Six Avoidable M&A Mistakes
What not to do to make the most of your acquisition opportunities.
September 2 2010 by Russ Banham
Corporate courtships are in the air, as evidenced by a 13.3 percent increase in global mergers and acquisitions announced in the first half of 2010—that’s 5,026 deals totaling $881 billion.
Grounded for much of the recession, M&A activity is again flying high. Expectations are for more deals to be consummated in the second half of the year, given the estimated $500 billion that private equity firms—pesky planners and plotters of corporate takeovers—are eager to put to use. Who can blame the deal makers? The performance of companies that consummated a merger or acquisition in the first quarter outperformed global stock market indices, according to personnel and risk-management consultancy Towers Watson, itself formed by a January merger. One either buys growth or earns it the old-fashioned way—organically, which isn’t easy in a protracted recession.
Arguably, it is a great time to merge or buy. Double-dip fears notwithstanding, the recession has exposed targets’ strength and weaknesses, whereas a heady economy has a way of covering them up. That gives leverage to buyers awash in equity capital and cash on their balance sheets looking for a place to berth. As Monty Hall used to wail, “Let’s Make a Deal!”
Well, not just yet. The landscape is littered with failed mergers and acquisitions, companies that did not heed obvious risks that, in retrospect, were avoidable. We’ve compiled six avoidable mistakes—lessons learned the hard way. Try not to repeat them.
Loving the Deal Too Much
You’ve set your sights on a target, the negotiations are drawn out, and suddenly your resolve to make the deal overwhelms your better thinking. You, my friend, are a victim of deal frenzy.
“Some CEOs see a big acquisition adding short-term sales and profits, the kind of move that will put them on the cover of magazines—for all the wrong reasons,” says A.G. Lafley, special partner at private investment firm Clayton, Dubilier & Rice and former chairman and CEO of Procter & Gamble. At P&G he presided over multiple successful acquisitions, like Gillette and Iams. “Once they’re set on the target, closing the deal becomes the solitary goal. Their egos get all whipped up.”
“Maintaining discipline in an M&A negotiation is tough,” agrees Sanford I. Weill, former chairman, CEO and creator of Citigroup. “You can get carried away feeling you have to get this thing done, and before you know it, you throw all caution to the winds.”
The moral—don’t lose perspective. “That’s what AOL and Time Warner did,” says Ryan Thomas, a partner at Nashville-based law firm Bass, Berry & Sims, which has an M&A focus. “They felt they had to do something, since the Internet was becoming the big thing, but they didn’t have a clear strategy in mind— just some big, global concept that ‘We think this will work and we’ll figure it out over time.’”
Many prospective acquirers are prone to make the same mistake, according to McKinsey. “We did a survey of top M&A executives at large companies and three out of four say they have a clear M&A strategy, but only one in four say they have quantified their strategic objectives, like capturing market share, and then measured against them,” says Anish Melwani, co-leader of the strategy consultancy’s corporate finance practice. “Don’t fall in love with the deal—to where you feel you have to do it no matter what,” says David L. Eslick, CEO and chairman of Marsh & McLennan Agency, a national insurance agency that closed five deals in the last year. “I once got so in love with a target that I made the deal without considering that the company’s leader and I didn’t see eye-to-eye. I should’ve worked out our differences beforehand. It made for some uncomfortable conversations afterwards.”
The solution? “Start with a strategy, not a target, clearly defining how the merged company will offer the customer something special,” says Rita McGrath, associate professor at Columbia Business School and author of Discovery-Driven Growth. “Then dig in and do the due diligence to assure it.”
Not So Diligent Due Diligence
Caught up in deal frenzy, many companies make avoidable mistake number two—failing, as McGrath puts it, to dig into the due diligence. “Acquirers myopically focus on the financial aspects of the target, all these brilliant minds putting together financial models, trying to predict the future and adjusting for risks, but then they fail to do the corresponding legal and regulatory due diligence or analyze whether or not key employees will leave after the deal closes,” suggests Doug Leary, a partner in the Washington office of law firm Sutherland Asbill & Brennan. “Due diligence requires collecting all the intelligence on the target, and that takes meticulous effort.”
