The research in mergers and acquisitions shows that when Company A is sold to Company B, the likely scenario is that 1) a significant number of employees are let go within the first year or two, 2) the value expected from the acquisition by the acquirer is not realized, 3) the premium of value goes to the seller instead, 4) the cultural and organizational challenges become all-consuming, adding to the disruption in the business, 4) customers are lost at a higher rate than expected, and 5) business growth does not materialize and in fact performance prior to the acquisition is retarded.
So why do mergers and acquisitions at all? If the odds are that the large majority fail at accomplishing the performance metrics which were used to justify the acquisition, what’s the point? And if an investment banker or business broker are involved, there’s another huge cost that is paid on the assumption of success for the performance post-merger. Attorneys, accountants, deal consultants, underwriters, lenders and sellers make the money more often than the buyers. Sure, the buyers can negotiate the traditional protections, or try to, such as holdbacks to insure the representations and warranties are as stated, earn-outs when the assets are more ethereal, etc. But again, history shows that these protections are customary and necessary, yet insufficient to effectively protect the buyer’s return. Why then are buyers so often willing to place the loser’s bet?
One reason is that in a compacted rivalry of product or service providers within a stagnant and constrained market, the two choices for growth are buying market share through an acquisition, and disruptively innovating by introducing a game-changing service, product, method, etc. Buying stuff is much, much easier.
Another reason that the fool’s bet for acquiring assets is placed is that, exactly like the crap tables in Vegas, once in a while someone achieves a phenomenal, well-publicized return. If you walk through a casino, you encounter huge rooms where thousands of slot machines chatter, blink and whir. Among those thousands of temptresses, three or four are singing the sailors to the rocks, announcing their payoffs with songs impossible to ignore. A few, out of thousands.
So the passers-by, the potential investors in those acquisitions, perk their heads up at the singing, turn to their financiers and say, “See?! I know I lost the last $100 you gave me, but if you’ll just lend me $200 more, I’ll bring you back 20 percent of my winnings. And that will be huge! Look at this graph I put together. You’ll see that after we implement our transition plan and meld our cultures successfully, returns accelerate in year five and yield a 35 percent IRR!”
The financier considers other options for comparatively pitiful returns, realizes that he is loaning out other people’s money anyway, and hands over the two C-notes. The acquirer puts the bills in his pocket and bounds through the carpeted aisles of machines. Two hours later, the lender searches for the borrower and finds him sweating in front of a slot machine, gripping the metal sides and using his fist to pound the tumbler button, shaking visibly.
“What are you doing?!” asks the lender. “You were supposed to make your first interest and principle payment an hour ago!”
The hypnotized acquirer stares at the whirling, colorful symbols, punching the buttons while the lights flash and in the distance, other winners are announced with horns and bells. He stares desperately at the spinning cherries and says, “I’m melding cultures! I’m forming a values statement! I’m reconfiguring our go-to-market strategy! I’m getting rid of unproductive elements of the business model!” He takes a rabbit’s foot out of his pocket and throws it away. “See?! We’re making progress!”
The few spectacular winners entice the hopeful few who, just as in any gambling adventure, think they can beat the odds. That’s why the M&A industry exists, promoted by the purveyors who sell the shovels and picks to the miners.
There’s another model, however. If you approach business like a gambler, the outcomes are as predictable as the guaranteed advantage of odds that the casino builds into all of its gaming operations. But if you approach business like sailing a ship to a far shore, the outcome is still partially a matter of luck, but a far greater proportion of the journey is determined by the preparation, the stamina, the skill, the commitment and the courage of the sailor.
“So Floyd,” I asked, “why did your acquisition work out so well, when so many others fail?”
“It’s pretty simple,” he replied. “We made sure that every party to the transaction came out ahead. We spent five years looking for the right deal, knowing that it may never come, and we resolved not to lower our standards for what constituted the ‘right’ deal. Besides the strategic coherency that everyone pays attention to in acquisitions, we made sure that the deal structure included a guaranteed return to us as well as to the seller. We ensured that all employees would be critical to the endeavor. We didn’t look for supposed efficiencies that could take costs out of the combined entity. That approach always kills teamwork and emotional commitment to the enterprise. We looked for a deal that needed all the existing people and infrastructure in order to succeed. We wanted a combined entity that was more financially rewarding for all the existing employees, vendors, customers, landlords and shareholders.”
“That sounds like an exceedingly difficult scenario to construct,” I responded.
“Yes it is. But if you are committed to long-term success, it’s the only way to do it. You have to engineer success, take most of the chance out of the endeavor. If we wanted a thrilling, disastrous adventure, we’d just go to Vegas and put all our money down on black seven and spin the tray.”
Friday, April 8, 2011