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Mergers and Acquisitions (M&As)
Mergers and Acquisitions are terms almost always used together in the business world to refer to two or more business entities joining to form one enterprise. More often than not a merger is where two enterprises of roughly equal size and strength come together to form a single entity. Both companies’ stocks are merged into one. An acquisition is usually a larger firm purchasing a smaller one. This takes the form of a takeover or a buyout, and could be either a friendly union or the result of a hostile bid where the smaller firm has very little say in the matter. The smaller, target company, ceases to exist while the acquiring company continues to trade its stock. An example is where a number of smaller British companies ceased to exist once they were taken over by the Spanish bank Santander. The exception to this is when both parties agree, irrespective of the relative strength and size, to present themselves as a merger rather than an acquisition. An example of a true merger would be the joining of Glaxo Wellcome with SmithKline Beecham in 1999 when both firms together became GlaxoSmithKline. An example of an acquisition posing as a merger for appearances sake was the takeover of Chrysler by Daimler-Benz in the same year. As already seen, since mergers and acquisitions are not easily categorised, it is no easy matter to analyse and explain the many variables underlying success or failure of M&As.
Historically, a distinction has been made between congeneric and conglomerate mergers. Roughly speaking, congeneric firms are those in the same industry and at a similar level of economic activity, while conglomerates are mergers from unrelated industries or businesses. Congeneric could also be seen as (a) horizontal mergers and (b) vertical mergers depending on whether the products and services are of the same type or of a mutually supportive nature. Horizontal mergers may come under the scrutiny of anti-trust legislation if the result is seen as turning into a monopoly. An example is the British Competition Commission preventing the country’s largest supermarket chains buying up the retailer Safeway. Vertical mergers occur when a customer of a company and that company merges, or when a supplier to a company and that company merges. The classic example given is that of an ice cream cone supplier merging with an ice cream manufacturer.
The ‘first wave’ of horizontal mergers took place in the United States between 1899 and 1904 during a period referred to as the Great Merger Movement. Between 1916 and 1929, the ‘second wave’ was more of vertical mergers. After the great depression and World War II the ‘third wave’ of conglomerate mergers took place between 1965 and 1989. The ‘fourth wave’ between 1992 and 1998 saw congeneric mergers and even more hostile takeovers. Since the year 2000 globalisation encouraging cross-border mergers has resulted in a ‘fifth wave’. The total worldwide value of mergers and acquisitions in 1998 alone was $2.4 trillion, up by 50% from the previous year (andrewgray.com). The entry of developing countries in Asia into the M&A scene has resulted in what is described as the ‘sixth wave’. The number of mergers and acquisitions in the US alone numbered 376 in 2004 at a cost of $22.64 billion, while the previous year (2003) the cost was a mere $12.92 billion. The growth of M&As worldwide appears to be unstoppable.
What is the raison d’etre for the proliferation of mergers and acquisitions? In a nutshell, the intention is to increase the shareholder value over and above that of the sum of two companies. The main objective of any firm is to grow profitably. The term used to denote the process by which this is accomplished is ‘synergy’. Most analysts come up with a list of synergies like, economies of scale, eliminating duplicate functions, in this case often resulting in staff reductions, acquiring new technology, extending market reach, greater industry visibility, and an enhanced capacity to raise capital. Others have stressed, even more ambitiously, the importance of M&As as being “indispensable…for expanding product portfolios, entering new markets, acquiring new technologies and building a new generation organization with power and resources to compete on a global basis” (Virani). However, as Hughes (1989) observed “the predicted efficiency gains often fail to materialise”. Statistics reveal that the failure rate for M&As are somewhere between 40-80%. Even more damning is the observation that “If one were to define ‘failure’ as failure to increase shareholder value then statistics show these to be at the higher end of the scale at 83%”.
