Why Do Mergers Fail

Assignment II

Mergers Acquisitions & Corporate Restructuring

‘Why do Mergers fail?’

Submitted to: Dr. Beena Dias Professor AIMIT

Submitted by: Mr. Nithin Pradeep Saldanha Reg. No. 0816093 IInd MBA ‘B’ Batch AIMIT

Date of Submission: 2nd November, 2009.

Why do mergers fail? Globalisation is the challenge, and for big business mergers are the solution. However, all too often the multi-billion dollar deals turn sour. The battle of three French banks over who should merge with whom is the latest example, and the managers making the deals might pause to ask if the end result will be worth it. The six-month battle involving BNP, Paribas and Societe Generale has been fought via advertising and in courtrooms, two costly arenas. Investors scrutinising the minutiae of the legal battles should worry if such a merger will create shareholder value. Chances are it won't. Whatever the logic or likely success of the French bank merger, analysts agree that many mergers are hit or miss. Commerzbank research -some of it anecdotal says that more than half of mergers ultimately fail to create value. Merger gains may have a short shelf life, Commerzbank said, with the merger only temporarily offsetting an inevitable decline. "Some research does show that companies don't deliver on all the promises they make," Stephen Barrett, head of mergers & acquisitions at KPMG, said, but he added that "many do create shareholder value". The problem, he said, was that little empirical evidence existed as to the success of merger and acquisition activity. With the recently announced mergers involving Procter & Gamble and Gillette, and SBC and AT&T, it's time to ask one of the most common questions about mergers: What does it take for a company to be successful, post merger? After all, many mergers ultimately don't add value to companies, and even end up causing serious damage. "Studies indicate that several companies fail to show positive results when it comes to mergers," says Wharton accounting professor Robert Holthausen, who teaches courses on M&A strategy. Noting that there have been "hundreds of studies" conducted on the long-term results of mergers, Holthausen says that researchers estimate the range for failure is between 50% and 80%. Management professor Martin Sikora, editor of Mergers & Acquisitions: The Dealmaker's Journal, agrees. "Companies merge and end up doing business on a larger scale, with increased economic power," Sikora says. "But the important questions are whether or not they gained competitive advantage or increased market power. And that will be reflected in the stock price. "The truth is," he adds, "mistakes happen. The accepted data say that most mergers and acquisitions don't work out."

Merger Failure Rates: The burning question remains-why do so many mergers fail to live up to stockholder expectations? In the short term, many seemingly successful acquisitions look good, but disappointing productivity levels are often masked by one-time cost savings, asset disposals, or astute tax maneuvers that inflate balance-sheet figures during the first few years. Merger gains are notoriously difficult to assess. There are problems in selecting appropriate indices to make any assessment, as well as difficulties in deciding on a suitable measurement period. Typically, the criteria selected by analysts are: •

profit-to-earning ratios;

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stock-price fluctuations;

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managerial assessments. Irrespective of the evaluation method selected, the evidence on M&A performance is

consistent in suggesting that a high proportion of M&As are financially unsuccessful. US sources place merger failure rates as high as 80%, with evidence indicating that around half of mergers fail to meet financial expectations. A much-cited McKinsey study presents evidence that most organizations would have received a better return on their investment if they had merely banked their money instead of buying another company. Consequently, many commentators have concluded that the true beneficiaries from M&A activity are those who sell their shares when deals are announced, and the marriage brokers—the bankers, lawyers, and accountants—who arrange, advise, and execute the deals.

"What Went Wrong?" According to Steve Tobak is managing partner of Invisor Consulting LLC, the kinds of problems companies face with mergers range from poor strategic moves, such as overpayment, to unanticipated events, such as a particular technology becoming obsolete. "You would hope these companies have done their due diligence, although that isn't always the case," he says. Aside from those extremes, however, many analysts view clashing corporate cultures as one of the most significant obstacles to post-merger integration. In fact, a cottage industry of sorts has emerged to

help companies navigate the rough terrain of integration -- and especially to help them overcome the internal inertia that comes with facing change. "It's like changing a wheel on a bus," says Cari Windt from Access GE, which offers GE best practices to clients who are undergoing M&A transitions. "You can't skip a beat for your customer." Windt says the earlier a company attempts to plan, the better. Often times, however, companies don't plan as thoroughly as they should: "It's unusual that companies work on developing quality solutions for the acceptance side of mergers."

