When talking about M&A one can assume two different perspectives: that of the investment bank and that of the acquirer. The bank deems a deal successful right after it is concluded, when it gets paid the fees. The reality is quite different for the company, as it might take several years to understand whether a deal was successful or not. In this article, the focus will be on the factors that cause a deal to be unsuccessful for the acquirer.
First of all, it is necessary to define what the expression “failed M&A” means: it is a transaction that has failed to enhance shareholder value. It is often said that M&A creates value from where there was none, making 1+1 equal 3. In that sense, failed deals make 1+1 equal 2 or even 1 in the worst cases.
Someone might think failures are exceptions, rather than the rule. However, many research studies conducted over the decades clearly show that the rate of failures is at least 50 per cent: a recent example is a study conducted by KPMG in 2015, which shows that the rate of failure is at 83 per cent.
Signs Leading to Failure
Signs leading to failure are those that seldom cause a merger or acquisition to fail by themselves but accompany other more important factors.
The first is the limited or no involvement from the owner or CEO. During a transaction, advisors have a limited role and it is the owner or the CEO who should be most involved in the deal. In fact, once the deal is closed and the advisors leave, it is up to the owner or CEO to make the combined entity work.
The second sign we have identified is the lack of clarity and execution of the integration process. It is important to identify key employees, crucial products, sensitive processes and bottlenecks before the closing of the deal. This saves time in the post-merger integration, which is one of the most delicate phases of an M&A transaction. Communication is also essential, both on an external and internal level. It is very important, for instance, that the companies involved keep their customers informed, so as not to lose them and their connected market share.
We now move on to explain the several factors that interfere with the outcome of M&A transactions.
Theoretical Valuation vs Practical Future Benefits
This first issue arises whenever the figures and the assets that looked good on paper do not perform well once the deal has been executed.
An example of how this problem can interfere with the future of a potentially promising deal is represented by the Bank of America–Countrywide Financial Case. Negotiations started in August 2007, with an offer by BoA of $2bn to acquire Countrywide. By January 2008 the company had to double the amount, then closing at $2.5bn on July 1st. The deal was aimed at making the financial institution the number 1 in home loans since the rival Charlotte bank was about to acquire what was considered the best mortgage platform on the marketplace. BoA expected to reach a 25% market share after the acquisition of Countrywide, which already controlled 17% of the market as a standalone.
In spite of the expectations, this acquisition produced approximately $52.7bn losses for the Bank’s mortgage business by 2014. It was even labelled as “the worst acquisition in history” by Guy Cecala, publisher of Inside Mortgage Finance. Besides the unfortunate timing, the main driver of failure was the difference between theoretical valuation and the practical benefits. In fact, in 2001 Bank of America had exited the business of making subprime mortgages, and in the fall of 2007, the bank had stopped selling mortgages through brokers, a major business of Countrywide. The acquired company’s performance fell way bellow expectations to the point that three quarters of the loan packages with poor performance owned by BoA had been originally issued by Countrywide.
Another factor of failure in M&A transactions is cultural mismatch. While synergies and cost saving can be easily put into an excel spreadsheet and quantified, it is almost impossible to evaluate the culture of a firm and its impact on a M&A deal. But culture matters, as the failure of Google’s acquisition of Nest demonstrates.
In 2014 Google acquired Nest for $3.2bn with high expectations. Nest made smart-home applications and Google could leverage its AI and machine learning expertise to make them even better. Despite that the two companies’ cultures were completely different. Nest was founded by ex-Apple employees and had a secretive, reserved culture where people didn’t talk or socialized much. Google instead encouraged over-communication and wanted employees to socialize as much as possible. There was also a difference in management: Nest, with its Apple DNA, was a top-down company, where only one person was in charge, Fadell, the CEO. Google, instead, presented an engineer-driven, bottom-up culture, probably due to its enormous size making it too large to be managed from the top. This problem arose at Nest too when it grew too much its employee base thanks to Google’s resources. That made it even harder for Fadell to lead the team towards his vision. As a result, plenty of Nest’s employees left, including the founder, Fadell, who was the main driver of the company’s innovation, making the deal fall short on expectations.
Somehow connected with cultural mismatch highlighted above, difficult integration issues arise whenever the involved parties fail in aligning practices and attitudes or do not make any effort whatsoever in thinking as a group. For instance, this might be the case whenever two corporations used to be competing in the same industry before the M&A transaction took place, and they fail in building the right post-merger mindset. It is somehow worth emphasizing that the HR department plays a relevant role in these circumstances.
