Firms that pursue takeovers should look to create value, not headlines. That’s one of the lessons I’ve picked up from some analysis of successful takeover strategies listed in the 2010 KPMG survey of global M&A. Here is a brief summary of their recommendations for approaches which are more likely to result in a takeover or merger..
(1) Don’t start with the deal (start the detail planning early)
The worst time to start evaluating the potential benefits and drawbacks of the deal is when the transaction is just about to be completed (or worse, just after). Integration planning needs to start as as soon as possible and it needs to be wide-ranging (i.e. not just limited to financial and marketing aspects).
(2) Define the strategy
Obvious really, but still essential. The buyer needs to have a clear and agreed understanding of the strategic rationale for the deal.
(3) Don’t just focus on costs
Cost synergies are important, but they shouldn’t be the only focus. It is important to work hard to identify and evaluate potential revenue synergies as well so that shareholders are better informed when they analyse whether to support the proposed deal.
(4) Focus due diligence on the future
The process of due diligence is often too focused on understanding the past performance of the target business. However, many takeover targets operate in markets which are changing rapidly - how reliable is the past in predicting performance in the future? For example, due diligence should critically analyse the competitive environment of the target, including the prospects for market growth.
(5) Is a takeover really the right answer?
A vital question to ask. Is a takeover the best option to deliver the growth objectives of the business? Are alternative external growth options a better bet (e.g. joint venture, licensing deals, strategic partnership etc). KPMG make the important point that some management teams become committed to takeovers too readily without critically evaluating whether an acquisition is the right tool.
(6) Recognise the hard truths about the soft issues
KPMG report a statistic that “45% of Fortune 500 CFOs blame post-M&A failure on unexpected people problems”. The key soft issues to address include choosing the right management team post deal, handling differences in culture between the buyer and target, and managing communication about the deal.
(7) One size does not fit all
An interesting one this - and a great “depends-on” evaluation point for students to make in an exam essay. There is no such thing as a standard takeover or merger. Every transaction has significant individual elements that need addressing in order to make it a success. Maybe a key customer needs to be brought on-board. Maybe there is a risk of the loss of highly-skilled and business-critical employees. Perhaps there is a strong entrepreneurial culture in the target business which needs to be embraced and nurtured in order for value to be created. Every takeover and merger is different - each requires careful thought and planning.
(8) Balance risk and reward
Another great point for evaluation. A business should not become over-reliant on acquisitions to sustain growth. As KPMG point out, being busy with takeovers is not the same thing as being busy creating value for shareholders. Once bought, every business needs detailed attention to make it even more successful.
Look at any major takeover or merger in the news and you’ll come across the concept of synergies….
For example:
‘‘The deal has potential synergies that make some observers drool.’‘
That’s the Wall Street Journal, commenting on Time Warner’s merger with AOL in 2000. How wrong they were!
But, sometimes the doubters are also proved wrong.
Back in 2004, investors and analysts were doubtful that Spanish banking giant Santander would be able to achieve its ambitious plan of stripping out £300million of costs from Abbey National when it made a £9.6bn bid. In fact, Santander delivered the £300million of cost synergies a year ahead of schedule. Profits at Abbey, which were £16million in the year of takeover, rose to £1.5bn at Santander UK in 2009.
More recently, the Kraft Foods takeover of Cadbury involved the acquirer (Kraft) assuming significant potential for cost and revenues synergies to help justify the price paid for Cadbury. At the time of the deal, Kraft targeted around £450million of annual cost savings by the end of the third year. It remains to be seen whether Kraft will achieve this target.
The role of synergies in M&A
The primary objective of any takeover is to create value for shareholders that exceeds the cost of the acquisition. In fact, synergies are fundamentally the only tangible justification for a takeover.
Synergies represent the extra value that can be created from the takeover. Assuming that the buyer has to pay a reasonable price for the takeover target, then no value has been created at that point.
For example, consider a business valued at £10 million by the market (e.g. from the market capitalisation on the stock market).
A buyer comes along and, after negotiation and due diligence, agrees to pay £13 million to complete the takeover. The buyer has paid a bid premium of 30% (or £3 million) to complete the takeover.