Is It Possible to Predict Success? Still, despite planning and good communication, things can go awry. According to Analysts, one-third of mergers create shareholder value, whereas one-third destroys value, and another third don't meet expectations. For shareholders, these deals can be "a crap shoot," however, that being in the successful one-third can add tremendous value. Aside from solid preparation for a deal, then, how can presence in that top third are predicted? "Companies that acquire with frequency and make it a major core competency tend to do well and perform better than their peers". In fact, he adds, more companies regard M&A as essential for growing value. He cites the recent history of M&A activity as evidence: As M&A activity has cycled over the past decade, the downturns have tended to be less extreme than years before. In other words, even when there's a lull in activity, there are more companies engaging in mergers than there were before during slow periods. In fact, according to press reports, last year's U.S. M&A volume ($886 billion) was almost double the volume of 2001 ($466.5 billion). It's more of an established structure. "More companies are equipped to do it, and it's more an integrated part of doing business." Integration is really about mobilizing chang. The key question is, what is the change dynamic of the companies involved -- how quickly do they adapt? Although companies may seem similar on the surface and therefore a perfect match, they are often vastly different in terms of change orientation, leadership style, organization systems, and methods of dealing with conflict, she notes. In addition to the ordinary due diligence of getting to know the acquired

company and industry thoroughly, speed is essential in these transactions -- especially with regard to anything that will impact employees, including layoffs, benefits changes, location, etc. "Difficult decisions need to be addressed early on so that they are not lingering and hit later." One of the most important aspects of the process, according to analysts, is a strong commitment to change on the part of management. First, there needs to be consistent communication regarding the process; ideally, there should be a "rhythm" of communications for employees, which might take the form of regular email updates, newsletters, and general visibility on the leadership level. Secondly, management needs to assign resources to complete the transition successfully. Acquiring companies should consider assigning an "integration leader" to help oversee the process. This is a ‘multi-directional ambassador" with leadership skills, "aggressive project management’ capabilities, and ‘exceptional people skills.’ ‘Listening is key.’

Some Reasons for Failure of Mergers and Acquisitions: A definite answer as to why mergers fail to generate value for acquiring shareholders cannot be provided because mergers fail for a host of reasons. Some of the important reasons for failures of mergers are discussed below: Excessive premium: In a competitive bidding situation, a company may tend to pay more. Often highest bidder is one who overestimates value out of ignorance. Though he emerges as the winner, he happens to be in a way the unfortunate winner. This is called winners curse hypothesis. When the acquirer fails to achieve the synergies required compensating the price, the M&As fails. More you pay for a company, the harder you will have to work to make it worthwhile for your shareholders. When the price paid is too much, how well the deal may be executed, the deal may not create value.

Size Issues:

A mismatch in the size between acquirer and target has been found to lead to poor acquisition performance. Many acquisitions fail either because of 'acquisition indigestion' through buying too big targets or failed to give the smaller acquisitions the time and attention it required. Lack of research: Acquisition requires gathering a lot of data and information and analyzing it. It requires extensive research. A carelessly carried out research about the acquisition causes the destruction of acquirer's wealth. Diversification: Very few firms have the ability to successfully manage the diversified businesses. Unrelated diversification has been associated with lower financial performance, lower capital productivity and a higher degree of variance in performance for a variety of reasons including a lack of industry or geographic knowledge, a lack of focus as well as perceived inability to gain meaningful synergies. Unrelated acquisitions, which may appear to be very promising, may turn out to be big disappointment in reality. Previous Acquisition Experience: While previous acquisition experience is not necessarily a requirement for future acquisition success, many unsuccessful acquirers usually have little previous acquisition experience. Previous experience will help the acquirers to learn from the previous acquisition mistakes and help them to make successful acquisitions in future. It may also help them by taking advice in order to maximize chances of acquisition success. Those serial acquirers, who possess the in house skills necessary to promote acquisition success as well trained and competent implementation team, are more likely to make successful acquisitions.

