- November 27, 2019
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
Large M&A Transactions Fail
History shows that many large M&A transactions are significant failures. The recent downfall of Thomas Cook, marred by a massive debt pile measuring back to an unfortunate 2007 merger with MyTravel, is a warning of an undeniable fact: mergers and acquisitions (M&A) is a precarious business. The Thomas Cook disaster was not an insular one. In 2015, Microsoft wrote off $7.6 billion (€ 6.8 billion) associated with its acquisition of Nokia’s handset business. The writeoff was even more than it had paid for it just a year earlier. The other instances of significant M&A transactions were when Google had to writeoff Motorola’s smartphone unit for only $2.9 billion after having spent $12.5 billion in 2012. Though Google claims it got access to Motorola patents and IP through this acquisition, nevertheless, this deal was a failure.
There are success stories too. For instance, Google acquired Android for $50 million in 2005, Disney bought Pixar in 2006, the merger of oil titans Exxon and Mobil in 1998. Warren Buffett’s Berkshire Hathaway is a thriving conglomerate renowned for its numerous acquisitions. Buffett and his partner, Charlie Munger, have regularly displayed doubt about the sense of most mergers and acquisitions. “Two-thirds of large M&A transactions don’t work,” Munger has said.
In Large M&A Transactions, One is Fighting a losing battle
Many studies validate that, most of the time, M&A is akin to fighting a losing battle. Various researches have discovered a vast majority of mergers and acquisitions are failing – as high as 83%, as per one KPMG study. The acquiring company shares poorly underachieved in stock markets, as stated in a 2016 report by S&P Global Market Intelligence Quantamental Research. That’s not shocking given the limited fundamentals – acquirers’ profit margins, earnings growth, and return on capital is well short of its rivals for a long time while interest expenses increase, and debt soars.
As said by distinguished valuation specialist and New York University finance professor Aswath Damodaran, about 50% of mergers get nullified in a decade. However, 2018 was the third-biggest year for mergers and acquisitions (M&A) activity, with deal volume exceeding $4.1 trillion.
Why do Large M&A Transactions fail?
The foremost cause is that the acquirer overpays. To convince stockholders in the target company to sell, the acquirer has to spend a premium to the current share price. The usual reasons given for this support for a bonus is the possible synergies on the proposal; when the two companies with the right strategic fit get together, the value of the combined entity is more than the sum of their parts.
There is no indication of synergy in around 60% mergers. On the contrary, there are many deals where synergies have reduced the initial value of both companies. The reasons for such occurrences are because synergies are not valued correctly. These synergies are inadequately planned and much more challenging to implement in real-time scenarios. There can also be cultural issues between the combined companies, which can derail the deal value. Integration can be difficult and takes time. Many times, the integration team needs to make agreements with unions, employees, and other stakeholders. These compromises can dilute the original synergies targets. Other typical reasons include organizational inertia and resistance to change. The deal teams tend to underestimate these issues when closing the transaction.
The deal teams are likely to be too confident. Certainly, pragmatic plans are not sufficient to persuade the board to proceed with an M&A transaction. Therefore, deals have to be aggressive, but there is a subtle difference between an overambitious and unrealistic mindset. As a result, M&A attempts are usually destined to fail at the outset due to unrealistic expectations.
Large M&A Transactions are made to strive for growth
In spite of the colossal failures in M&A transactions, companies pursue the M&A strategy mainly for the search for growth. Analysts and shareholders expect double-digit growth from companies. With growth not coming from organic opportunities, inorganic growth strategy such as M&A seems to be the only solution. Buying a new business looks to be a more straightforward proposition than coming up with better products, especially if companies do not have an innovative mindset.
The famous management guru Peter Drucker once wrote, “dealmaking beats working.” Dealmaking is exciting and fun. As few deals have proved to be successful, many leaders think they are likely to succeed. Warren Buffett earlier notably said, several managers, view themselves as pretty princesses who can change toads into handsome princes.
Many companies refuse to learn from earlier blunders. Most acquirers do not initiate a formal review process after closing a deal. A recent survey shows that only 37% of dealmakers consider large M&A transactions to create value for the buyers. Around 21% believe large M&A transactions satisfy strategic purposes fixed by acquirers; but, when it comes to their deals, 58% state they generated value, and 51% think they adhered their strategic targets. This aggregate of factors indicates that M&A activity isn’t going away any soon.
The valuation expert Aswath Damodaran has other opinions. According to him, “You do a large acquisition, I’m out of your stock. I don’t mind what answer you provide to me. If you make a big acquisition, the odds are loaded up against you.”