New research turns conventional wisdom about successful company acquisitions on its head
One irony of takeovers is that shareholders in the target company often enjoy windfall gains, while employees suffer disruption, uncertainty and loss. Another irony that fascinates business economists is that shares in the predator company frequently underperform after the acquisition. Could the two be linked?
The question is of more than academic interest. Worldwide merger and acquisition activity reached an astonishing $2,242bn (£1,485bn) in the last quarter of 1999 and first quarter of this year, according to Thomson Financial Securities Data. Two years ago the figure for the comparable six-month period was $1,077bn. The deals are bigger too; those whose value has been disclosed are worth an average $295m, almost double what they were two years ago.
Although mergers have become more popular, they are as hard as ever to pull off. Cambridge university's Judge Institute looked at 77 large takeovers by UK companies from 1990 to 1996. It found that shares in the acquiring companies underperformed the FT All-Share index by an average of 18 per cent in the two years after their deals.
The secret of success, according to the conventional wisdom, is for predators to act fast. They should integrate the target company as completely as possible and make it absolutely clear who is boss and which corporate culture will dominate.
But a new study* turns this on its head. The research, by PA Consulting Group and the University of Edinburgh Management School, suggests that acquirers who avoid the slash-and-burn approach enjoy better shareholder returns. Deals should take a selective rather than an all-embracing approach to integration. Acquirers are more likely to be successful if they recognise the existence of cultural differences and, before the deal closes, form an "integration team" that includes a substantial number of staff from the target company.
The PA study set out to establish objectively how acquirers could reduce the risks involved in post-merger integration. It surveyed 85 companies that made acquisitions worth at least £50m between the start of 1997 and mid-1999. The takeover targets were all UK-based, with buyers mainly from the UK, but also from North America, Australia, Belgium, Finland, Ireland and the Netherlands.
The researchers evaluated different approaches to post-merger integration according to short-term shareholder returns. They calculated these from the difference between share-price performance immediately before and after the merger announcement and its predicted value had the deal not taken place. (Previous research found a strong correlation between short-term share-price movements and long-term cash flows.)
The methods that appear to add shareholder value include early and detailed planning and communication, regular cash-based reports on progress, and explicit rewards for staff who achieve a successful integration.
Jeremy Stanyard, head of PA Consulting's M&A team, says speed is as important as ever. "But people have mistaken this for doing everything very quickly. We're saying you should do certain things very quickly, but be selective about what you do."
In one merger, two sales and marketing departments that had been deadly rivals were hastily integrated, leading to confusion over brand management and the loss of key people.
John McGrath, chief executive of Diageo, the food and drink group, is persuaded by the research findings. "There are dangers in over-integration, or in moving too fast in an attempt to realise all your synergies at once," says the man who presided over the 1997 merger of Guinness and Grand Metropolitan. "It's a question of identifying where value is being created, and then making sure you protect it during the integration process."
Few companies can be happy to see knowledgeable and talented staff walking out of the door. Why then, is it common to ride roughshod over people, even though that causes damaging culture clashes and can diminish employees' commitment?
Rob Yeung, a business psychologist at the London office of the Nicholson McBride consultancy, says acquisitions are often driven by ego. "In many organisations that say they'll respect the target company's values, they're only paying lip service to it," he says. "They don't promote the best and brightest people, but the people who are best for their own purposes."
Even sensitivity after the merger will not save deals that are done for the wrong reasons. The PA study also found that the motive for the merger appears to have a crucial effect. Acquisitions aimed primarily at cost savings are found to produce no shareholder benefits. By contrast, those aimed at increasing revenues, gaining access to new markets, or acquiring technology, do tend to deliver value.
Mr Stanyard believes that markets question the strategic value of cost reduction on its own. "If the acquired company becomes leaner and fitter, is that doing anything to take the combined company forward strategically?"
In their book After the Merger**, three consultants with A.T. Kearney in Germany support this view. Synergies aimed at "efficiency", rather than growth, can also have an unwelcome psychological impact on employees of the target company. Merged companies seek "early wins", such as factory closures and job cuts, but the antipathy that is stirred up can cause them to backfire.
"There can be no truly successful merger without growth," the book's authors argue. "The perspective of something positive and expansive creates a much more favourable and optimistic climate than the fear of shrinkage and loss."
And what methods do the masters of acquisition recommend? A discussion between several well-known managers that featured in the latest edition of Harvard Business Review supports PA's finding that a high degree of cultural integration is not always appropriate.
"You can't try to slam every acquisition into one mould," says Ed Liddy, chief executive of Allstate, the large US insurance company that has made a series of acquisitions in the past 15 months. "In some cases, we've completely integrated them into Allstate. But in other cases, much to the chagrin of our very good Allstate executives, I've said: 'I don't want to Allstate-ise them. I want them to be separate'. What you do with an acquisition depends on the channels and the products that you and the acquired company are in."
The discussion also highlights sharply divergent views among chief executives from different sectors and countries about the importance of both cost reduction and culture. Dennis Kozlowski, chief executive of Tyco International, the acquisitive US manufacturing and service group, says takeovers work best when cost reduction is the main rationale. "You can define, measure and capture them. But there's more risk with revenue enhancements; they're much more difficult to implement."
This is not the view of Jan Leschly, recently retired as chief executive of SmithKline Beecham, which failed to merge with Glaxo Wellcome under his leadership in 1998, only to do so now. "When we look at acquisitions, we focus on revenues because our production costs, once we've developed a drug, are minimal. So if we can increase revenues, we're in great shape. And what really drives revenues in the drug business is R&D."
Mr Leschly argues that differences between British and American management philosophies can be almost impossible to reconcile. But Mr Kozlowski retorts: "I've never seen a deal really fall apart on a culture issue - or any soft issue. Most collapse on price, and managers just use soft issues as an excuse."
Mr Kozlowski does, however, take cultural issues very seriously. "Moving fast and getting the right people in place are extremely important. At Tyco, we look to the companies we acquire to provide those people."
In one case, Tyco took 25 people from the acquired company to a small town in Germany for a weekend to consider ways of changing the business. "They came up with a drastically different organisational structure for the company, which we implemented pretty well 100 per cent."
If a deal's success depends so heavily on fostering a culture in which employees feel respected and involved, what are the chances for hostile takeovers? Mr Kozlowski is characteristically forthright. "It's almost impossible to build such a culture when you do hostile acquisitions, which is why we don't do them."
*Creating shareholder value from acquisition integration, available from Sheonagh Friend at PA Consulting, 020 7333 5260 or email: m-a@pa-consulting.com.
**After the Merger, published by Financial Times Prentice Hall.
© Financial Times 2000
For more information, please see the M&A area on the PA Web site and our press release on this research.
