Mergers and Acquisitions - A Case of System Failure


By

Varsha Virani
Lecturer
R.K. College of Business Management
Rajkot-Bhavnagar Highway, Rajkot
 


Abstract

Corporate mergers and acquisitions (M&As) have become popular from corner to corner the world during the last two decades thanks to globalization, liberalization, technological developments and intensely competitive business environment. The synergistic gains from M&As may result from more efficient management, economies of scale, more profitable use of assets, exploitation of market power, the use of complementary resources, etc. Interestingly, the results of many empirical studies show that M&As fails to create value for the shareholders of acquirers. In this article I covered background of merger and acquisition, reasons for failure of merger and acquisition, and impact of merger on shareholders.

Introduction

Mergers and acquisitions are almost a daily occurrence in the life sciences. Competition is fierce, and companies must team up to survive in an industry where specialized knowledge is king. One of the largest, most critical, and most difficult parts of a business merger is the successful integration of the enterprise networks of the merger partners.  BPO Systems has the expertise and skills to make your merger or acquisition a much smoother process.

The prime objective of a firm is to grow profitably. The growth can be achieved either through the process of introducing or developing new products or by expanding or enlarging the capacity of existing products. Mergers and Acquisitions (M&As) are quite important forms of external growth. The last decade of 20th century has been substantial increase in both number and volume of M&A activity. In fact, consolidation through M&As has become a major trend across the globe. This wave was driven by globalization, liberalization, technological changes, and market deregulation and liberalization. Almost all industries are going through reorganization and consolidation. M&A activity has been predominant in sectors like steel, aluminum, cement, auto, banking and finance, computer software, pharmaceuticals, consumer durables, food products, agro-chemicals, textiles, etc. Generally M&As aims at achieving greater efficiency, diversification, market power, etc. The synergistic gains by M&A activity accrue from more efficient management, economies of scale and scope, improved production techniques, combination of complementary resources, redeployment of assets to more profitable uses, the exploitation of market power or any number of value enhancing mechanisms that fall under the rubric of corporate synergy. M&As is a indispensable strategic tool for expanding product portfolios, entering new markets, acquiring new technologies and building new generation organization with power and resources to compete on a global basis.

Background

When M&As is taking place all over the world irrespective of the industry, it is necessary to understand the basic concepts pertinent to this. The term merger involves coming together of two or more concerns resulting in continuation of one of the existing entities or forming of an entirely new entity. When one or more concerns merge with an existing concern, it is the case of absorption. The merger of Global Trust Bank (GTB) with Oriental Bank of Commerce (OBC) is an example of absorption. After the merger, the identity of the GTB is lost. But the OBC retains its identity. Amalgamation involves the fusion of two or more companies and forming of a new company. The merger of Bank of Punjab and Centurion Bank resulting in formation of Centurion Bank of Punjab is an example of amalgamation. Acquisition is an act of acquiring effective control over the assets or management of the corporate without any combination of both of them. When the acquisition is 'forced' or 'unwilling', it is generally called takeover. Though, the terms 'merger', 'amalgamation', 'acquisition' and 'takeover' have specific meanings, they are generally used interchangeably. Mergers may be horizontal, vertical or conglomerate. Further, they may be friendly or hostile. Generally, mergers are friendly whereas tender offers are hostile. M&As aim at optimum utilization of all available resources, exploitation of unutilized and under utilized assets and resources including human resources, eliminating or limiting the competition, achieving synergies, achieving economies of scale, forming a strong human base, installing an integrated research platform, removing sickness, achieving savings in administrative costs, reducing tax burden and ultimately improving the profits.

Reasons for Failure of Mergers and Acquisitions

Though the M&As basically aim at enhancing the shareholders value or wealth, the results of several empirical studies reveal that M&As consistently benefit the target company's shareholders but not the acquirer company shareholders. A majority of corporate mergers fail. Failure occurs on average, in every sense, acquiring firm stock prices likely to reduce when mergers are announced; many acquired companies sold off; and profitability of the acquired company is lower after the merger relative to comparable non-merged firms. Consulting firms have also estimated that from one half to two thirds of M&As do not come up to the expectations of those transacting them, and many resulted in divestitures. Statistics show that roughly half of acquisitions are not successful. M&As fails quite often and fails to create value or wealth for shareholders of the acquirers. A definite answer as to why mergers fail to generate value for acquiring shareholders cannot be provided because mergers fail for a host of reasons. Some of the important reasons for failures of mergers are discussed below:

1. Excessive premium

In a competitive bidding situation, a company may tend to pay more. Often highest bidder is one who overestimates value out of ignorance. Though he emerges as the winner, he happens to be in a way the unfortunate winner. This is called winners curse hypothesis. When the acquirer fails to achieve the synergies required compensating the price, the M&As fails. More you pay for a company, the harder you will have to work to make it worthwhile for your shareholders. When the price paid is too much, how well the deal may be executed, the deal may not create value.

