Wall Street Journal
February 22, 1999
 

What Acquiring Minds
Need to Know

By Mark L. Sirower, a visiting professor at the University of Pennsylvania's Wharton School and author of "The Synergy Trap: How Companies Lose the Acquisition Game" (Free Press, 1997).

It's the age of the mega-acquisition: In 1998, 190 deals involving an American target company valued over $1 billion were announced. And the pace hasn't slackened this year. What does it take to make a successful acquisition? It's fashionable to assert that acquirers must "move fast and decisively," "integrate carefully" and achieve "quick wins." But because large acquisitions bring with them immense performance demands and organizational disruption, what's really important is that there be a clear plan in place long before the corporate checkbook is opened. Wake up the morning after to sort out the details, and you'll end up with a disaster. Little wonder so many acquisitions fall short of expectations.

Mega-acquisitions must be evaluated like any acquisition decision: Can the acquirer make competitive changes that create performance gains over the already expected improvements--what is often called synergy--that justify the takeover premium (the price paid above the acquired firm's market value)? Acquisitions require an extraordinary amount of financial and strategic analysis and organizational planning. They entail tremendous and immediate risk because all the money is paid up front. Once integration begins, reversing a failing acquisition only becomes more painful.

The central dilemma for executives today is that just as they are under increasing pressure to build shareholder value, the chief method they have used to facilitate strategic growth--mergers and acquisitions--is, on balance, hurting their shareholders. Despite all the hype that the 1990s deals are "more strategic" than the deals of the 1980s, the evidence shows that today's large deals are no more likely to succeed. I recently completed a study of 100 large deals made between 1994-97. Just as with the large deals of the '80s, roughly two-thirds of these deals met with negative market reactions and for the most part remained underperformers a year later. It turns out that markets are amazingly proficient in projecting deals' performance gains. Also as in the 1980s, the worst performance on average is associated with higher acquisition premiums.

Even experienced acquirers with great track records are not immune. Two well-known large failures of the 1990s, Quaker's acquisition of Snapple and Novell's acquisition of WordPerfect, were surprises because both Quaker and Novell had had great success with past acquisitions. Newell, a company with an excellent track record of making small consumer products acquisitions, recently lost close to $1 billion of market value, the entire amount of the premium, on its purchase of Rubbermaid. Its stock has continued to underperform the market. Conseco, which had a string of successful acquisitions in the insurance business, paid an 83% premium for the subprime lender Green Tree Financial. Since announcement of the deal last April, Conseco's shares have declined by more than half--the entire $7.6 billion announced value of the Green Tree acquisition. Chalk up another disappointing experiment in getting synergies from cross-selling financial services.

The evidence is consistent with a comment made by Warren Hellman, former head of Lehman Brothers: "So many mergers fail to deliver what they promise that there should be a presumption of failure. The burden of proof should be on showing that anything really good is likely to come out of one." Senior executives must meet this burden of proof in explaining their acquisition plans not only to markets but to their own organizations.

It's a challenge just achieving the expected performance improvements already built into preacquisition market values--what I call the base case. Steve O'Byrne of Shareholder Value Advisors has calculated that the expectations of future growth account for more than 60% of the average company's market value, up from roughly 40% a decade ago. Companies must run harder than ever just to stay in place, let alone to improve performance enough to justify their market value plus a premium. Even with an identifiable strategy and a well-articulated integration plan, large acquisitions are especially susceptible to three critical risk areas that can upset the best-laid plans:

Focus. One of the most common mistakes in postacquisition integration is to divert resources from some businesses to go after performance gains in others. The common result: a damaged base case in one business, which cancels out the gains in the other. There is a good reason that Daimler announced last November that it would keep almost all of its automotive operations separate from Chrysler's. If resources get diverted from preserving the base cases of the automotive operations, and if there is any confusion from customers, the combined company can do a lot worse than not paying off the premium. In the Quaker/Snapple deal, not only was Quaker not able to manage the base case of Snapple but the damage took a toll on its core businesses.

Competitor response. Competitors will not sit still while an acquirer attempts to generate synergies at their expense. Only when an acquisition represents a realistic strategy not easily replicated by competitors does any possibility exist to justify the transaction. What's more, acquisitions increase vulnerability to competitive attacks, because acquirers often allow the challenge of integrating organizations to divert their attention away from the competition. The week after Quaker announced it was acquiring Snapple, Coca-Cola expanded its competing Fruitopia line; it also matched Snapple's ad budget. Acquisitions also create an opportunity for competitors to poach talent. After Deutsche Bank's recent acquisition of Bankers Trust, it ended up having to pay huge sums on top of the acquisition premium to retain both banks' top-performing managers.

Strategy and organizational design. Perhaps the most important challenge is to determine what is the new mission of the combined organization and how to organize to accomplish the new mission. This is the heart of what is often called "culture" clashes. Mega-acquisitions by their nature are especially difficult to plan, value and execute. They involve incredibly complex organizations with unique histories and vast webs of formal and informal relationships, both internal and external. Too often acquirers only describe what the projected cost savings will be and how many people will be fired. But merging organizations may need to create very different organizational structures and incentives to pursue a new strategy. Sony had no management team in place when it acquired Columbia Pictures. Citigroup, the combination of Citibank and Travelers, is already having problems with unexpected departures from its top management team.

For an example of how to do it right, consider Gillette's 1996 acquisition of Duracell for $7.5 billion. Gillette had examined Duracell for several years and the company met Gillette's clear acquisition criteria. Since the closing of the deal, Gillette has transferred manufacturing expertise to Duracell's products, creating manufacturing efficiencies. More important, Duracell's strong brand has capitalized on Gillette's world-wide distribution power, giving it better access to customers. Competitors cannot easily replicate these advantages.

But Gillette/Duracell is a happy exception. Just as in the 1980s, the majority of today's mega-acquisitions are likely to be judged as unsuccessful. About one in three will be an unambiguous loser for shareholders. With most of today's large deals paid for with the stock of the acquirer, executives of both companies owe their shareholders a duty of care in making these decisions. The markets will continue to punish uninformed and poorly executed acquisitions rapidly and severely--and shareholders will not soon forget.