Unwieldy and Inefficient:

Conglomerate mergers proliferated in 1960s and 1970. Many conglomerates proved unwieldy and inefficient and were wound up in 1980s and 1990s. The unmanageable conglomerates contributed to the rise of various types of divestitures in the 1980s and 1990s. Poor Cultural Fits: Cultural fit between an acquirer and a target is one of the most neglected areas of analysis prior to the closing of a deal. However, cultural due diligence is every bit as important as careful financial analysis. Without it, the chances are great that M&As will quickly amount to misunderstanding, confusion and conflict. Cultural due diligence involve steps like determining the importance of culture, assessing the culture of both target and acquirer. It is useful to know the target management behavior with respect to dimensions such as centralized versus decentralized decision making, speed in decision making, time horizon for decisions, level of team work, management of conflict, risk orientation, openness to change, etc. It is necessary to assess the cultural fit between the acquirer and target based on cultural profile. Potential sources of clash must be managed. It is necessary to identify the impact of cultural gap, and develop and execute strategies to use the information in the cultural profile to assess the impact that the differences have. Poor Organization Fit: Organizational fit is described as "the match between administrative practices, cultural practices and personnel characteristics of the target and acquirer. It influences the ease with which two organizations can be integrated during implementation. Mismatch of organation fit leads to failure of mergers. Faulty evaluation: At times acquirers do not carry out the detailed diligence of the target company. They make a wrong assessment of the benefits from the acquisition and land up paying a higher price.

Poorly Managed Integration:

Integration of the companies requires a high quality management. Integration is very often poorly managed with little planning and design. As a result implementation fails. The key variable for success is managing the company better after the acquisition than it was managed before. Even good deals fail if they are poorly managed after the merger. Ego Clash: Ego clash between the top management and subsequently lack of coordination may lead to collapse of company after merger. The problem is more prominent in cases of mergers between equals. Incompatibility of Partners: Alliance between two strong companies is a safer bet than between two weak partners. Frequently many strong companies actually seek small partners in order to gain control while weak companies look for stronger companies to bail them out. But experience shows that the weak link becomes a drag and causes friction between partners. A strong company taking over a sick company in the hope of rehabilitation may itself end up in liquidation. Failure of Top Management to Follow-Up: After signing the M&A agreement the top management should not sit back and let things happen. First 100 days after the takeover determine the speed with which the process of tackling the problems can be achieved. Top management follow-up is essential to go with a clear road map of actions to be taken and set the pace for implementing once the control is assumed. Lack of Proper Communication: Lack of proper communication after the announcement of M&As will create lot of uncertainties. Apart from getting down to business quickly companies have to necessarily talk to employees and constantly. Regardless of how well executives communicate during a merger or an acquisition, uncertainty will never be completely eliminated. Failure to manage communication results in inaccurate perceptions, lost trust in management, morale and productivity problems,

safety problems, poor customer service, and defection of key people and customers. It may lead to the loss of the support of key stakeholders at a time when that support is needed the most. Inadequate Attention to People Issues: Not giving sufficient attention to people issues during due diligence process may prove costly later on. While lot of focus is placed on the financial and customer capital aspects, not enough attention is given to aspects of human capital and cultural audit. Well conducted HR due diligence can provide very accurate estimates and can be very critical to strategy formulation and implementation. Expecting Results too quickly: Immediate results can never be expected except those recorded in red ink. Whirlpool ran up a loss $100 million in its Philips white goods purchase. R.P.Goenk's takeovers of Gramaphone Company and Manu Chhabria's takeover of Gordon Woodroffe and Dunlops fall under this category.

Biggest Merger and Acquisition Disasters: If a merger goes well, the new company should appreciate in value as investors anticipate synergies to be actualized, creating cost savings and/or increased revenue for the new entity. However, time and again, executives face major stumbling blocks after the deal is consummated. Cultural clashes and turf wars can prevent post-integration plans from being properly executed. Different systems and processes, dilution of a company's brand, overestimation of synergies and lack of understanding of the target firm's business can all occur, destroying shareholder value and decreasing the company's stock price after the transaction. New York Central and Pennsylvania Railroad: In 1968, the New York Central and Pennsylvania railroads merged to form Penn Central, which became the sixth largest corporation in America. But just two years later, the company shocked Wall Street by filing for bankruptcy protection, making it the largest corporate bankruptcy in American history at the time. The railroads, which were bitter industry rivals, both

