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Why M&A deals fail or succeed
Moneycontrol.com | June 27, 2007
The head of the global merger management practice at McKinsey & Company, Clay Deutsch, takes us behind the scenes of some of India's biggest deals and tells you why deals succeed or fail, because 70% of all deals fail.
He told CNBC-TV18, "I agree factually with the analysis. I think the untold part of the story though is why do M&As at all. We believe there is increasingly a case to be made that doing nothing is a worse answer than M&As. It's a very difficult undertaking, making M&A work is one of the really challenging life events that many management teams faced in the company."
Rewind to the late 1990s when Silicon Valley was a deal-paradise and dot-com was a currency in itself, but this period of M&As is unprecedented -- not only is it bigger it's also better. Research shows it's creating more shareholder value.
McKinsey reviewed nearly 1,000 global mergers and acquisitions from 1997 to 2006. It compared share prices two days before and two days after each deal was announced. The analysis shows that value created in deals between 2003 and 2006 averaged 6% of the transaction values, whereas those between 1997 and 2000 average less than 2% and though an alarmingly high 58% of all acquiring companies are still overpaying for acquisitions - this is better than the 70% that were doing so in 2000.
So, why are shareholders getting a better deal. Lower acquisition premiums is one reason. More cash deals is the other and finally an increase in hostile takeovers. The market believes unsolicited bids create more value than friendly ones, but it's not all hunky-dory. Deal premiums are going up and value creation have started to decline.
Excerpts from an interview given to CNBC-TV18:
Why do you think some M&As fail?
Theories abound and what the analysis shows is that the dominant reason actually is not some failing in doing the deal or structuring the deal or negotiating. The dominant reason is what does or doesn't happen post-agreement and post-closing and the failure to manage the combined entity in a superior way.
What could that failure include? Is it failure in terms of overestimating the synergies or failure in terms of the management which doesn't get it right?
We have been looking at this question in earnest since about 2001, and we have looked at literally hundreds of transactions through a close file review -- a host analysis, if you will.
It's very clear to us that the overwhelming reason that an M&A fails is something loosely called 'culture.' And culture means failure of leadership, failure of integration, communication failures, failure to populate the new organisation with sufficient talent.
What usually goes wrong more than the other things?
You have to start with the belief that M&A is inherently an unnatural act. Putting two successful organisations together is difficult, putting a successful and an unsuccessful organisation together is difficult. Combining two organisations of any level of complexity is actually an extraordinary undertaking.
I think the most common cause of failure is just insufficient management response, insufficient leadership and insufficient management intensity to offset the inherent difficulties in putting two organisations of any size and any complexity together. It actually proves in our analysis, to be one of the most difficult things the management team will ever take on.
What kind of CEO do you need to make deals?
A CEO who is a builder, a CEO who is aspirational, a CEO who has the courage and appetite and risk threshold to be willing to substantially change even a successful organisation or successful formula.
I also think a CEO with an almost tireless performance standard. I will use a funny word -- the stamina required of the CEO and the management team who spend literally 2-3 years in some cases, painstakingly assembling a global combination across borders is a hugely fatiguing event. So, a CEO's stamina is something that not much is written or said about -- it's more than just being a builder and a dreamer.
The other big reason why deals have failed is the fact that you haven't got the entire organisation on board and the defensive nature of some of the employees. So, what can companies do to overcome this?
Again I think this is a topic of CEO leadership. Some of the greatest transactions of all time would not have been done by popular vote. In fact, I was talking to a CEO today who was talking about a past deal which is now by any measure a huge success - it was transformational in nature.
At the time, he did this deal, only three of his top 10 executives were in favour of it and that was in his company - not to mention the counterparty company. Again I think a very important part of the CEO leadership equation here is, rendering the ownership logic, the combination logic, clear and appealing. Why is it that this combination makes sense?
You have seen a large number of deals fail because organisations haven't got on board or is it the deals' structure or the lack of synergies that forces deals to fail more often than the lack of teamwork?
There are 2-3 variables that will merge. One variable is, does the new management team maintain an unwavering focus on their value creation logic or does it somehow get lost in the fog of war. It's interesting to me how often the original ownership logic either gets watered down or to some extent, forgotten or moved off, as events and organizational pressures overtake.
Number two, a huge variable is how you choose to build the newly combined organisation - in a sense of organisation design, senior management appointments, the processee to use to bring the companies or the assets together.
There is a McKinsey research that says that this sort of deals happened in 2006 and continues to happen in 2007. They are considered structurally sounder or has created more shareholder value than the last record deal we have had, which is 2000. Why is that?
There are two pieces of research coming out of McKinsey's Corporate Finance Practice that I think are noteworthy because they seem to turn a lot of academic evidence on its head.
Some of my colleagues in the Practice have done a piece of work, looking strictly at the financial anatomy of a number of recent announcements in contrast to the combinations, in the years passed, and their conclusion was that, whatever you might think, deals today are not overpriced.
A number of the deals today in the universe, seemed to have higher integrity. The second bit of research that I think is really turning things on its head - for years we have all believed that M&As were very risky because quite often, what used to come out was that there was value destruction not value creation.
Lot of that research is in my opinion, it's a very announcement- period based. It looks at very short swing movements, pre and post-announcements and concludes therefore the price immediately after announcement is the best future forward protector etc, which I think are sketchy arguments.
There is some interesting research some of my colleagues have done that has shown, if you take a more longitudinal look and really look at 10-20 years of value creation, you actually discover that large, mature companies that only grow at GDP have a very high extension rate - in fact above five times the extension rate.
As the company is actually sourcing a tremendous amount of their growth inorganically - using M&A to drive huge ongoing portions of the overall enterprise growth and revenue growth over long periods of time.
We have seen a string of commodity deals. Are there any sectors which you think in the next 2-3 years is likely to see more consolidation or acquisition activity?
The cross border M&A activity in basic industries has been interesting to follow. You see it in Europe in energy, you see it playing out globally in things like steel, aluminium, metals etc. In many of these industry verticals, there still seems to be room left for subsequent M&A possibilites, whether it's on paper, metals, mining, energy and power.
Any other sectors you like?
There is tremendous opportunity in financial services and more narrowly banking - not to exclude insurance. There is still tremendous unconsolidated banking landscape globally. We see a lot of activity in pharmaceutical, healthcare, in high tech, in telecom and in media.
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