Emotions have a way of undermining diligent due diligence. “Often companies run out of organic growth, so they buy market share, acquiring a company and passing it off as strategic when it really isn’t,” Lafley says. “They think there are synergies but they really haven’t done the due diligence. The ‘financial supermarket’ concept is the perfect example. Companies got caught up in combining banking with insurance brokerage, stocks and real estate, without really thinking through whether it will work out or not.”
“Do your homework,” says Donald Peterson, CEO and chairman of Ford in the late ’80s, when he presided over the automaker’s acquisition of Jaguar. “Don’t let the consultants snooker you into a deal because they have a strong bias to get it done. Be clear in your analysis why you think you need to make the deal, and then continually test whether or not you do.”
Extra due diligence may be required in the current economic climate. “Many companies have spruced up their balance sheets and might look healthier than they actually are,” warns Rob Coble, national leader in corporate transactions and restructuring at KPMG. “They may have cut costs in areas like R&D and sales and marketing that are important to long-term growth. You need to get under the financials, figuring out what initiatives were put in place for the company to become profitable. That takes work.”
Marriage Without Engagement
Key to any successful acquisition is the human capital—the folks you’re buying to continue to do the great things they did. If they’re not treated well financially or fail to fit into the combined entity from a cultural standpoint, the business case for the deal may have just walked out the door. As McKinsey’s Melwani puts it, “If everyone leaves, you didn’t buy anything.”
Ignoring the critical talent in the acquired organization or failing to engage them after the deal is done is a huge misstep, says David Carney, managing principal of the M&A practice at Deloitte Consulting. “It’s easy to take care of the CEO and the direct reports, but what about the individuals whose work and knowledge have contributed to the company’s success— the researchers, engineers and salespeople? Acquirers get so caught up in rationalizing costs through post-deal downsizing that they often let the wrong people go.”
Those who aren’t downsized, on the other hand, may leave because they sense their futures aren’t bright. “I’ve seen situations where the target CEO’s body language sends a message that he or she isn’t completely enthusiastic about the deal, and it rubbed off on key people who then headed for the doors,” Nashville lawyer Thomas says.
More employees may be going that way. “We just did a study that indicates that workers who were affected by an M&A in the recession were two times more likely to leave the combined entity than someone at a company not involved in M&A,” says Mary Cianni, global leader of M&A at Towers Watson.
Hewlett-Packard’s acquisition of VeriFone in 1997 also sent management packing—in this case the acquiring company’s senior leaders. The deal was predicated on combining H-P, a computer company, with an e-commerce company, VeriFone, to accelerate Internet-based sales. “HP acquired VeriFone in a stock swap valued at $1.8 billion, and years later sold the division for pennies on the dollar—a nine figure loss,” says John Bender, former head of H-P’s merger integration operation and managing director of Bender Consulting today.
He attributes the failure to senior leaders at H-P—the deal’s champions— rushing for the exits. “Rick Beluzzo (H-P executive vice president at the time) left nine months after the acquisition closed, and Glenn Osaka (then general manager of enterprise systems) left around the same time,” Bender says. “The guys who put this together no longer were there to exploit the assets VeriFone brought to the table. The fact that Gores Technology, which bought VeriFone from H-P, made it profitable 100 days later, tells you something.”
It tells you, as Cianni puts it, “that there is a definite connection between employee engagement and post-merger financial performance.” To stabilize an organization for its new, post-merger state, she advises doling out retention bonuses to talent in both organizations: “You want to assure people are motivated about the future.”
“Never treat the people in the company you’re buying as the losers because their company was for sale,” mergermeister Weill says. “And don’t just pick your people for the plum jobs. When Citicorp merged with Travelers to form Citigroup, we had two successful companies, each with great talent who were proud and rightfully so. Had we given our people top jobs and relegated their people to lesser or no jobs, it wouldn’t have made for a very good consolidation.”
Cultural Faux Pas
In 1993 Volvo and Renault decided they would merge. Volvo, a Swedish automaker extolled for the safety and engineering of its cars, and Renault, a French automaker highly regarded for its vehicles’ design and style, decided to tiptoe into the merger with a joint venture. Looking back, the JV was the smartest decision they made; the rest was disastrous. “There were too many cultural incompatibilities to make a merger work,” says Robert F. Bruner, dean of the Darden Graduate School of Business at the University of Virginia, and author of Deals from Hell: M&A Lessons That Rise Above the Ashes.