2. Size Issues

A mismatch in the size between acquirer and target has been found to lead to poor acquisition performance. Many acquisitions fail either because of 'acquisition indigestion' through buying too big targets or failed to give the smaller acquisitions the time and attention it required.

3. Lack of research

Acquisition requires gathering a lot of data and information and analyzing it. It requires extensive research. A carelessly carried out research about the acquisition causes the destruction of acquirer's wealth.

4. Diversification

Very few firms have the ability to successfully manage the diversified businesses. Unrelated diversification has been associated with lower financial performance, lower capital productivity and a higher degree of variance in performance for a variety of reasons including a lack of industry or geographic knowledge, a lack of focus as well as perceived inability to gain meaningful synergies. Unrelated acquisitions, which may appear to be very promising, may turn out to be big disappointment in reality.

5. Previous Acquisition Experience

While previous acquisition experience is not necessarily a requirement for future acquisition success, many unsuccessful acquirers usually have little previous acquisition experience. Previous experience will help the acquirers to learn from the previous acquisition mistakes and help them to make successful acquisitions in future. It may also help them by taking advice in order to maximize chances of acquisition success. Those serial acquirers, who possess the in house skills necessary to promote acquisition success as well trained and competent implementation team, are more likely to make successful acquisitions.

6. Unwieldy and Inefficient

Conglomerate mergers proliferated in 1960s and 1970. Many conglomerates proved unwieldy and inefficient and were wound up in 1980s and 1990s. The unmanageable conglomerates contributed to the rise of various types of divestitures in the 1980s and 1990s.

7. Poor Cultural Fits

Cultural fit between an acquirer and a target is one of the most neglected areas of analysis prior to the closing of a deal. However, cultural due diligence is every bit as important as careful financial analysis. Without it, the chances are great that M&As will quickly amount to misunderstanding, confusion and conflict. Cultural due diligence involve steps like determining the importance of culture, assessing the culture of both target and acquirer. It is useful to know the target management behavior with respect to dimensions such as centralized versus decentralized decision making, speed in decision making, time horizon for decisions, level of team work, management of conflict, risk orientation, openness to change, etc. It is necessary to assess the cultural fit between the acquirer and target based on cultural profile. Potential sources of clash must be managed. It is necessary to identify the impact of cultural gap, and develop and execute strategies to use the information in the cultural profile to assess the impact that the differences have.

8. Poor Organization Fit

Organizational fit is described as "the match between administrative practices, cultural practices and personnel characteristics of the target and acquirer. It influences the ease with which two organizations can be integrated during implementation. Mismatch of organation fit leads to failure of mergers.

9. Poor Strategic Fit

A Merger will yield the desired result only if there is strategic fit between the merging companies. Mergers with strategic fit can improve profitability through reduction in overheads, effective utilization of facilities, the ability to raise funds at a lower cost, and deployment of surplus cash for expanding business with higher returns. But many a time lack of strategic fit between two merging companies especially lack of synergies results in merger failure. Strategic fit can also include the business philosophies of the two entities (return on investment v/s market share), the time frame for achieving these goals (short-term v/s long term) and the way in which assets are utilized. For example, P&G –Gillette merger in consumer goods industry is a unique case of acquisition by an innovative company to expand its product line by acquiring another innovative company, which was, described analysts as a perfect merger.

10. Striving for Bigness

Size no doubt is an important element for success in business. Therefore there is a strong tendency among managers whose compensation is significantly influenced by size to build big empires. Size maximizing firms may engage in activities, which have negative net present value. Therefore when evaluating an acquisition it is necessary to keep the attention focused on how it will create value for shareholders and not on how it will increase the size of the company.

11. Faulty evaluation

At times acquirers do not carry out the detailed diligence of the target company. They make a wrong assessment of the benefits from the acquisition and land up paying a higher price.

12. Poorly Managed Integration

Integration of the companies requires a high quality management. Integration is very often poorly managed with little planning and design. As a result implementation fails. The key variable for success is managing the company better after the acquisition than it was managed before. Even good deals fail if they are poorly managed after the merger.