The shareholders of the target business are happy. But the shareholders of the buyer business will need to be convinced that the price was worth paying. They have had to pay £3 million over the apparent value
of the business to achieve the takeover.
How can the bid premium be justified? Only if the takeover achieves synergies worth at least £3 million in value terms (e.g. the NPV of future synergies).
In practice, synergies are “easier said than done.” While cost synergies are difficult to achieve, revenue synergies are even harder. The implication is that many mergers fail to live up to expectations and wind up destroying shareholder value rather than create it.
Cost synergies
Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations
Potential sources of cost synergies include:
- Headcount reduction (redundancies)
- Elimination of surplus facilities
- Reduced overheads (e.g. consolidate functions such as accounting, IT and marketing)
- Increased purchasing power (greater bargaining power with suppliers due to greater combined size)
Revenue synergies
Revenue synergies refer to the ability to sell more products/services or raise prices due to the deal.
Potential revenue synergies include:
- Marketing and selling complementary products
- Cross-selling into a new customer base
- Sharing distribution channels
- Access to new markets (e.g. through existing expertise of the takeover target)
- Reduced competition
I’ve spent a day reading through a detailed analysis of global takeover and merger evidence (“M&A”) written by accountants KPMG in 2011. The report is both comprehensive and complex. However, it contains some useful insights for students and teachers researching the key strategic issues raised by M&A. I have highlighted and summarised some of the key findings below.
Summary findings
Strategic growth remains the dominant driver for doing a deal, with market leaders wanting to retain and improve their market positions.
How many deals create value? Only 31% So, it’s still a high proportion of deals that fail to create value for the shareholders of the buying company. In essence, most M&A is bad news for shareholders
Increased scrutiny of proposed deals by stakeholders - management have to work harder to convince stakeholders (particularly shareholders) that there is real value in what they are buying.
Successful deals tend to be ones that focus on delivering growth (revenue) rather than by reducing costs.
Corporate buyers are becoming more careful in their selection of targets and are taking more time to avoid overpaying.
Increasingly, M&A transactions will be cross-border and multinational as firms seek to extend their activities beyond the mature Western economies towards emerging markets. This adds to the risks and complexities of M&A.
There is still a lot of work to be done to improve the way that HRM is integrated into the M&A process. Managers are still not focusing on areas that have been regularly singled-out as post-deal challenges, particularly dealing with the differences in corporate culture between the buyer and target business.
What are the main reasons for M&A?
For many companies surveyed, the main strategic driver of M&A is now revenue growth. They have come through a cost-reduction phase (prompted by the 2007-2009 credit crunch) and are now looking for opportunities to develop new markets, increase market share, and boost revenues
When asked about the rationale behind their takeovers, the survey indicates the following:
Increase market share / market presence: 48%
Geographic growth: 35%
Expand into a growing sector: 27%
Cost synergies: 19%
Investment opportunity: 18%
Enter a new market: 17%
Acquire a brand or additional service: 13%
Other: 12%
Diversify: 10%
The importance of synergies
For example, way back in 1999, KPMG reported on what they considered to be the “six keys to unlocking shareholder value” from takeovers and mergers, dividing them into two categories: hard keys and soft keys:
Hard keys:
Synergy evaluation
Integration project planning
Due diligence
Soft keys:
Management team
Cross-border & cultural issues addressed
Communication internally and externally
Fast-forward 13 years and HRM issues in takeovers and mergers are still prevalent. Staff retention is seen as the most important issue (28% stated it as a top issue) followed by managing different corporate cultures (25%). KPMG conclude that it is vital for acquirers to develop retention strategies to get people to stay long enough to make the deal a success.
Despite the well-documented impact of cultural issues on the success of M&A, due diligence on potential HRM issues is still a low priority. Whilst 81% of survey respondents said that they conducted financial due diligence on the takeover target, only 38% said that they did due diligence on HRM issues.
Lessons learned: what firms would do differently next time
In each survey, KPMG ask managers responsible to leading takeovers what they would do differently next time! This is great research evidence for students - it indicates the lessons learned from doing transactions. The three themes that recur each time this question is asked are;
- Better due diligence and planning
- Faster implementation & integration
- More attention to HRM and cultural issues.
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