Learning Services Team Cranfield School of Management Cranfield University 2007