Not only did each company have a dissimilar brand, making it difficult to imagine the kinds of cars the combo would produce, but their ownership was off kilter. Volvo was investor-owned, while the French government owned a majority of Renault. Post-merger, Volvo would have held a 35 percent stake in the combined company, with the rest in the hands of the French government. Then, France kept murmuring about privatizing Renault, which made Volvo shareholders’ fearful the company might effectively become a French enterprise, with no jobs for Swedish workers. National pride was at stake. “The CEOs of both companies decided to go forward anyway,” Bruner says, “but employees at Volvo rebelled, ultimately forcing out the CEO. Volvo’s stock price cratered and the brands of the two companies suffered.”
CEOs need to undertake “cultural due diligence,” Bender, the H-P vet, says, “examining what relationships will look like across the company, how work will be done formally and informally, how customers and external parties will be treated, and what the learning environment will be. Lafley acknowledges cultural issues in P&G’s acquisition of German hair products company Wella. “Half of it was that they were German and the other half was that they were very sales- and service-oriented, selling products and design services to salons,” he says. “Meanwhile, we’re an American branded-products company, not in the business of offering services. We worked it out by eventually selling off their services-oriented business and putting a P&G person in charge of the company.”
Avoiding cultural mismatches requires more time to deal with the integration issues of a cross-border merger effectively. “CEOs tend to think that integration merely consists of connecting the IT pipelines, getting the cash to flow in the right direction and consolidating the accounting systems, but that is just the start,” Bruner says. “Integration is about building a joint vision and strategy of the combined company, and creating a set of norms about how decisions will be reached.”
Paying More Than It’s Worth
Sandy Weill rode herd on some of the mega-deals of the last century, acquiring Primerica, Shearson, Travelers Group and Salomon, among others, before vacuuming up Citi. Not that he hasn’t walked away from a deal or two. “We were set to acquire the consumer finance business of Manufacturers Hanover and it would have been a pretty big deal, but the price got beyond what we felt was the value and we dropped the talks,” he says. “Then, nine months later the market had a big correction and Primerica became available at an excellent price. Had we made the earlier deal, we wouldn’t have had the gunpowder to buy Primerica.”
The converse—failing to blink at too high a price—describes the acquisition of medical device maker Guidant by Boston Scientific in 2006. “Guidant’s owners were looking to sell the company and they approached Johnson & Johnson about buying it,” says Prof. McGrath . “J&J played it cool for a few months, not liking the price the owners wanted, when in jumps Boston Scientific, which started this massive bidding war with J&J. They were so intent on wrapping up the deal, so caught up in the emotion of closing it at all costs, that they ended up overpaying, buying it for $27 billion. Then, the roof caved in.”
A few months later, Boston Scientific issued recalls or warnings on nearly 50,000 Guidant cardiac devices, prompting a profit warning that shook Wall Street. The company’s stock fell 46 percent, wiping out $18 billion in shareholder value. “Acquirers spend all this energy negotiating the transaction and fail to figure out how they’re going to earn back all that cash or equity, plus the premium shareholders are expecting,” says Deloitte’s Carney. His advice: “Know exactly how you’re going to make money in the deal.”
Not Respecting the Other Boss
Failing to get the pulse of the other guy sitting across the table in a planned merger or acquisition is a big no-no—as Lafley learned to his regret in the Wella acquisition. “I didn’t give enough attention to the fact that their CEO didn’t really want to sell the company, and that he wanted to continue to run it,” he says. “We were trying to integrate an organization that was dragging its heels as a result. Finally, we figured this out and retired the gentleman.”
It’s crucial to ensure an important role for the target’s CEO, assuming he or she is worth keeping. When P&G acquired Gillette, Lafley and Gillette’s CEO Jim Kilts got along famously. “Jim said to me that I was his succession plan at Gillette, which sent a strong message down the chain of command,” Lafley recalls. “Not only did he share my belief that P&G and Gillette combined would be stronger than each company alone, he offered to serve at my pleasure for as long as I wanted, post-acquisition. I asked him to join my board and the leadership team guiding the integration and he heartily obliged. We nailed it.”
Summing up about avoidable mistakes, Lafley says once you make one, you don’t forget. “I’ve made some great acquisitions and some bad ones, but fortunately they were little,” he says. “When you’re doing 10 to 12 deals a year, bad bets are going to happen. If you make a mistake, you minimize the damage and move on. The key is not to make the same mistake twice.”
Now that’s something to avoid.