Magnificent and Atrocious

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When I first joined the corporate world, I was most attracted to the area of Mergers and Acquisitions. To be in the driver's seat, responsible for the game-changing decisions of buying, selling, combining or dividing companies, with the aim of creating new value, was my perception of excitement and absolute authority.

For those who are unfamiliar with the topic, a merger is a legal consolidation of two companies into one entity, and an acquisition is where one company completely takes over another to establish itself as the new owner. I suppose that I could use marriage as an offbeat analogy to describe such differences, where the marriages in countries that support equal rights could be deemed as mergers and marriages in less enlightened places would be considered as acquisitions. I may even correlate the hostile take-over and ideal amount of M&A activity to examples of the royal intermarriages of the past and polygamy, but let's hope that you get the point by now.

What I will do is share a few Magnificent and Atrocious examples of M&A activity with the aim of shedding light on what has been demonstrated to work and what has not. Keep in mind that the strategic goal behind M&A should be to create positive growth or value, or in some cases, to avoid extinction.

The most common categories of M&A are known as Horizontal and Vertical Mergers, Product and Market Extension Mergers, and Conglomerate Mergers. In order to prevent redundancy, I will point out examples of each as we go.

The Magnificent: Before diving into the best practices of M&A, management needs to do its due diligence to create a vision. This starts by knowing all of today's costs, margins, competitors, markets, advantages and disadvantages of your company, as well as the anticipated trends and projections for the next three to five years.

Magnificent M&A can allow cash rich and sales starved companies to penetrate new markets, as well as enable sales rich and profit starved companies to improve margins.

In order to be successful, the executive team must know (beyond and shadow of a doubt) what the company needs and why it needs it. Decisions to improve financial performance often center around expanding the company's scale and scope, increasing its revenue and market share, and creating untapped advantage through vertical integration and synergy.

Elon Musk, Tesla CEO, provides a sound example of such performance. Elon knew that batteries were the cost drivers of the electric car industry. Since he did not have the option to feasibly backward integrate by buying an existing battery manufacturer (vertical merger) to support his sustained needs, he decided to build his own "gigafactory" ... A new plant that will produce 500,000 car batteries at a rate that's 30% cheaper than what he assembles today; which is more than 50% cheaper than those of his competitors. To compete in the electric car market, Tesla competitors may now be forced into M&A tactics.

A couple of great M&A decisions of the past include: Exxon and Mobil's $81B agreement to become the strongest leader in the oil market (horizontal merger). eBay's purchase of PayPal for $1.5B. This acquisition was a steal that reduced eBay's operational cost and supported its mission to create an efficient online global marketplace. Thermo Fisher Scientific bought Life Technologies for $13B. This move granted Thermo, a huge maker of scientific equipment, entry and a dominant position in the growing markets of DNA sequencing and personalized medicine (market extension merger).

M&A best practices starts with the following:

Strong Evaluation - 1.) Is the merger strategically and financially logical? Develop a very clear assessment of the financial and strategic risks, advantages, trade-offs and ROI of the integration. 2.) Does it build management or other capabilities? Gains in talent, patents, products, systems, global leverage and synergies should all be known. 3.) How will the combined companies perform better as a whole? The answer to this question must roll off of the tongue. The harder it is to say the harder it will be to do.

Effective Integration - 1.) Do you have the best team possible? The assembly of a strong leadership team who can assign the right roles, report on the right measures and drive the right results is a necessity. 2.) Are all expectations set? This is not learn as you go and you cannot overpromise and under deliver. Focus on what is most important and list the steps to get there. A phased timeline for all actions needs to be realistic with accountability measures in place at the onset. 3.) Do both companies share the same vision? Developing one culture is necessary. In most circumstances, companies will be going down from two CEOs to one. This is probably the greatest political feat to pull off. M&A creates nervousness in both organizations. Before shaking things up, be sure to win over the hearts and minds of the employees. If you are not welcoming, you are alienating. Clear communication and a shared understanding on how each individual will contribute to the new company will appease the masses.

The Atrocious: There are many horrific past deals that have completely evaporated billions in market cap overnight. It should already be clear that skipping any of the steps in the short list of best practices above will lead to some sort of failure ...

Like when you do not properly perform financial due diligence, as is the case in 2008 when BOA bought Countrywide for $2.5B, a deal that ended up costing the bank more than $40B ...