An example of how a promising M&A transaction can fail for integration issues is represented by the Daimler-Benz – Chrysler merger of equals. The transaction, which took place back in 1998, was expected to build a win-win strategy for the two parties. Indeed, both Daimler-Benz and Chrysler enjoyed a good market share, with the European player boasting superior research and focusing on the luxury car segment, and the American peer counting on creative styling and mainly producing mini-vans and SUVs. By merging, the two corporations could start exploiting each other’s strengths and capabilities. Specifically, Daimler was supposed to expand in the US and gain on creative styling, whereas Chrysler could penetrate the EU market, improve on technical capability and safety features, eventually stepping in the luxury car segment. The forecasted synergies were also encompassing $1.4bn pre-tax cost savings, to be achieved by 1999 ($3bn by 2001), alongside with better capacity utilization and shared R&D costs to produce cars for emerging markets.
Several integration issues arose over the years, impeding a successful consolidation. First, the differences in working style, with the conservative and disciplined approach adopted by Daimler clashing with the spontaneous, informal and team-oriented Chrysler’s entrepreneurial style. Second, the HR department failed to normalize the existing disparities in pay structure, compensations and incentive systems, which provided for higher salaries to the American car manufacturer’s employees and managers. For example, Robert Eaton (Chrysler’s CEO at the time) was earning as much as $9.7m per year, when instead Jurgen Schrempp (Daimler’s CEO at the time) received no more than $1.3m. Third, internal silent conflicts arose, up to the extent that it became easy to hear Daimler-Benz’s representatives and managers making negative comments about Chrysler. For instance, when asked: “How do you pronounce the name of the German – American car company?”, Daimler-Benz’s managers answered: “It’s Daimler, ‘Chrysler’ is silent”; or also when the German corporation’s top-leaders declared: “I would never drive a Chrysler”. These subtle conflicts made resentment spread across the consolidated entity, up to the point that some Chrysler’s top executives left, alongside with some employees, who got demoralized by the German colleagues’ behaviour. As a consequence of the addressed problems, the merger of equals was reverted in 2007, with Chrysler even filing for bankruptcy two years later.
Companies sometimes enter what they hold to be very promising acquisitions, at least at a first glance. In some cases, however, they realize they cannot keep up with the pace of growth of the acquired company in the years that follow the transaction.
This has been the case, for instance, when MySpace bought Photobucket, back in May 2007. The transaction had been long-awaited, ever since the two involved parties realized they were de facto already partnering. Indeed Photobucket (the world’s top photo-sharing platform at the time) worked as a free online storage tool for pictures, which were eventually uploaded on about 300,000 Internet sites, such as MySpace (the world’s online top meeting place). Therefore, the $250m acquisition at issue looked like a natural upgrade of the already-existing collaboration between the two involved parties, with Photobucket working as an unofficial outsourced provider of photo services to MySpace users. However, in less than two years’ time, MySpace indirectly started interfering with the acquired company’s growth expectations. MySpace was preventing Photobucket from partnering with other websites and other social networks. Having realized this, MySpace decided to sell the subsidiary to Ontela, a mobile photo upload and storage service. The transaction took place in May 2009 for $60m only, representing an impressive 83% valuation write-off.
A second example of how holding companies can end up impeding the acquired company’s growth is to be found in Condé Nast – Reddit transaction. Specifically, Condé Nast (an American mass media company) targeted Reddit (an American social news aggregation and discussion website), with a clear expansionary goal. The $20m acquisition was executed in 2006 but subsequently reverted in 2011. As a matter of fact, Reddit grew well beyond expectations in the mentioned timeframe, and Condé Nast found itself incapable of further sustaining and supporting the pace of growth. Reddit was indeed forced to be operating under a severely restricted budget, which could not even fulfil the company’s basic needs. Having realized this, Condé Nast decided to spin-off Reddit, so as to let the company pursue its own expansionary goals.
Sometimes M&A transactions simply strategically fail in their attempt to achieve the pre-determined goals and synergies that the deal was expected to generate, due to managerial strategic errors.
A powerful explanatory example of this circumstance is provided by the Kraft-Heinz case. The two companies (i.e. H.J. Heinz Co. and The Kraft Foods Group) merged in 2015, in a massive $49bn transaction. The consolidation was expected to evolve and exploit synergies, mainly pointing at an international growth, through economies of scale. In the aftermath of the merger, the two parties adopted the so-called “zero-based budgeting”, which provided for some strong measures to reduce all costs. According to the rules of this game, the managers were asked to provide detailed explanations of all the expenses to be incurred in the incipient year from scratch, as opposed to the common practice of adding/removing percentage points from the previous years’ estimates. Specifically, the policy was targeting SG&A and R&D items, for an overall estimated $1.5bn cost savings by 2017. In 2016, Harvard Business School screened the case, eventually providing its own point of view about the managers’ approach; according to the analysts, the technique at issue was not to be considered as a “wonder diet for the companies”. The prophecy was confirmed in February 2019, when Kraft Heinz disclosed falling revenues and margins, rising debt and zero growth. As a matter of fact, the first pieces of evidence of the failure of the strategy had already started rising in 2015, when Kraft Heinz started realizing that profits were exclusively driven by savings. At the time, the executives decided not to change the approach, and indeed cut marketing costs even further. It is now clear that the brand has been damaged permanently, and the market is still closely examining how the Berkshire Hathaway – 3G owned entity will carry on its business in the months to come.
