There are many reasons why Takeovers or Mergers (TOMs) go wrong. Set out below are some of the common ones. This is an extract from David Parmenter’s working guide on What You Need to Know Before Undertaking a Takeover or Merger. There are 10 reasons why your takeover maybe a lemon:
- Synergy Calculations Are Totally Flawed
- Loss of Focus on Customers
- Culture Clash
- There Is No Heart in a Merged Organisation
- Loss of Years of Intangibles
- The Wrong Management Rises to the Top
- Salary Costs Escalate
- Human Beings Find It Hard to Conceptualise the Intangibles
- Mergers Are Seldom Done from a Position of Strength
- There Is Never Enough Time to Fully Evaluate the Target
1. Synergy Calculations Are Totally Flawed
My interest in the failure rate of TOMs dates back to the Economist[i] series on six major takeovers or mergers (TOMs). In the articles, the writers commented that over half of TOMs had destroyed shareholder value, and a further third had made no discernible difference.
KPMG undertook a cutting-edge study[ii] into TOMs and is a must read for CFOs and controllers involved in a TOM. The study found:
“Only 17% of deals had added value to the combined company, 30% produced no discernible difference, and as many as 53% actually destroyed value. In other words, 83% of mergers were unsuccessful in producing any business benefit as regards shareholder value.”
TOM advisers and hungry executives are as accurate with potential cost savings estimates as they are with assessing the cost of their own home renovations (in other words, pretty hopeless). Press clippings are easily gathered with CEOs stating that the anticipated savings have taken longer to eventuate. The reason: It can take up to four years to merge the information technology platforms together, and even when this is achieved, many of the future efficiency and effectiveness initiatives have been put on the back burner.
CFOs and controllers, as the experts with the numbers, need to ensure that the CEO and the board are under no illusion about the extent of the cost savings synergies. You can put your last dollar on the fact that the investment bank behind the deal has well and truly overstated these benefits.
The synergy calculations never allow enough costs for the myriad of consultants who are in a feeding frenzy and largely left to their own devices, staff redundancies, loss of some key customers, productivity shortfalls due to uncertainty and the costs of recruiting for key positions, as talented staff decide to move to a less stressed organization.
Morrisons, a relatively small but profitably supermarket based in the North of England, has made a number of failed takeovers.
It purchased Safeway for $3 billion, based on the following logic:
- Both businesses were supermarkets, so the merged company could apply greater pressure to suppliers.
- Back-office, distribution, and marketing costs could be cut because of economies of scale.
- Morrisons had a reputation for being very tightly run with good cost controls, and these skills could be applied to the much larger Safeway.
The merger went through in early 2004, and within the next 15 months, or so, Morrisons had to issue five profit warnings. In the year to the end of January 2006, the group made a pretax loss of around £300 million compared to combined profit of about £650 million before the merger. The mistakes made included:
- The 300 Safeway staff at their head office were alienated, severely damaging morale
- Morrisons failed to persuade many key Safeway staff to move north to the group’s headquarters.
- Morrisons did not protect the key Safeway IT staff who left leaving little knowledge of the Safeway IT system.
- Mixing the two brands, Safeway stores began stocking Morrisons-branded products, which were deemed inferior by Safeway customers.
- The companies underestimated the difficultly to integrate the two company’s IT systems—a common mistake.
To prove the lessons had not been learned, in 2011 Morrison’s made its first entry into online retailing by paying £70 million to acquire Kiddicare—a leading baby products retailer. The rationale was that the US online retailer would give it a cut-price entry into online retailing, even though the baby goods website had no grocery-related software.
Just three years later, Morrisons sold Kiddicare to a specialist private equity company (Endless) for just £2 million, with the grocery retailer also left with substantial ongoing liabilities for shop leases and other commitments it had made as it tried to grow the Kiddicare business under its control. The total cost of the disastrous takeover for Morrison’s shareholders was in excess of £100 million.
2. Loss of Focus on Customers
There is no better way to lose sight of the ball than a merger. Merging the operations will distract management and staff from the basic task of making money. While meeting after meeting occurs at the office and sales staff focus on their futures (either applying for positions elsewhere or joining in the ugly scramble for the new positions), the customers are up for grabs. Researchers, sales staff, and marketers are all busy back at their desks trying to perform damage-control exercises as they either jockey for the lifeboats or stay on board to try to keep the ship afloat. It would be an interesting PhD thesis to assess the loss of customers due to merger activity.