In spite of the reported high incidence of its failure rate “Corporate mergers and acquisitions (M&As) (continue to be) popular… during the last two decades thanks to globalization, liberalization, technological developments and (an) intensely competitive business environment” (Virani 2009). Even after the ‘credit crunch’, Europe (both Western and Eastern) attract strategic and financial investors according to a recent M&A study (Deloitte 2007). The reasons for the few successes and the many failures remain obscure (Stahl, Mendenhall and Weber, 2005). King, Dalton, Daily and Covin (2004) made a meta-analysis of M&A performance research and concluded that “despite decades of research, what impacts the financial performance of firms engaging in M&A activity remains largely unexplained” (p.198). Mercer Management Consulting (1997) concluded that “an alarming 48% of mergers underperform their industry after three years”, and Business Week recently reported that in 61% of acquisitions “buyers destroyed their own shareholders’ wealth”. It is impossible to view such comments either as an explanation or an endorsement of the continuing popularity of M&As.
Traditionally, explanations of M&A performance has been analysed within the theoretical framework of financial and strategic factors. For example, there is the so-called ‘winner’s curse’ where the parent company is supposed to have paid over the odds for the company that was acquired. Even when the deal is financially sound, it may fail due to ‘human factors’. Job losses, and the attendant uncertainty, anxiety and resentment among employees at all levels may demoralise the workforce to such an extent that a firm’s productivity could drop between 25 to 50 percent (Tetenbaum 1999). Personality clashes resulting in senior executives quitting acquired firms (‘50% within one year’) is not a healthy outcome. A paper entitled ‘Mergers and Acquisitions Lead to Long-Term Management Turmoil’ in the Journal of Business Strategy (July/August 2008) suggests that M&As ‘destroy leadership continuity’ with target companies losing 21% of their executives each year for at least 10 years, which is double the turnover of other firms.
Problems described as ‘ego clashes’ within top management have been seen more often in mergers between equals. The Dunlop – Pirelli merger in 1964 which became the world’s second largest tyre company ended in an expensive splitting-up. There is also the merger of two weak or underperforming companies which drag each other down. An example is the 1955 merger of car makers Studebaker and Packard. By 1964 they had ceased to exist. There is also the ever present danger of CEOs wanting to build an empire acquiring assets willy-nilly. This often is the case when the top managers’ remuneration is tied to the size of the enterprise. The remuneration of corporate lawyers and the greed of investment bankers are also factors which influence the proliferation of M&As. Some firms may aim for tax advantages from a merger or acquisition, but this could be seen as a secondary benefit. Another reason for M&A failure has been identified as ‘over leverage’ when the principal firm pays cash for the subsidiary assuming too much debt to service in the future.
M&As are usually unique events, perhaps once in a lifetime for most top mangers. There is therefore hardly any opportunity to learn by experience and improve one’s performance, the next time round. However, there are a few exceptions, like the financial-services conglomerate GE Capital services with over 100 acquisitions over a five-year period. As Virani (2009) says “…serial acquirers who possess the in house skills necessary to promote acquisition success as (a) well trained and competent implementation team, are more likely to make successful acquisitions”. What GE Capital has learned over the years is summarised below.
1. Well before the deal is struck, the integration strategy and process should be initiated between the two sets of top managers. If incompatibilities are detected at this early stage, such as differences in management style and culture, either a compromise could be achieved or the deal abandoned.
2. The integration process is recognised as a distinct management function, ascribed to a hand-picked individual selected for his/her interpersonal and cross-cultural sensitivity between the parent firm and the subsidiary.
3. If there are to be lay-offs due to restructuring, these must be announced at the earliest possible stage with exit remuneration packages, if any.
4. People and not just procedures are important. As early as possible, it is necessary to form problem solving groups with members from both firms resulting, hopefully, in a bonding process.
These measures are not without their critics. Problems could still surface long after the merger or acquisition. Whether to aim for total integration between two very different cultures is possible or desirable is questioned. That there could be an optimal strategy out of four possible states of: integration, assimilation, separation or deculturation.