Failure of due diligence
Before a deal takes place, buyers conduct due diligence procedures, thoroughly screening the targeted Before a deal takes place, buyers conduct due diligence procedures, thoroughly screening the targeted company. Despite the efforts that the acquirer might put into the research, sometimes it overlooks important information about the company. Specifically, outsiders seldom grasp its exposure to intangible risk factors or, in some circumstances, fraud and improper revenues recognition.
A clear example of a failure in the screening of the targeted company is represented by HP’s $11bn acquisition of Autonomy, a British software developer. The transaction took place back in 2011 and embodied a 64% premium, since Autonomy recorded a $1bn revenues in 2010 and was boasting a consistent track record of double-digit revenue growth, with 87% gross margins and 43% operating margins. As a matter of fact, the British company turned out to have been cheating on revenues growth, by inflating figures and backdating transactions, so to meet forecasts year after year. Indeed, an attentive observer should have been suspicious about the fairness of a company who has been systematically perfectly matching analysts’ expectations (with an error margin of 4%) for the 10 quarters preceding the acquisition. Anyhow, HP realized those accounting irregularities only in early 2014, thanks to an enquiry led by the company’s own legal firm, Proskauer Rose LLP. Unfortunately, by that time, HP had already been forced to make an $8.8bn write-down on Autonomy.
Another main driver of failures in an M&A transaction is to be found in the changes in the business environment and in the business cycle itself. Neither managers nor advisers have much power to completely hedge these risks.
An example of how external factors can interfere in corporate plans is represented by American Online – Time Warner case. Still being counted among the biggest mergers in history, the $165bn transaction at issue took place back in 2000, pointing at heralding the future of content distribution via the Internet. Useless to say, due to the bubbles that have eventually burst in the months that immediately followed, the object was never achieved. Before actually spinning-off AOL, Time Warner’s executives declared they would have rather waited, in order to see how much of the company’s troubles were a consequence of the cyclical nature of the economy, and how much instead was permanent. By the end of 2009, when AOL was valued at $3.44bn (against the $163bn market capitalization it displayed at the time when the merger was executed), Time Warner Inc. finally realized “AOL has been a distraction for a number of years”, “we are pleased to announce AOL will be on its own”. Therefore, the spin-off was executed on December 9th, leaving Time Warner focused on content, and luckily not deleting the company from the list of profitable cable networks. Once again, plans were potentially value-accretive, but external factors and extant bubbles interfered with the results.
With more than half of the M&A deals failing, companies entering such transactions should always keep a backup plan, so to be prompt in disengaging in a timely manner, thus avoiding further losses. Or, at least, they should be quick and responsive in implementing a B-plan, in case they have suspect that the A-plan is doomed to failure.
A successful case-study, in which the involved company demonstrated its responsiveness in going around potential obstacles, is the one from Cadbury Schweppes. In 2007, the group was planning to de-merge its US fizzy drinks business. For obvious antitrust reasons, the corporation was not allowed to receive any offer from PepsiCo or CocaCola. Therefore, the best option seemed to be the sale to a private equity fund, ideally for £6.5bn. However, the clouds of the financial crisis were already approaching, and the credit crunch prevented private equity funds from raising the capital they would have needed to carry out the transaction. At this point, it became clear that Cadbury Schweppes was forced to find an alternative solution. What the corporation came up with, the following year, was a brave IPO on the NYSE, in which Cadbury listed its fizzy drinks unit as a separate entity. In May 2008, Dr Pepper Snapple Group successfully landed at the NYSE, yet not without huge de-merger costs.
Assessment of alternatives
Most of the times, the core aim of an expensive and demanding M&A transaction is that of surpassing competitors. The question companies should instead start addressing more attentively is the following: “Are there alternative ways to achieve the same leadership and growth goal, besides acquiring or merging with some targeted entities?”. In other words, corporations should rather start considering other paths to success, such as developing new products, becoming a sale target themselves, or engaging in strategic collaborations.
Once again, the case-study the article will present concerns a successful implementation of an accurate assessment of alternatives. Indeed, earlier this year, Newmont Mining Corp. declined a $17.8bn hostile bid from Barrick Gold Corp. As a matter of fact, both the two involved parties have realized the current timeframe does not provide for the best conditions for a merger. Moreover, both the two American corporations have declared their main goal was that of extracting value from the recently uncovered Nevada’s gold mines, in the shortest possible timeframe. Therefore, they were definitely not willing to go through months of costly negotiations, mainly on the grounds of the huge opportunity and transaction costs that they would have incurred. This is the reason why they have recently disclosed their joint venture plans, which will allow the two parties to start operating promptly and friendly, with an expected $4.7bn in synergies ahead.