The M&A Paradox: Factors of Success and Failure in Mergers and Acquisitions
Why do experienced senior managers fail again and again in mergers and acquisitions (M&A)?1 For example, in a well-documented case, Daimler had to separate from Chrysler, which it had purchased approximately 10 years before, after continuous losses of billions of dollars. And in another case that was widely covered in newspapers, in October 2007, Patricia Russo, the CEO of the Alcatel-Lucent merger, admitted that after three sequential profit warnings, the results of the merger were lower than expected (The Associated Press, October 31, 2007). In contrast, few companies succeed persistently in M&A, such as Heinz, Unilever, and Electrolux.
Does the success of a few companies explain the continuous increase in the number of M&A? The main drivers for M&A relate to various growth opportunities such as acquiring new products, expansion into new geographical areas, or access to new customers. This is in addition to such motives as improving profitability and the company’s strategic capabilities and positioning. Thus, there is no surprise that the activity of M&A in 2011 showed continued recovery from the downturn of 2008 and 2009, despite the U.S. debt downgrade, Europe’s ongoing debt crisis, and heightened worries about global economic conditions.
Many research studies conducted over the decades clearly show that the rate of failures is at least 50 percent. In surveys conducted in recent years, the percentage of companies that failed to achieve the goals of the merger reached 83 percent. Following these findings, it can be expected that senior managers and boards of directors would avoid merger and acquisition activities as much as possible and would search for other strategies to achieve market share and profitability goals. However, reality indicates the opposite. The trend of mergers and acquisitions has been constantly increasing over the past 20 years. Moreover, the number of mergers and acquisitions and the sums of money invested in them have shattered the all-time record almost every year!
Global M&A deal volume rose from 27,460 transactions in 2010 to 30,366 in 2011, an 11 percent increase according to WilmerHale report from 2012 on M&A activity. Similarly, global M&A deal value increased 53 percent to $3.11 trillion in 2011, up from $2.03 trillion in 2010. Average global deal size grew to $102.6 million in 2011, up from $73.8 million in 2010. In the United States, the volume of M&A activity was fairly steady, increasing 7 percent, from 9,238 transactions in 2010 to 9,923 in 2011. U.S. deal value jumped 79 percent, from $887.3 billion in 2010 to $1.59 trillion in 2011, due to a spate of large transactions.
In Europe, both deal volume and deal value continued to increase from their 2010 levels. Deal volume increased 15 percent, from 11,736 transactions in 2010 to 13,501 in 2011. Boosted by a number of large transactions, total European deal value increased 91 percent, from $780.5 billion to $1.49 trillion. The Asia-Pacific region also experienced growth in deal volume and value. The number of Asia-Pacific deals increased 12 percent, from 7,970 transactions in 2010 to 8,905 in 2011, whereas aggregate deal value increased 26 percent, from $652.5 billion to $822.2 billion. According to Bloomberg’s M&A report from 2012, China’s appetite for buying opportunities continued to increase, with $158 billion worth of deals announced in 2011, a moderate 9 percent increase from $145 billion in 2010.
And the forecast? According to a survey report of financial market professionals made by Bloomberg, the M&A activity will continue to grow. Asia-Pacific companies are expected to be the most aggressive buyers, whereas respondents expect the most attractive targets to be found among firms in the European region.
Yet, even if the number of mergers and acquisitions declines in the next few years, it is clear that this strategy will continue to remain important to many organizations. In addition, the increase of international activities and processes of globalization will encourage international mergers and acquisitions. Will the high rate of failures continue to characterize the M&A activities? It is hard to say. There are reasons to believe that certain dimensions of M&A remain difficult due to the complexity of M&A.
The primary reasons for failures is related to the fact that it is easy to buy but hard to perform an M&A. In general, many mergers and acquisitions are characterized by the lack of planning, limited synergies, differences in the management/organizational/international culture, negotiation mistakes, and difficulties in the implementation of the strategy following the choice of an incorrect integration approach on the part of the merging organizations after the agreement is signed. Most failure factors indicate a lack of knowledge among senior managers for the management tools that enable coping with the known problems of M&A.
The sharp increase in M&A activities during the second half of the past century on the one hand, and the tremendous amount of failures on the other hand, draw research interests from different areas of business administration and economics. Each area of interest has a special point of view and different measures of success. This chapter describes the factors of success or failure in mergers and acquisitions according to three main areas: economics and finance, strategic management, and organizational behavior. The overarching theme of this book is that only the combination of knowledge from all these areas can bring M&A success.
