Keys to Winning the M&A Game Before the Deal is Signed
History has shown that 60% to 90% of all M&A deals fall well short of expectations and fail to create value. The track record of M&A failures is overwhelming and the odds are such that you have a much better chance of winning by placing a bet on a gaming table in Las Vegas than by playing the M&A game.
So how do you win at the M&A game?
The success, or failure, of any acquisition is forged long before the deal is ever signed and involves strategic rationale, clear objectives, integration planning, and cultural fit.
Success Starts with Strategy
The pursuit of a deal should be driven from a well thought out corporate strategy. The strategy prioritizes how a company’s money and resources will be invested to achieve growth through an appropriate mix of organic and inorganic (acquisitive) objectives. However, I’m astonished how often a deal is pursued because it’s opportunistic; a reaction to competition; swept up in an M&A buying frenzy; or, a short term fix to boost financials. In these cases, the corporate strategy is overly broad; or, tweaked and contorted to rationalize doing the deal. In most companies, commanding and determined CEOs drive the overall corporate strategy and if they decide they want to buy a company, they’ll simply tweak the strategy to justify getting the deal done.
One notable example of this was the acquisition of the $40M VoIP company Skype by eBay in 2005 for $2.6B. In the 75 page presentation eBay’s CEO gave investors justifying this expensive deal, she explained the strategic rationale and spoke of increasing transaction volume and fees by allowing buyers and sellers to talk directly with one another over their PCs. In that same meeting, the CFO was quoted to have posed the rhetorical question, “How do we make 1+1 equal to greater than 2?”. Investors left that meeting scratching their heads.
The reality was that the online marketplace in the U.S. was slowing while Skype (and VoIP in general) was growing rapidly. Skype had 54 million users and claimed to be adding 150K more every day. Internet based companies like eBay were all vying to capture new users as internet usage rapidly expanded globally and skeptics believed the Skype acquisition was little more than a desperate attempt to grow subscribers. Beyond its rapid subscriber growth, Skype was projecting to grow its revenues from $60M to $200M the following year. eBay believed Skype would be a much needed financial shot in the arm and, in the buying frenzy occurring at that time, eBay needed to move aggressively to snap up Skype before competitors Google and Yahoo did.
Unfortunately, the success eBay had hoped for did not materialize and in 2009 they unloaded Skype to a group of private investors (eBay maintained a minority interest) who in turn sold Skype to Microsoft. There were a number of reasons why the Skype acquisition failed; but, the fundamental reason was that buyers and sellers preferred the anonymity and documentation trail afforded by email and they had no desire to talk directly to one another. The acquisition of Skype was a gamble and the strategic fit was unclear, or at best, contorted, to justify it.
Companies that are successful acquirers don’t gamble their future by placing bets on companies that aren’t an integral part of their overall corporate strategy. Corporate strategy should drive deals and each deal should be directly linked to the fulfilment of specific strategic goals. Doing a deal for any other reason is tantamount to gambling shareholder value and gambling is best left to the Venture Capitalists and Las Vegas.
Objectives and the Integration Plan Drive Success
Assuming the deal you’re about to do is a direct result of a well thought out corporate strategy; the next key to success is to make sure you define clear, concise, and realistic objectives and Critical Success Factors (CSFs) for the acquisition. Defining clear and specific objectives and CSFs for the acquisition helps to ensure that all the stakeholders are on the same page in terms of what the success of the acquisition means and how it will be accomplished. They’re designed to turn the strategic goals behind why you’re doing the deal into clear and measurable actions that define what success for the deal means. The objectives and CSFs also serve as the foundation upon which the Integration Plan is built and executed upon after the deal is done. The Integration Plan details the specific deliverables for how the objectives and CSFs you’ve defined for the deal will be achieved. The objectives and CSFs also serve as input into the revenue and cost synergies that are baked into the financial models that are used to justify the deal with the board. These same financial models ultimately become part of the company’s operating plans which are used to measure the financial performance of the acquisition after the deal is done.
By far, the number one criteria acquirers’ use for evaluating a deal relies on the financial model and more specifically on the accretiveness of the deal on EPS. In a 2013 AT Kearney survey of M&A stakeholders they found that EPS accretion /dilution was the most used metric for the evaluation of a deal by a 2 to 1 margin over the next closest criteria and nearly three times more important than cultural fit and core capabilities. The focus on EPS has been criticized as questionable and misleading for years and yet this metric is still the number one criteria used for deal evaluation. An overemphasis on financial metrics such as EPS often has an adverse effect on the operational objectives and integration plan that are essential to the success of an acquisition.