traced their roots back to the early- to mid-nineteenth century. Management pushed for a merger in a somewhat desperate attempt to adjust to disadvantageous trends in the industry. Railroads operating outside of the northeastern U.S. generally enjoyed stable business from long-distance shipments of commodities, but the densely-populated Northeast, with its concentration of heavy industries and various waterway shipping points, created a more diverse and dynamic revenue stream. Local railroads catered to daily commuters, longer-distance passengers, express freight service and bulk freight service. These offerings provided transportation at shorter distances and resulted in less predictable, higher-risk cash flow for the Northeast-based railroads. Short-distance transportation also involved more personnel hours (thus incurring higher labor costs), and strict government regulation restricted railroad companies' ability to adjust rates charged to shippers and passengers, making cost-cutting seemingly the only way to positively impact the bottom line. Furthermore, an increasing number of consumers and businesses began to favor newly constructed wide-lane highways. The Penn Central case presents a classic case of post-merger cost-cutting as "the only way out" in a constrained industry, but this was not the only factor contributing to Penn Central's demise. Other problems included poor foresight and long-term planning on behalf of both companies' management and boards, overly optimistic expectations for positive changes after the combination, culture clash, territorialism and poor execution of plans to integrate the companies' differing processes and systems. Quaker Oats Company and Snapple Beverage Company: Quaker Oats successfully managed the widely popular Gatorade drink and thought it could do the same with Snapple. In 1994, despite warnings from Wall Street that the company was paying $1 billion too much, the company acquired Snapple for a purchase price of $1.7 billion. In addition to overpaying, management broke a fundamental law in mergers and acquisitions: make sure you know how to run the company and bring specific value-added skills sets and expertise to the operation. In just 27 months, Quaker Oats sold Snapple to a holding company for a mere $300 million, or a loss of $1.6 million for each day that the company owned Snapple. By the time the divestiture took place, Snapple had revenues of approximately $500 million, down from $700 million at the time that the acquisition took place.

Quaker Oats' management thought it could leverage its relationships with supermarkets and large retailers; however, about half of Snapple's sales came from smaller channels, such as convenience stores, gas stations and related independent distributors. The acquiring management also fumbled on Snapple's advertising campaign, and the differing cultures translated into a disastrous marketing campaign for Snapple that was championed by managers not attuned to its branding sensitivities. Snapple's previously popular advertisements became diluted with inappropriate marketing signals to customers. Oddly, there is a positive aspect to this flopped deal (as in most flopped deals): the acquirer was able to offset its capital gains elsewhere with losses generated from the bad transaction. In this case, Quaker Oats was able to recoup $250 million in capital gains taxes it paid on prior deals thanks to losses from the Snapple deal. This still left a huge chunk of destroyed equity value, however. Sprint and Nextel Communications: In August 2005, Sprint acquired a majority stake in Nextel Communications in a $35 billion stock purchase. The two combined to become the third largest telecommunications provider, behind AT&T and Verizon. Prior to the merger, Sprint catered to the traditional consumer market, providing long-distance and local phone connections and wireless offerings. Nextel had a strong following from businesses, infrastructure employees and the transportation and logistics markets, primarily due to the press-and-talk features of its phones. By gaining access to each other's customer bases, both companies hoped to grow by cross-selling their product and service offerings. Soon after the merger, multitudes of Nextel executives and mid-level managers left the company, citing cultural differences and incompatibility. Sprint was bureaucratic; Nextel was more entrepreneurial. Nextel was attuned to customer concerns; Sprint had a horrendous reputation in customer service, experiencing the highest churn rate in the industry. In such a commoditized business, the company did not deliver on this critical success factor and lost market share. Further, a macroeconomic downturn led customers to expect more from their dollars. Cultural concerns exacerbated integration problems between the various business functions. Nextel employees often had to seek approval from Sprint's higher-ups in implementing corrective actions, and the lack of trust and rapport meant many such measures were not approved or

executed properly. Early in the merger, the two companies maintained separate headquarters, making coordination more difficult between executives at both camps. Sprint Nextel's managers and employees diverted attention and resources toward attempts at making the combination work at a time of operational and competitive challenges. Technological dynamics of the wireless and Internet connections required smooth integration between the two businesses and excellent execution amid fast change. Nextel was simply too big and too different for a successful combination with Sprint. Sprint saw stiff competitive pressures from AT&T (which acquired Cingular), Verizon and Apple's popular iPhone. With the decline of cash from operations and with high capitalexpenditure requirements, the company undertook cost-cutting measures and laid off employees. In 2008, the company wrote off an astonishing $30 billion in one-time charges due to impairment to goodwill, and its stock was given a junk status rating. With a $35 billion price tag, the merger clearly did not pay off. HUMAN RESOURCE: KEY FACTOR It is reported that one of the main reasons for failure of a merger or acquisition is based on Human Resources neglect. People issues have been the most sensitive but often ignored issues in a merger and acquisition. When a decision is taken to merge or acquire, a company analyses the feasibility on the business, financial and legal fronts, but fails to recognize the importance attached to the human resources of the organizations involved. Companies which have failed to recognize the importance of human resources in their organizations and their role in the success of integration have failed to reach success. While it is true that some of these failures can be largely attributed to financial and market factors, many studies are pointing to the neglect of human resources issues as the main reason for M&A failures. PricewaterhouseCoopers global study concluded that lack of attention to people and related organizational aspects contribute significantly to disappointing post-merger results. Organizations must realize that people have the capability to make or break the successful union of the two organizations involved. Cartwright and Cooper (2000) acknowledged that the leading roles of modern human resources functions are to be actively engaged in the organization and perform as a business