13. Failure to Take Immediate Control

Control of the new unit should be taken immediately after signing of the agreement. ITC did so when they took over the BILT unit even though the consideration was to be paid in 5 yearly installments. ABB put new management in place on day one and reporting systems in place by three weeks.

14. Failure to Set the Pace for Integration

The important task in the merger is to integrate the target with acquiring company in every respect. All function such as marketing, commercial; finance, production, design and personnel should be put in place. In addition to the prominent persons of acquiring company the key persons from the acquired company should be retained and given sufficient prominence opportunities in the combined organization. Delay in integration leads to delay in product shipment, development and slow down in the company's road map. Acquisition of Scientific Data Corporation by Xerox in 1969 and AT&T's acquisition of computer maker NCR Corporation in 1991 were troubled deals, which resulted in large write offs. The speed of integration is extremely important because uncertainty and ambiguity for longer periods destabilizes the normal organizational life.

15. Incomplete and Inadequate Due Diligence

Lack of due diligence is lack of detailed analysis of all important features like finance, management, capability, physical assets as well as intangible assets results in failure. ISPAT Steel is a corporate acquirer that conducts M&A activities after elaborate due diligence.

16. Ego Clash

Ego clash between the top management and subsequently lack of coordination may lead to collapse of company after merger. The problem is more prominent in cases of mergers between equals.

17. Merger between Equals

Merger between two equals may not work. The Dunlop Pirelli merger in 1964, which created the world's second largest tier company, ended in an expensive divorce. Manufacturing plants can be integrated easily, human beings cannot. Merger of equals may also create ego clash.

18. Over Leverage

Cash acquisitions results in the acquirer assuming too much debt. Future interest cost consumes too great a portion of the acquired company's earnings (Business India 2005).

19. Incompatibility of Partners

Alliance between two strong companies is a safer bet than between two weak partners. Frequently many strong companies actually seek small partners in order to gain control while weak companies look for stronger companies to bail them out. But experience shows that the weak link becomes a drag and causes friction between partners. A strong company taking over a sick company in the hope of rehabilitation may itself end up in liquidation.

20. Limited Focus

If merging companies have entirely different products, markets systems and cultures, the merger is doomed to failure. Added to that as core competencies are weakened and the focus gets blurred the fallout on bourses can be dangerous. Purely financially motivated mergers such as tax driven mergers on the advice of accountant can be hit by adverse business consequences. The Tatas for example, sold their soaps business to Hindustan Lever.

21. Failure to Get Figures Audited

It would be serious mistake if the takeovers were concluded without a proper audit of financial affairs of the target company. Though the company pays for the assets of the target company, it also assumes responsibility to pay all the liabilities. Areas to look for are stocks, salability of finished products, receivables and their collectibles, details and location of fixed assets, unsecured loans, claims under litigation, loans from the promoters, etc. When ITC took over the paperboard making unit of BILT near Coimbatore, it arranged for comprehensive audit of financial affairs of the unit. Many a times the acquirer is mislead by window-dressed accounts of the target.

22. Failure to Get an Objective Evaluation of the Target Company' Condition

Risk of failure will be minimized if there is a detailed evaluation of the target company's business conditions carried out by the professionals in the line of business. Detailed examination of the manufacturing facilities, product design features, rejection rates, and distribution systems, profile of key people and productivity of the workers is done. Acquirer should not be carried away by the state of the art physical facilities like a good head quarters building, guest house on a beach, plenty of land for expansion, etc.

23. Failure of Top Management to Follow-Up

After signing the M&A agreement the top management should not sit back and let things happen. First 100 days after the takeover determine the speed with which the process of tackling the problems can be achieved. Top management follow-up is essential to go with a clear road map of actions to be taken and set the pace for implementing once the control is assumed.

24. Mergers between Lame Ducks

Merger between two weak companies does not succeed either. The example is the Stud backer- Packard merger of 1955 when two ailing carmakers joined hands. By 1964 both companies were closed down.

25. Lack of Proper Communication

Lack of proper communication after the announcement of M&As will create lot of uncertainties. Apart from getting down to business quickly companies have to necessarily talk to employees and constantly. Regardless of how well executives communicate during a merger or an acquisition, uncertainty will never be completely eliminated. Failure to manage communication results in inaccurate perceptions, lost trust in management, morale and productivity problems, safety problems, poor customer service, and defection of key people and customers. It may lead to the loss of the support of key stakeholders at a time when that support is needed the most.

