By Alexandra Dent· On March 30, 2017
When a corporation is looking to kick start long term growth and improve performance metrics, it is not uncommon that they look to acquiring another company as a solution. The 20th Century brought about six periods of major merger activity, catalyzed by various political and technological forces. Last year may have been the start of the newest wave of this type, setting the new global record for the greatest value of M&A transactions at $4.7 trillion USD. This dramatic 42% increase from the previous year has so far shown no signs of slowing down, with 2016 demonstrating similar growth. What makes this particular bout of M&A activity unique however, is that it has so far been due more so to an increase in the scale of transactions than in their frequency.
Mega-mergers involve two well-established corporations looking to team up to create a single, more formidable force within their market. The resulting transaction must be valued at a minimum of $5 billion in order to make the cut — a threshold which is being surpassed far more often, and to a greater degree, than ever before.
2015 saw a plethora of notable deals take place, such as Charter’s $78 billion purchase of Time Warner Cable, AB InBev’s $100 billion takeover of SABMiller, and Dow and Dupont’s $130 billion merger of equals. 2016 has brought about yet another acquisition of Time Warner Cable, this time by AT&T for $85 billion, as well as Bayer’s $66 billion bid for Monsanto — which, if seen through, would be the largest agricultural takeover in history.
Canada has been following suit, with a number of deals having taken place since September that nearly reach the record value set by Rio Tinto’s $38 billion acquisition of Alcan in 2005. Enbridge announced a bid to buy Spectra Energy Corp. for $37 billion CAD, and Agrium Inc. and Potash Corporation of Saskatchewan Inc. announced a merger-of-equals transaction valued at $36 billion USD.
The increasing occurrence of mega-mergers is indicative of a significant return of confidence to the corporate sector. It is certainly refreshing to observe corporate giants carrying out more adventurous strategies, and this has caused many to view these deals as symptoms of a strengthening economy. While this trend towards confidence deviates from what we have grown used to in the past decade, it is not necessarily true that M&A deals always have happy endings.
Mergers are marketed as a means to create significant shareholder value through the benefits of larger, more diversified companies. While this may certainly be the goal executives have in mind when entering the process, it is achieved a discouragingly low proportion of times. According to the Harvard Business Review, approximately 70% to 90% of all M&A type deals fail to generate tangible long term growth for the companies involved. This is not to say that mergers do not pose a relevant model for achieving growth, but that this model often applied incorrectly — even by the most prolific of executive teams.
The process of marrying two companies is extremely complex and demands a significant amount of time and energy from all those involved. There are a number of places where mistakes can be made along the way, ranging from quantitative errors to clashing cultures.
Misjudging the value of a prospective acquisition has trapped a number of companies into vastly underwhelming partnerships. This was the case in the previously mentioned deal between Rio Tinto and Alcan, where the later was bought at a 65% premium in a bidding war. This deal is presently recognized as the largest, and arguably worst, that the mining industry has ever seen.
Incorrect forecasting before and during a transaction can also result in massive losses. When Kmart acquired Sears in 2005 for $11.5 billion, it did not anticipate the pullback in consumer spending that hit the retail sector in 2008. The newly managed Sears was not able to hold its own in the resulting increase of competition, and revenues dropped 10% from what they were previously.
Sometimes the issue is as simple as incompatible infrastructure. In Sprint and Nextel’s 2005 merger of equals, technological differences between the two parties were so profound that they were unable to from optimize their wireless infrastructure resources. After attempting to make things work for a number of years, the companies announced that Nextel was to be shut down in the summer of 2013.
One of the most reoccurring, yet unanticipated, threats to M&A deals is cultural fit. It is a key aspect in successfully integrating two companies together in a way that allows synergies to be realized. When not addressed proactively, this type of misalignment can end in disaster. AOL’s acquisition of Time Warner in 2000 is a perfect example of how clashing cultures can be deadly to deals that look near to perfect on paper. Despite the majority of individuals involved completing their due diligence on the quantitative side of the transaction, the companies’ management teams failed to create an effective strategy regarding cultural fit. The $164 billion deal went south shortly after its inception, due to the unbending natures of employees on every level of the two companies. When the companies announced their split 9 years later, their combined value had dropped by billions of dollars.
Many of these threats become more and more difficult to mitigate as the size of the corporations involved increases. Larger corporations tend to employ a greater number of systems, and these often operate at higher levels of complexity. They have thoroughly integrated infrastructure, and often embody incredibly well-established identities. It goes to say that mega-mergers carry a much greater risk than their smaller counterparts, and this is not something to be taken lightly.
When evaluating growth opportunities, management teams should pinpoint exactly what they are attempting to achieve, then follow through with a painstakingly thorough selection process in order to identify which prospects are not only attractive, but also realistic. There are a number of different strategies a company can adopt when carrying out an M&A deal, and each of these presents a valid formula for success. What is absolutely essential, however, is that the process be mapped out meticulously from start to finish.
Mergers carry a high degree of risk, and the greater their magnitude, the greater the consequences of their failure. Because of this, the mega-merger frenzy we are in the midst of should be met with caution as much as with excitement. Whenever over-confidence hits any sector of the corporate world, mistakes tend to be made that result in major losses. Today’s CEOs would be wise to remain skeptical when presented with M&A prospects, and look far beyond the numbers in order to assess their true value.