Finance and the Capital Market
Researchers from economics and finance areas measure success by the change in the stock rates (with the reduction of industry fluctuations) in the first few days after the announcement of the merger. When the stocks rise, the merger is successful, and when the stock price falls, the merger is described as a failure. The basic assumption of economics/finance scholars is that the stock value reflects the company value in an objective manner based on all the existing public information. The idea is that the immediate change in the stock price reflects changed expectations on the value of the firm, and thereby indicates a long-term trend. Therefore, they assert that every M&A that causes an immediate rise in the stock value (after the reduction for fluctuations in the capital market), reflects success and creates value for the stockholders. In contrast, a merger that causes the decline in the stock price in the first days after the announcement of the merger reflects failure and loss for the stockholders.
A conclusion accepted today, after decades of research, is that only stockholders of the acquired company profit, whereas the stockholders of the acquiring firm do not, on the average, receive any benefit from the merger. The main reason for failures, according to this perspective, is that the acquiring company pays a premium that reaches above the value of the acquired company. This premium is generally so high that even successful management activities after the acquisition do not provide return on investment and do not remedy the valuation “error.” The capital market identifies this mistake and responds in the change of the stock price. For example, the stocks of AOL declined in the first 24 hours after the acquisition of Time Warner was announced. The assumption was that the price paid for Time Warner was very high and not justifiable. Its stocks continued to decline for many months after the acquisition. It should be noted though that the capital market’s valuation makes mistake in many cases, such as the Daimler-Chrysler merger. In that case, the stock price rose immediately after the merger announcement. However, 2 years following it, the stock value declined to 50 percent of its value at the time of the merger.
It also becomes clear that the over-payment for acquisitions is a frequent problem also for other reasons. The personal interests of senior management are not always commensurate with those of the stockholders. The CEO and his peers see personal advantages in the merger, such as greater empowerment and control of a larger organization, improvement of the social-management status, and higher salaries and benefits. In addition, senior managers have the possibility of moving to the management of another company from an improved position following the merger because of the considerable experience that characterizes a larger company. In other words, one of the main reasons for the failures of M&A, according to finance and economics researchers, is the ego of the CEO and his management. One of the senior vice managers of the large pharmaceutical company Glaxo Welcome addressed this issue: “Ego has precedence over future strategies” (Fortune, March 1998). In other words, the personal considerations of senior managers precede rational considerations that are supposed to be expressed in the prior planning of the future strategies of the organization.
Another reason for failures, related to the ego of the CEO and the over-payment, is known as the hubris hypothesis or the sin of pride. This issue addresses the considerable self-confidence that a person has in his ability to overcome mishaps and succeed even when the chances are low. The concept is known from Aristotle’s model of tragedy, in which successful and talented people suffer from pride or excessive self-confidence and thus fail. The tragedy is that they, more than other people, can avert the failure. Exactly like Icarus, who, according to Greek myth, despite his father’s warnings, flew too high with his wax wings, which melted when he was too close to the sun—and he fell to the sea and drowned. In the Israeli version of the “Icarus” story, there are several expressions that indicate the sin of pride, such as “Trust me,” “It will be alright,” and “It won’t happen to me.” In other words, the CEO is certain that despite the over-payment, the merger/acquisition is worthwhile. He is certain that under his management and through integration of the organizations, effectiveness will increase, new options will be created, the performances of the acquired company will improve within a short period of time, and the advantages of the merger will be realized.
It should be noted that there are cases in which it became clear that the over-payment was worthwhile. When Electra was acquired by Elco, for instance, approximately 30 percent more than the worth, according to the stock value, was paid, but eventually it became clear that the acquisition was very beneficial, at least in the field of manufacturing and sales of air-conditioning units.
In any event, despite the lack of profitability of the acquiring companies, the activity of mergers and acquisitions continues to grow and break records. Why? Following are several possible explanations for this conundrum:
One possibility is that although there is no potential for profit, the activity continues because
- Managers make mistakes in the evaluation of the value.
- Managers search to maximize their profit, even at the expense of the stockholders.
- Managers act out of pressure from the board of directors and stockholders to show continuous growth.
Mergers have the potential for profit but
- Organizational problems that occur after the merger entail many costs that negate the potential profit or do not allow for the realization of the M&A.
- There is a methodological problem with the measurement of the success and profitability of mergers and acquisitions, and therefore the existing profitability is not evident.
- The M&A causes reactions among external stakeholders that offset possible positive consequence. Such reactions include how customers decide to change their ways of buying products, whereas a continuous cash flow from these customers was part of the valuation of the acquired party. It is possible that only certain types of mergers bring a profit to the stockholders, whereas others do not.
The reasons in the first preceding topic lead to two other areas that explain differently the factors of success and failure of mergers and acquisitions: strategic management and organizational behavior.