26. Failure of Leadership Role

Some of the role leadership should take seriously are modeling, quantifying strategic benefits and building a case for M&A activity and articulating and establishing high standard for value creation. Walking the talk also becomes very important during M&As.

27. Inadequate Attention to People Issues

Not giving sufficient attention to people issues during due diligence process may prove costly later on. While lot of focus is placed on the financial and customer capital aspects, not enough attention is given to aspects of human capital and cultural audit. Well conducted HR due diligence can provide very accurate estimates and can be very critical to strategy formulation and implementation.

28. Strategic Alliance as an Alternative Strategy

Another feature of 1990s is the growth in strategic alliances as a cheaper, less risky route to a strategic goal than takeovers.

30. Loss of Identity

Merger should not result in loss of identity, which is a major strength for the acquiring company. Jaguar's car image dropped drastically after its merger with British Leyland.

31. Diverging from Core Activity

In some cases it reduces buyer's efficiency by diverting it from its core activity and too much time is spent on new activity neglecting the core activity.

32. Expecting Results too quickly

Immediate results can never be expected except those recorded in red ink. Whirlpool ran up a loss $100 million in its Philips white goods purchase. R.P.Goenk's takeovers of Gramaphone Company and Manu Chhabria's takeover of Gordon Woodroffe and Dunlops fall under this category.

Conclusion

M&As have become very popular over the years especially during the last two decades owing to rapid changes that have taken place in the business environment. Business firms now have to face increased competition not only from firms within the country but also from international business giants thanks to globalization, liberalization, technological changes, etc. Generally the objective of M&As is wealth maximization of shareholders by seeking gains in terms of synergy, economies of scale, better financial and marketing advantages, diversification and reduced earnings volatility, improved inventory management, increase in domestic market share and also to capture fast growing international markets abroad. But astonishingly, though the number and value of M&As are growing rapidly, the results of the studies on the impact of mergers on the performance from the acquirers' shareholders perspective have been highly disappointing. In this paper an attempt has been made to draw the results of only some of the earlier studies while analyzing the causes of failure of majority of the mergers. Making the mergers work successfully is not that easy as here we are not only just putting the two organizations together but also integrating people of two organizations with different cultures, attitudes and mindsets. Meticulous pre-merger planning including conducting proper due diligence, effective communication during the integration, committed and competent leadership, speed with which the integration plan is integrated all this pave for the success of M&As. While making the merger deals, it is necessary not only to make analysis of the financial aspects of the acquiring firm but also the cultural and people issues of both the concerns for proper post-acquisition integration.

Reference

1. "The Basel Accord – More questions than answers", Chartered Financial Analyst, March 2004, pp.59-62

2. Business India, "Biggest deal?" Business India, March 2005, pp.162-163

3. Banerjee Gargi, "Year of Deals", Business World, Vol.25, Issue 21, October, 2005a, Pp.34-37.

4. Banerjee Gargi, "How Much Value is Created by M&A Deals in India?" Business World, October 2005, pp.40.

5. Machhi Hetal, "Merger and Acquisition," The Management Accountant, October 2005, pp. 767-770.

6. Maheshwari S.N., "Financial Management, Principles and Practices," Sultan Chand & Sons, New Delhi, 2002, p. E127-E161.

7. Maitra Dilip, "Mega Money Mergers," Business Today, December 1996, p. 82-93.

8. Chandra Prasanna, "Financial Management: Theory and Practice", Fifth Edition, Tata Mcgraw-Hill Publishing Company Limited, New Delhi, 2001, p.911-960.

9. Pawaslar, Vardhana, "Effects of Mergers on Corporate Performance in India," Vikalpa, Vol.26, No.1, January- March 2001, pp.19-32.

10.Prayag Anjali, "M&Aing It Work", Praxis-Business Line's Journal on Management, October, 2005, pp.34-41.

11. I M Pandey, 'Financial Management", Ninth Edition, Vikas Publishing House Ltd., New Delhi, 2004pp.685-695.

12. H V Harish, India Inc goes global (Mergers and Acquisitions), Capital Market, Jan 2006, pp. 5-12.

13. Kumar Rajesh, "Effect of RPL- RIL Merger on Shareholder's Wealth and Corporate Performance," The ICFAI Journal of Applied Finance, September 2004, pp.13-35.
 


Varsha Virani
Lecturer
R.K. College of Business Management
Rajkot-Bhavnagar Highway, Rajkot
 

Source: E-mail August 22, 2007

         

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