I’ve been involved in a number of preliminary deal reviews where the first thing the CEO would do is flip through 100+ slides to the one that showed the deals’ impact on EPS. If the deal was accretive, the meeting would be allowed to continue. If it was only slightly accretive, or worse yet, dilutive, the deal team and executive business sponsor would be dismissed with the feedback that, “If this is the best you can do, we’re not doing this deal”. What this meant was that the team needed to find more synergies by boosting revenues and/or cutting more costs. In some cases this resulted in objectives being built into the financial model that couldn’t realistically be accomplished during the post-merger integration. In one of the worst cases I’ve seen, the deal team was dismissed because the deal was dilutive and they were indeed able to find more revenue and cost synergies; however, the objectives and CSFs that would be required to achieve them bordered on the fanciful. Somehow these unrealistic operating assumptions got lost in the 120 page slide deck used to justify the deal. However, the one slide showing the EPS impact did flip the deal from being dilutive to accretive. Needless to say, the post-merger integration plan for achieving the synergies and objectives for the acquisition was dead on arrival.
Culture Eats Strategy for Breakfast
Strategic fit along with clear and realistic objectives and an integration plan to put these into action are essential to the success of any acquisition; however, in my experience, the most important determinant of the ultimate success of any acquisition is the cultural fit between the two companies. As Peter Drucker so eloquently put it, “culture eats strategy for breakfast”.
According to Aon Hewitt, cultural integration was cited as the second most common direct factor for deal failure. In spite of the importance of culture to the success of a merger, it’s surprising how little attention is actually paid to culture prior to signing a deal. In the same research from AT Kearney previously cited, cultural assessment ranked at the bottom of the list at seventh place in emphasis when evaluating deals. Perhaps more startling is the finding from a Pritchett survey where 45% of large cap public companies surveyed said they don’t perform any cultural assessment when acquiring companies.
I happened to live through one of the most notable M&A failures due to cultural mismatch. When I was CIO of Teradata in 1991, we were acquired by NCR. Shortly before NCR acquired Teradata, AT&T had acquired NCR through a hostile takeover with the intention of having NCR take over their troubled PC division in what was intended as a reverse merger. These acquisitions were a tremendous clash of dramatically different cultures that ultimately resulted in epic failure.
At the time of the acquisition, Teradata was Inc Magazine’s fastest growing company for a five year period and the epitome of a rapid growth, high tech company. NCR on the other hand was a hundred year old cash register company with a culture and bureaucracy to match. I recall needing to procure critical servers to support our rapidly expanding business. Shortly after the deal closed, I eagerly met with NCR execs to seek approval of these capital purchases only to run into the bureaucracy of a company forged slowly over 100 years. I was accustomed to near real time approvals to support the meteoric growth of Teradata only to be told that the capital planning process at NCR had closed for the year and wouldn’t be revisited for almost twelve months. Surely, I thought, there must be an exception process within NCR to fund critical out of cycle requests such as mine. Indeed there was; however, I was told it would take at least three months to work through their process and that exceptions were rarely approved. It became immediately clear to me how dramatically different our corporate cultures were and at that point I realized NCR would slowly drain the life out of Teradata, and me. I resigned shortly thereafter. After many years, NCR was still unable to bridge the cultural divide with Teradata and they expelled the company by spinning it out in 2007.
Mergers are a lot like a marriage and every one of them will face adversity along the way. The more you’re aligned in your beliefs, behaviors, values, and vision of the future (i.e. culture), the easier it is to work through the tough times and not end up in a messy divorce. It’s rare when the cultures of two companies align perfectly and the reality is that in most cases there will be gaps. In some cases these cultural gaps can be very wide. In one case where a company acquired another with a culture that was vastly different than their own, it was explained, “we bought the best of the worst”. The key to success is to identify the cultural gaps and put a plan in place to address them before you ever sign the deal. In some cases, the gaps may be a deep cultural chasm that you’ll never be able to successfully bridge and you’re better off walking away from the deal.
Success is Determined before the Deal is Signed
The success, or failure, of every acquisition is determined before the deal is ever signed. Strategy needs to drive the deals that are targeted. Once a target is identified, clear, concise, and realistic objectives define what success means for the acquisition. Next, an integration plan turns those objectives into the actionable deliverables required to achieve success. Overarching all of these determinants of success; the M&A game is won, or lost, by how close the cultures fit and how well the cultural differences are addressed.
In my next article, I’ll explain the post-merger keys to success.