The cold light of experience can often save management teams the high price of wishful thinking. Keith Roberts says using empirical research can make the difference between getting acquisitions right or wrong
Most acquisitions destroy shareholder value for one or more of four reasons. The first is the most commonly repeated mistake: the company being acquired is valued incorrectly. Marconi bought several US telecoms companies for their internet equipment, on the basis of inflated prices. The acquisition spree left Marconi heavily indebted. In short, it did not assess its targets' strategic fundamentals in what was a bubble market, and, as a result, overvalued the candidates. The fundamentals it should have looked at more closely were competitive strength, leanness of production, market attractiveness and the strength of the management.
Secondly, the enthusiastic merger or acquirer does not always understand the true potential of the combined company, or lack of it. Regrettably, this was the case in the merger of Royal Insurance & Sun Alliance, whose logic was to achieve critical mass in casualty and life assurance businesses. They have now had to exit life assurance. It would appear that they misunderstood where the potential of the merger lay.
Thirdly, an acquirer can be motivated by completely the wrong drivers. This was clearly the case when Vivendi bought Seagram's media assets (Universal). They assumed that controlling the entertainment pipeline from content to distribution was the key to success. In fact vertical integration often causes more problems than it solves.
Finally, foreseeable but unexpected events do happen, even to the most robust businesses. The value of trying to predict the most pessimistic scenarios should not be underestimated.
Is there a formula for avoiding all of the these hazards? Perhaps not, but empirical research taken from an established source of hard scientific data will help an acquirer prove the worth of a target company. Such an assessment can improve the likely shift in shareholder value by up to 15%, in that it will quantify the true value and future potential of a business, based on buying future cash flow.
It is essential that companies gain a strategic understanding of what is driving the business they are buying so that they can measure how a change of ownership can improve things. Investing in research into how structurally similar companies (or strategic peers) have behaved in the past will help acquirers to determine whether the target company is already delivering a higher or lower return on investment than expected (par ROI). It will quantify potential growth. Crucially, such research will also help acquirers paint alternative scenarios of the combined business performance - pessimistic but necessary - and will determine whether the company fits the acquirer's corporate strategy and culture.
Does the acquisition target complement your business?
The value gained from cross-examining the differences between previous winners and losers in the same situation and, then determining the most successful strategies to increase ROI and/or profitable growth, is a useful weapon. By analysing business unit profiles and understanding market characteristics, this approach determines what the target company needs to do differently to achieve potential in marketing, cost control, HR, innovation and diversification. It then quantifies the risk of of the alternative scenarios that have been evaluated. It will also assess the target's capability to deliver change.
Acquirers should acknowledge that businesses will have been dressed up for sale. A scientific analysis will help them select organisations that will genuinely deliver. This means being bolder about taking on problem companies. These will have the potential to deliver increased shareholder value, assuming that there is synergy with the acquirer and that necessary changes are made quickly.
Management teams tend to assume that the competitive climate will continue 'as was'. Discontinuity surprises people, and, when companies change the rules of the game, the behaviour of stakeholders can be highly unpredictable. Managers need to avoid the unseen by painting pessimistic scenarios and analysing how they might affect performance. My own company's database has shown time and again that, when a company falls off a cliff, there are certain scenarios you can expect to see. Planning ahead in this way will help companies avoid entering markets that will not perform in their favour.
Buying a well-managed company involves paying a high price. You need to be sure the business is worth it, and that you can integrate the acquired managers into your culture. Existing intellectual capital will not necessarily stick around, so what you are really buying into is the robustness of the business itself.
There are more downsides. A business that was performing above par can come down to par with a bump. Many companies are on record as saying that they will only buy well-managed companies. Yet this is a high-risk strategy. Thinking instead about marketplace opportunities is wiser.
Post-acquisition
In the period that follows an acquisition, organisational culture often leans towards being control orientated. This happens because control freaks can always make the case for more control in an uncertain climate. Often mergers are successful at driving down costs, but not at being innovative and creative in their drive to get new growth. This may be a sensible approach, but companies must ask themselves how long they can afford not to concentrate on innovation. They might also want to think twice about the type of managers that will be most useful to them in the new business structure.
Even before plans are finalised, companies must consider the implications of merging two company cultures and must be clear about the positioning of the merged business. Measure the right things and set the right targets and benchmarks promptly.
It is better to get it nearly right quickly than get it precisely right over three years.
Keith Roberts is managing director of business strategy consultants PIMS Associates.The PIMS database holds data from over 4,100 companies, Tel: 020 7776 2800, E-mail: kjr@pims-europe.com