Or, if you cannot clearly articulate the logic behind the merger, the shareholders, analysts and employees will likely not see it.

This was Wall Street's biggest gripe with Symantec's purchase of Veritas for $13B back in 2005. The booming software company joined forces with a storage company based on the intent of offering its customers a more comprehensive set of safeguarding solutions. Years later the market cap of the conglomerate was worth less than the initial $13B paid for Veritas, evaporating more than $17B.

The lack of compatibility between two companies will always result in costly issues if not complete failure.

This common problem goes unnoticed in many of the smaller mergers that do not get ongoing media attention. Large companies gobble up little ones, sometimes just out of start-up mode, in hope to capitalize on growing sales or markets. Unfortunately, in many cases, the smaller company is better operated on its own and gets "stupefied" by joining the giant, that is slower to adopt the most current processes and technologies.

Just imagine how an integration like this must feel on the little guy. "Wait, we have a state-of-the-art system and superior process in place and you want us to convert everything to your legacy platform? Um, thanks but no thanks." Talk about a quick way to turn things sour. It would be a major disservice for most of the smaller company's talent to work for the giant; which is why many take their cash and bail to start another pioneering company.

Large company mergers are also not exempt from this compatibility crisis. In 2005, eBay bought Skype for $2.6B. The two companies were unable to integrate their systems forcing eBay to sell for a loss four years later. During that same year, Sprint faced similar problems with its $36B purchase of Nextel. This has also plagued the United Airlines merger with Continental, where an unparalleled global network was promised and hobbled operations were delivered; which led to angry passengers and disgruntled employees.

Some CEO's lack vision and do not understand that bigger does not mean better ...

This is probably the most exploited problem of all. In 2007, it won Eddie Lampert the title of "worst CEO of the year" for his decision to join Kmart with Sears. In 2000, it backfired on AOL with it's $160B purchase of Time Warner, and it created losses for Daimler-Benz when paying nearly $1B to sever its $36B purchase of Chrysler.

PepsiCo has also been famous for growing its business through acquisitions, acquiring such brands as Frito-Lay, Quaker Oats, Pizza Hut, Taco Bell, KFC, Tropicana and Gatorade (product extension merger). However, the company later reverted back to its core focus of packaged foods and beverage brands and exited out of all other business lines.

The fear of survival may also lead to risky or failed acquisitions ...

You may have noticed that there are no shortages of available stock symbols in any of our indices. That's partially because companies can come and go while ticker symbols remain for the next new public company in line ... RCA, Compaq, E.F. Hutton, Arthur Anderson, TWA, MCI, General Foods, Woolworth, Montgomery Ward and Enron are just a few companies to have vanished.

Most companies don't just disappear overnight. Product lines continuously fail making it nearly impossible for companies to sustain profits. The writing for such events is typically on the wall; which sometimes fuels long battles in the market space where two competing technologies will result in only one (e.g. 8-Track versus Cassette, Betamax versus VHS, HD DVD versus Blue Ray).

So what should the CEO of the losing company do, follow the advice of Frank Sinatra and roll up in a big ball and die? No, companies may need to invest outside of their market space to mitigate risk. In many cases this is known as a pure conglomerate merger, where the joined companies have nothing in common. To the public this may not appear as logical or synergistic, however, to the company it may be a dire necessity.

In 2005, this sort of thinking prompted big tobacco company Philip Morris to buy General Foods for $5.6B. Philip Morris knew that the tobacco industry was in trouble and wisely chose to offset its risk. During that same year, risk mitigation could have also been the underlying reason why Symantec acquired Veritas. At the time, it was rumored that Microsoft had planned on offering free internet security software. If the deep-pocketed software giant launched a superior security software, Symantec could have been quickly obsoleted.

If there's one thing to take away from this post, it's that our business world is not short on M&A activity. Also realize that what's mentioned here barely scratches the surface, and that Mergers and Acquisitions are here to stay. The book Blue Ocean Strategy said it best "there is no such thing as a permanently excellent company or a permanently excellent industry." Change is the only constant, and proven way for companies to sustain revenue growth, increase profits and avoid extinction. For this reason, executives will always consider M&A to be a most desired option, whether you and I see the logic in it or not.

 

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