partner and advisor on business-related issues. Employees do not participate enough in the integration process of a merger. If a merger is to reach its full success potential, they need to be informed and involved more actively throughout all the stages of the merger process. Human resource professionals are key in pre-merger discussions and the strategic planning phase of mergers and acquisitions early as to allow them assess to the corporate cultures of the two organizations (Anderson, 1999). Being involved in the pre-merger stage allows HR to identify areas of divergence which could hinder the integration process. They can play a vital role in addressing any communication issues, employees concerns, compensation policies, skill sets, downsizing issues and company goals that need to be assessed.

Making It Happen Making a good organizational marriage currently seems to be a matter of chance and luck. This needs to change so that there is a greater awareness of the people issues involved, and consequently a more informed integration strategy. Some basic guidelines for more effective management include: •

extension of the due diligence process to incorporate issues of cultural fit;

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greater involvement of human resource professionals;

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the conducting of culture audits before the introduction of change management initiatives;

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increased communication and involvement of employees at all levels in the integration process;

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the introduction of mechanisms to monitor employee stress levels;

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fair and objective reselection processes and role allocation;

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providing management with the skills and training to sensitively handle M&A issues such as insecurity and job loss;

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creating a superordinate goal which will unify work efforts.

Conclusion: When contemplating a deal, managers at both companies should list all the barriers to realizing enhanced shareholder value after the transaction is completed.

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Cultural clashes between the two entities often mean that employees do not execute postintegration plans.

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As redundant functions often result in layoffs, scared employees will act to protect their own jobs, as opposed to helping their employers "realize synergies".

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Additionally, differences in systems and processes can make the business combination difficult and often painful right after the merger. Managers at both entities need to communicate properly and champion the post-

integration milestones step by step. They also need to be attuned to the target company's branding and customer base. The new company risks losing its customers if management is perceived as aloof and impervious to customer needs. Finally, executives of the acquiring company should avoid paying too much for the target company. Investment bankers (who work on commission) and internal deal champions, both having worked on a contemplated transaction for months, will often push for a deal "just to get things done." While their efforts should be recognized, it does not do justice to the acquiring group's investors if the deal ultimately does not make sense and/or management pays an excessive acquisition price beyond the expected benefits of the transaction.

Bibliography: Journals: •

Ashok Banerjee, “Managing Risk in Mergers and Acquisitions”, The Journal of accounting and Finance, October-March 2008, Page 64-69.

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Mergers, Acquisitions and Wealth Creation in Indian Context, S Pannerselvam and B Rajesh Kumar, Indian Institute of Management Bangalore - Management Review, India

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Rajesh Kumar, B., "Effect of RPL-RIL Merger on shareholder's wealth and Corporate Performance", ICFAI J. of Applied Finance, Vol 10, No. 9, September 2004.

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“Mergers and Managers Don’t Mix. Will Corporate Marriage Mania Ever Get Better?”, The Executive Issue, Issue 2, 2005

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Wayne R. Pinnell, “People and Purpose: Tips for a Successful Merger or Acquisition”, Advisor, November 29, 2001

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Agrawal, Anup, Jeffrey F. Jaffe, and Gershon N. Mandelker, 1992, The post-merger performance of acquiring firms: a re-examination of an anomaly, Journal of Finance 47: 1605-1621

Websites: •

http://news.cnet.com/8301-13555_3-9796296-34.html, Last accessed on 28-10-2009.

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http://skylla.wz-berlin.de/pdf/2005/ii05-09.pdf, Last accessed on 28-10-2009.

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http://www.mid-day.com/lifestyle/2009/sep/030909-Nine-Reasons-Failed-Mergers-ITAdda-Bangalore.htm, Last accessed on 31-10-2009.

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http://jacksonville.bizjournals.com/jacksonville/stories/2000/08/28/smallb2.html, accessed on 1-11-2009.

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