A paper by Robert Heller and Edward de Bono entitled ‘Mergers and acquisitions and takeovers: Buying another business is easy but making the merger a success is full of pitfalls’ (08/07/2006) looks at examples of unsuccessful mergers from the relatively recent past and makes recommendations for avoiding their mistakes. Their findings could be generalised to other M&As and therefore is worth paying attention to.
They begin with the BMW – Rover merger where they have identified strategic failings. BMW invested £2.8 billion in acquiring Rover and kept losing £360,000 annually. The strategic objective had been to broaden the buyer’s product line. However, the first combined product was the Rover 75, which competed directly with existing BMW mid-range models. The other, existing Rover cars were out of date and uncompetitive, and the job of replacing them was left far too late.
Another fly in the ointment was that the stated profits that Rover had supposedly enjoyed were subsequently seen as illusory. Subjected to BMWs accounting principles, they were turned into losses. Obviously, BMW had failed in the exercise of ‘due diligence’. (Due diligence is described as the detailed analysis of all important features like finance, management capability, physical assets and other less tangible assets (Virani 2009). Interestingly, the authors allude to instances of demergers being more successful than mergers. For example, Vodafone, the mobile telephone dealer, which was owned by Racal, is now valued at $33.6 billion, 33 times greater in value than the parent company Racal. The other instance is that of ICI and Zeneca where the spin-off is worth £25 billion as against the parent company being valued at £4 billion.
The authors refer to the fact that after a merger, the management span at the top becomes wider, and this could impose new strains. Due to difficulties in adjustment to the new realities, the need for positive action tends to get put on the back burner. Delay is dangerous as the BMW managers realised. While BMW set targets and expected 100% acquiescence, Rover was in the habit of reaching only 80% of the targets set. Walter Hasselkus, the German manager of Rover after the merger, was respectful of the Rover’s existing culture that he failed to impose the much stricter BMW ethos, and, ultimately lost his position.
Another failure of strategy implementation by BMW recognised by the authors was that of investing in the wrong assets. BMW paid only £800 million for Rover, but invested £2 billion in factories and outlets, but not in developing products. BMW hitherto had concentrated quite successfully on executive cars produced in smaller numbers. They obviously felt vulnerable in an industry dominated by large, volume producers of cars. It is not always the case that bigger is better. In fragmenting markets, even transnational corporations lose their customers to niche, more attractive, small players.
There was an earlier reference in this essay to the success of giant pharmaceuticals like SmithKline Beecham. However, they are now losing large sums of money to divest themselves of drug distribution companies they acquired at great cost; clearly a strategic mistake, which the authors’ label ‘jumping on the bandwagon’. They quote a top American manager bidding for a smaller financial services company in 1998 being asked why, as saying ‘Aw, shucks, fellers, all the other kids have got one…’ The correct strategy, they imply, is to reorganise around core businesses disposing of irrelevancies and strengthening the core. They give the example of Nokia who disposed of paper, tyres, metals, electronics, cables and TVs to concentrate on mobile telephones. Here’s a case of successful reverse merging. On the other hand, top managers should have the vision to transform a business by imaginatively blending disparate activities to appeal to the market.
Ultimately it is down to the visionary chief executive to steer the course for the new merged enterprise. The authors give the example of Silicon Valley, where ‘new ideas are the key currency and visionaries dominate’. They say that the Silicon Valley mergers succeeded because the targets were small and were bought while the existing businesses themselves were experiencing dynamic growth.
What has so far not being addressed in this essay is the phenomenon of cross-border or cross-cultural mergers and acquisitions, which are of increasing importance in the 21st century. This fact is recognised as the ‘sixth wave’, with China, India, and Brazil emerging as global players in trade and industry. Cross-cultural negotiation skills are central to success in cross-border M&As. Transnational corporations (TNCs) are very actively engaged in these negotiations, with their annual value-added business performance exceeding that of some nation states. A detailed exposition of the dynamics of cross-cultural negotiations in M&As is found in Jayasinghe 2009 (pp. 169 – 176). The ‘cultural dynamics of M&A’ has been explored by Cartwright and Schoenberg, 2006. Other researchers in this area use terms such as ‘cultural distance’ ‘cultural compatibility’, ‘cultural fit’, and ‘sociocultural integration’ as determinants of M&A success.
