Mergers and acquisitions: Four steps to deliver value

Mergers and acquisitions (M&A) are increasing again as corporates and private equity start to stir in pursuit of growth.

Improvements in liquidity and falling interest rates are helping to reignite M&A inspired growth. And while political uncertainty and tariff concerns are currently holding back activity, these should be resolved in due course.

Even so, pursuing growth through M&A is a risky business. The research is largely consistent in its findings and delivers a damning verdict on the outcomes. In fact, M&A deals are more likely to destroy value than create it.

So why do industry leaders continue to tread such a treacherous path?

Many do so because they are under pressure from investors to grow the business. In most industries, organic growth is too slow to satisfy those investors and their desire for rapid returns. M&A offers the prospect of more rapid growth - at the cost of significant risk.

However, there are means of managing and containing those risks to ensure your M&A strategy does create profitable growth and value for your investors.

The following advice to improve outcomes is based on years of practical experience and research, which identified some of the main causes of bad performance and how to avoid them.

1 Be strategic

We know that going big with acquisitions almost invariably destroys value. It's no wonder that when large bids are announced, the bidder’s shareholders collectively sigh and many sell up.

Large acquisitions are usually highly priced, introduce high levels of risk, and are difficult to integrate due to their sheer complexity and scale.

There are two rules to M&A strategy. First, go small but do it repeatedly to create low risk and fairly priced growth.

Secondly, pursue a strategy which allows synergies to be developed from the acquisitions. For example supply chain benefits from collective buying, or from selling and marketing through a common recognisable brand.

More often than not, such strategies are successful and as a result, they are frequently pursued by both corporates and private equity owners.

We see Compass, the UK listed global outsourced caterer, pursuing such a strategy over the long term to create consistent investor growth. Private equity are also known for their ‘buy and build’ strategies.

2 Do not overpay

The easiest and most frequent way of destroying long term value is to pay too much.

No one does that deliberately, but determination to do a deal often results in the acquiring party paying far more than a business is worth.

Corporates are often driven by FOMO - fear of missing out. Their strategic belief is that if they don’t buy a target business when it becomes available, they may never own it.

Worse still, a competitor may buy that business instead.

However, there are ways of valuing a business, both as a standalone entity and including the various benefits from integrating. This value should be your north star during negotiations over the price you are willing to pay.

Too often, corporates sacrifice the future benefits of a merger or acquisition by allowing the price to exceed this value.

For example, take the $106 bn merger between two of the world's largest brewers, when AB InBev bought SABMiller in 2016.

The objective was to create a formidable enterprise that produced one in every three beers consumed globally. But that $106 bn price was steep at 17 times SABMiller's earnings. And by the time ABInBev had made the various forced sales of acquired businesses in North America, Europe, and China, which were required by rulings of the regional competition authorities, the cost of the acquisition stood at a staggering 23 times earnings.

As a result, the share price plummeted. Nine years on, it has recovered somewhat, but still shows a 30 per cent discount on the price paid at the time of the deal.

3 Due diligence matters

Time and time again businesses ignore the due diligence findings because they are so determined to do the deal.

Fred Goodwin, former CEO of RBS, admitted that virtually no due diligence had been done prior to its deal for fellow bank ABN-AMRO when he was questioned at the inquiry into the ill fated €71 bn deal.

That due diligence was have revealed that ABN-AMRO was well stocked with sub-prime mortgage bonds and synthetics prior to the deal in 2007. Those became worthless in the following banking crash and the UK Government had little option but to rescue RBS.

In the case of AB InBev, the legal due diligence must have identified the likelihood of competition inspired divestments. Clearly those warnings were ignored and the worst case projections became reality.

Other well known disasters include Bayer’s $66 bn acquisition of Monsanto in 2016. After completing the deal, Bayer found itself saddled with a huge number of class actions over the ill effects of Monsanto’s long selling weed killer Roundup. It had acquired a major liability.

The risks must have been apparent in the due diligence, only to be ignored due to the determination to acquire Monsanto. Bayer’s value now is hovering at around 30 - 40 per cent of its price at the time of the acquisition. Perhaps next time they will all take the due diligence findings a little more seriously.

4 Integration, integration, integration

Integration is a perpetual problem area for acquirers. Forecast benefits are rarely achieved following integration for a number of reasons.

Top of the list is lack of planning. Integration teams are often only told of an acquisition when it has already happened. Secrecy over the deal may be a factor. Deal teams consisting of corporate finance, accountants, lawyers and other advisors are usually quite separate from the operational integration team.

Many deals fail in the making, so acquirers often think that they will worry about integration when the deal is done.

But in reality, effective integrations are planned in advance with meticulous detail using the due diligence. Adequate resources to complete the integration should be allocated in advance.

To make matters worse the chosen mode of integration is often wrong and inconsistent, with the strategy presenting still more problems.

Choosing the right type of integration - such as complete integration versus light touch - does matter. Similarly the decision to go fast or slow is also important.

Typically acquisitions of businesses who are competitors in the same industry should choose a rapid and complete integration approach. Whereas acquisitions of businesses for their knowledge or technology should be light touch or the key people who have the sought after knowledge will likely leave.

In conclusion there is much that can be done to improve M&A outcomes.

Many businesses are successful with their longer term strategy. Most will consistently go small, avoid overpaying, pay attention to their due diligence, and carefully plan and resource the integration in advance.

This requires objectivity in decision-making and discipline in sticking to the basic rules. However, it can pay dividends for the management team and investors alike.

This article is adapted from a piece that was originally published by Management Today.

Further reading:

Four rules to avoid value in mergers and acquisitions

Six tips to find hidden value in tech M&A

Deliveroo investors are paying the price amid takeover

How to build corporate transformation capabilities

John Colley is Professor of Practice in Strategy and International Business at Warwick Business School and author of The Unwritten Rules of M&A: Mergers and Acquisitions that Deliver Growth - Learning from Private Equity.

Learn how to add value and avoid common pitfalls in M&A with the three day programme, Mergers and Acquisitions: How to Maximise Success, at WBS London at The Shard.

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