3. Culture Clash
Managing the aftermath of a TOM is like herding wild cats. Where have readers seen cultures merged successfully? In reality, one culture takes over another. This is okay when one culture is fundamentally flawed. However, in many mergers, both entities have cultures that work. Now you have a problem. Many competent staff members may choose to leave rather than work in a culture that does not suit their working style.
4. There Is No Heart in a Merged Organization
How long does it take for a company to develop a heart? This is more than just the culture; it includes the lifeblood of the organization. I think it takes years, and some consistency among the management and staff. The merged organization thus cannot have a heart. The organization can be kept alive on life support, but just like a critical patient, it is effectively bedridden and will be in intensive care for some time.
5. Loss of Years of Intangibles
An organization is a collection of thousands of years of experience, knowledge, networking, research, projects, and methodologies. If a major blue-chip company said that it was going to disestablish all its staff and management, shareholder analysts would think management had simply lost control. The stock values would fall. This is exactly what a merger does. Research and development is another victim. How do you keep on projects and maintain the level of momentum with unhappy research staff? At worst, you will be moving one team to a new location, making redundant those whom you believe are making the least contribution, and haemorrhaging talent. Research basically gets decimated.
6. The Wrong Management Rises to the Top
I have a theory that the main beneficiaries of a merger are the piranhas, those managers who see burying a dagger in someone’s back as a necessary occurrence. The result is quite interesting; the merged company very soon becomes dysfunctional as more and more of these caustic managers rise to the top.
The senior management meetings make the feeding frenzy over a carcass on the plains of Africa look orderly. These managers do not live and breathe the organization; the ones who did have long since left.
7. Salary Costs Escalate
There are many financial time bombs that impact shareholder value.
Severance packages can create further waste as staff members, especially the talented ones, leave before generous severance terms disappear. Thus, to retain such people, further salary incentives need to be made that create further pressure on the bottom line.
The TOM is often the time when the shareholders realize the dilution they have been a silent party to comes into full swing, the conversion of options. The surge of the share price as speculators play with the stock means that options can be exercised profitably by the executives who then leave the shareholders holding the rotten TOM.
8.Human Beings Find It Hard to Conceptualize the Intangibles
For many of us, conceptualizing the abstract is very difficult. A company is most definitely an abstract quantity. It is not a balance sheet; it is much more and much less. Executives in major corporations can write off the annual gross national product of a small country on a failed merger and still not lose sleep at night. The numbers are so large that they appear unbelievable, and the senior management team (SMT) seems to be able to pass them off as just poor management decisions. Yet they are a catastrophe for the investor whose savings are now reduced and the retiree who was relying on the dividends to cover yearly living expenses.
It is impossible for the average board and SMT to completely appreciate all the implications of a merger.
9. Mergers Are Seldom Done from a Position of Strength
Most mergers are defensive; management is on the back foot trying to make something happen. Defensive TOMs are not a great idea as the companies escaping from a threat often bring their problems into the marriage.
Alternatively, TOMs occur because management consider themselves invincible. They talk to the general public through the press, reveling in their moment in the limelight. Their brief track record of stellar growth is now extrapolated out of all proportion.
10. There Is Never Enough Time to Fully Evaluate the Target
A merger is like an auction. The buyer rarely has more than a cursory look at the goods before bidding. Management often does not want to find the dirty laundry as it would mean going back to square one again.
It is important not to limit due diligence in the haste to close the deal, as you tend to know less about each other than you think. The dirty laundry often takes years to discover and clean.
Warning Signs of A Lemon Checklist
|Is it covered?|
|Stock market loves the share for over a 2–3 year period||o Yes o No|
|CEO has become a media loved person||o Yes o No|
|The company has adopted some bizarre HR practices||o Yes o No|
|There is an over hyped culture within the company||o Yes o No|
|The key positions in the top are head hunted visionaries||o Yes o No|
|The investment bankers are earning large transactions fees||o Yes o No|
|There are no questioning articles in the press||o Yes o No|
|Excessive company executive remuneration||o Yes o No|
|Senior management team consists of many rags to riches stories||o Yes o No|
|Outside superstars are recruited in with media fan fare||o Yes o No|
|A high proportion of the income comes from “invisibles”||o Yes o No|
|The organisation has created a new market, service that the||o Yes o No|
|market does not yet understand||o Yes o No|
|Take-overs are becoming a regular occurrence in the company||o Yes o No|
|There are signs that business ethics are questionable||o Yes o No|
|Very innovative company||o Yes o No|
|Taxi drivers are talking about the share||o Yes o No|
|The company has changed its executive jet twice in the last three years!||o Yes o No|
|Excessive media interest borne from media spin||o Yes o No|
|Executives are charismatic in front of analysts and the press||o Yes o No|
The Enron documentary should be a compulsory watch for all investors and employees with pensions invested in their companies. The lessons from Enron and other similar collapses provide a useful guide to predicting corporate collapses.