There is general agreement that M&A activity is at its height following an economic downturn. All five historical ‘waves’ of M&A dealings testify to this. One of the main reasons for this could be the rapid drop in the stock value of target companies. A major factor in the increase in global outward foreign direct investment (FDI) stock which was $14 billion in 1970, to $2,000 billion in 2007, was ‘due to mergers and acquisitions (M&As) of existing entities, as opposed to establishing an entirely new entity ( that is, ‘Greenfield’ investment’)’ (Rajan and Hattari 2009). Increased global economic activity alone may have accounted for this increase. In the early 1990s M&A deals were worth $150 billion, while in the year 2000 it had peaked to $1,200 billion, most of it due to cross-border deals. However, by 2006 it had dropped to $880 billion. Rajan and Hattari (op cit) ascribe this growth to the growing significance of the cross-border integration of Asian economies.
During 2003-06, the share of developed economies (EU, Japan and USA) in M&A purchases had declined. From 96.5 percent in 1987 it had fallen to 87 percent by 2006. This is said to be due to the ascendancy of developing economies of Asia both in terms of value as well as the number of M&As. Substantiating the thesis that economic downturns appear to boost M&A activity, sales jumped following the Asian crisis of 1997-98. While in 1994-96 the sales were put at $7 billion, it had increased three-fold to $21 billion between1997-99. Rajan and Hittari (2009) attribute this increase to the ‘depressed asset values compared to the pre-crisis period’. Indonesia, Korea and Thailand affected most by the crisis reported the highest M&A activity.
China is one of those countries not suffering from the effects of global recession to the same extent as most Western economies. China has been buying assets from Hong Kong, and in 2007 the purchases amounted to 17 percent of the total M&A deals in Asia (excluding Japan). Rajan and Hattari looked at investors from Singapore, Malaysia, India, Korea and Taiwan. This led to the hypothesis that the greater size of the host country and its distance from the target country is a determinant of cross-border M&A activity. They also found that exchange rate variability and availability of credit are factors impacting on M&As, and have generalised this to conclude that ‘financial variables (liquidity and risk) impact global M&A transactions… especially intra-Asian ones’.
On the other hand, it is reported that overall M&As were hit by the global recession and had lost valuation by 76% by 2009. While 54 deals worth $15.5 billion occurred in 2008 between April and August, during the same period 72 M&A deals were worth only $3.73 billion in 2009. The industries dominating the M&A sectors were IT, pharmaceuticals, telecommunications, and power. There were also deals involving metal, banking/finance, chemical, petrochemical, construction, engineering, healthcare, manufacturing, media, real estate and textiles.
The influential Chinese consulting firm, China Center for Information Industry Development (CCID) has concluded that although some enterprises are on the brink of bankruptcy during the global recession, it has ‘greatly reduced M&A costs for enterprise’. As industry investment opportunities fall, investment uncertainties increase, M&As show bigger values…. As proven in the 5 previous high tide of global industry capital M&As, every recession period resulting from (a) global financial crisis has been a period of active M&As’.
Most commentators believe that in addition to the empirical research as quoted above, research from a wider perspective to encompass the disciplines of psychology, sociology, anthropology, organisational behaviour, and international management, is needed to make continual improvements to our understanding of the dynamics for the success or failure of mergers and acquisitions, which are increasingly becoming the most popular form of industrial and economic growth across the globe. The evidence regarding how the current global financial crisis affects the proliferation of M&As has not been straightforwardly negative or positive. Many intervening variables have been hinted at in this essay but more systematic work is required for an exhaustive analysis.
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