Takeover or Merger Scorecard
I have designed a scorecard, see Exhibit 2, covering the aspects executives need to know before boldly going where others have mistakenly gone before (five out of six TOMs fail to achieve the synergism planned). If the merger must go ahead, then please look at the TOM scorecard in the electronic media and get to it. I will not wish you good luck, as that would not be adequate enough.
Exhibit 2: Takeover or Merger Scorecard
|Key Task||Tick if covered|
|Has your company got the ability to turn away from a deal if it does not stack up?||o Yes o No|
|Have you done an evaluation of the potential downside?||o Yes o No|
|Are all the following team players experienced in accurately assessing the full costs of the TOM and accurately estimating synergistic savings?|
|§ Advising Brokers||o Yes o No|
|§ TOM advisors||o Yes o No|
|§ Board||o Yes o No|
|§ Executive||o Yes o No|
|Have all other alternatives to the TOM been fully explored?||o Yes o No|
|Have safeguards been put in place to ensure that the benefits from this TOM accrue to shareholders, staff, local community as well as the executive ‘share option holders’?||o Yes o No|
|Has your company got experience in doing a proper due diligence process?||o Yes o No|
|Has your company enough time to do a proper due diligence process?||o Yes o No|
|Has an impact assessment been undertaken on the organization if the TOM fails?||o Yes o No|
|Has the company got enough cash reserves to ‘weather any eventual storm’ arising from the TOM?||o Yes o No|
|Have you performed a culture audit – a TOM is like merging two families and many problems are overlooked in the frenzied courtship?||o Yes o No|
|Have you locked-in a portion of your advisors’ fees to a successful realization of the proposed TOM benefits? – remember many of your advisors have never worked in an organization which has had a successful TOM.||o Yes o No|
|Have you performed an assessment of asset fit – quality, condition and usage?||o Yes o No|
|Is your target company a ‘CAMEL’? – a company with adequate capital, good asset quality, good management, record of sound earnings growth and with good liquidity.||o Yes o No|
|Has an assessment been done on the locked-in employment terms and conditions (especially relevant if acquiring an Australian company)?||o Yes o No|
|Has an evaluation been performed of the current pressure on the environment in which the organization is trading? (At the time you are the weakest, post-merger, the industry is likely to have a major crisis)||o Yes o No|
|Has an assessment been performed on the IT systems integration? – Few understand the implications of a TOM and the time-frames involved. The IT team may not have the skills to cope with the now larger environment.||o Yes o No|
|Has the TOM been initiated through sound reasoning? (Many mergers based on a defensive or cost cutting strategy fail).||o Yes o No|
|Have you carefully selected the target? Or if you have been approached, have you really ascertained why they want to sell?||o Yes o No|
|Have you checked the adequacy of provisioning for potential bad debts and under performing loans?||o Yes o No|
|Is the business tied to contractual conditions, which enable customers to pull out of profitable contracts? (a lesson that the Australian Bank NAB learned)||o Yes o No|
|Have you established an integration plan which would include the setting up of a ‘council’ which would oversee the key integration projects?||o Yes o No|
|Current relationship between the companies is favourable (in other words have not been fierce rivals in the past).||o Yes o No|
|Do you have the resources to select the new management structure ASAP?||o Yes o No|
|Have you got a contingency plan for the potential loss of key staff? – uncertainty and very generous severance clauses may force executives, who you want to keep, to activate the severance clause for fear of losing the generous terms.||o Yes o No|
|Are you prepared to go through the potential pain of lower revenue as management and staff are diverted by the merger?||o Yes o No|
|Are you prepared to be made surplus to requirements when all the dust has settled, and the bloodletting finished?||o Yes o No|
|Have you set up a clear strategy for after the merger, including who is getting what job, thus avoiding the cancer of uncertainty?||o Yes o No|
|Have you set up an in-house think-tank whose task is to speed up integration and to extract knowledge from the different parts of the joint company and use it in the new organization?||o Yes o No|
|Have you ensured that the joint CEOs are able to work together until the designated word CEO leaves? Remember appearances count.||o Yes o No|
Although it is tempting, avoid bringing in outside consultants to run this transition process. Most of their previous assignments will have failed and they will have no credibility in-house. Far better to use takeover specialists as advisers to the joint committee.
[i] “How Mergers Go Wrong,” The Economist, (July 22 – August 26, 2000).
[ii] KPMG Mergers & Acquisitions, A Global Research Report, 2000