Most gamblers know the odds of winning a bet is usually stack against them. Yet that hasn’t stopped most people from trying their luck at betting in the believe that they have a good chance at upsetting the odds. This seems to be the case with Mergers and Acquisitions(M&A). There is overwhelming evidence to suggest that M&A do not perform as well as expected for most companies (Clark,2013). That notwithstanding, M&A’s are still popular across the world with transactions of above $4trillion being undertaken in 2019 alone (Dealogic,2019). That’s partly because, whilst most organizations get it wrong leading to loss of investments and sullied reputations, those who get it right benefit by becoming more competitive.
From a shareholder perspective the success of any M&A is measured by how much an M&A increases shareholder wealth (Horgarty,1970). Specifically, shareholders are interested in how much value a new acquisition adds to their investments. There are many other operational and strategic reasons why a business might pursue an M&A transaction though. It is important that organizations are clear in their mind what the specific operational or strategic benefits they seek to achieve is before they dip their feet into the uncertain waters of M&A. I will discuss below some operational and strategic motives behind Mergers and Acquisitions. I will also review the various forms of takeovers.
Shareholder Value growth is one objective of most M&A transactions. The acquisition of an existing business with established cashflow is a quick way to maximise shareholder wealth (Hanson,2017). An existing business will already have established structures and competencies that can quickly be tapped into. It might already have a well-recognized brand name with a dedicated customer base. For instance, when Apple shelled out $3Billion for Beats Electronics, it was paying to get a head start into the lucrative ‘cool’ headset and streaming music market (NBC,2011). Apple could have developed its own product, but it saw in Beats Electronics a cash cow it could tap into readily. This allowed Apple to also bring on board key personal from Beats like its founder Dr Dre to give it the street credibility it otherwise could not generate on its own.
An acquisition could also help increase shareholder wealth if it allows the acquiring entity to tap into new technologies and staff competencies the target can bring onboard. For instance, when Tesla Inc. bought Deepscale for about $300M (CNBC,2019), it was because of the driverless technologies that the target company was bringing to Tesla to help advance its engineering capabilities. As news reports suggests, this acquisition came not long after Tesla had a jump in staff turnover within its driverless engineering team. Tesla decided to acquire a company that right away brings on board the capability it needed. So sometimes an acquisition allows the acquiring the entity to bring on board experience staff and technology it readily needs to quickly achieve an objective.
Sometimes state backed entities use acquisition to secure access to technology that helps the country to be ‘self-reliant’. For instance, Chinese firms’ pursuit of computer chip manufacturing companies, which has often been blocked by lawmakers in the US is one such situation (Breakingviews,2016). Access to the technology underpinning chip manufacturing will allow Chinese firms to produce their own chips. Something most Chinese watchers say China views as something in its national security interest (Marketrealist,2019). There has also been Chinese acquisitions in Australia that has been made to feed the growing appetite for food and dairy as living standards continue to improve (CNBC,2017). With an ever-growing population in China and other fast developing economies, the market and appetite for exotic food from destinations viewed as having rigorous food safety standards are highly sort after (Adage,2013).
An acquisition can be used as a tool to grow market share than organic growth. Increased market share increases profitability through efficiency cost savings as a result of the positive impact of economies of scale. Also reduced market competition resulting from the acquisition of a competitor can help improve sales as the acquiring company automatically gains the customers of the target company. This can lead to the company’s ability to increase revenue by charging at a premium (Sudarsanam,2004).
A combined firm’s overall market share can also grow resulting from an acquisition or a merger as the two becomes one. In Ghana for instance, Bharti Airtel which was the number three telecoms company measured by subscriber base, acquired Millicom Ghana Limited, the then fourth mobile operator by subscriber base. This acquisition enabled the combined business to leapfrogged Vodafone Ghana limited which was then in second place to become the number two telecoms operator measured by subscriber base (Reuters,2017). The benefits for the combined business were the improved revenue for the new business as they combined their customer base. The new business consolidated many senior executive roles and many other departments into one resulting in cost savings.
Another strategic motive for acquisitions is to diversify the business, into other sectors or industries to spread the risk to avoid being overly concentrated in one industry. It involves investing in other businesses or industries that have different risk profiles. So that whilst the performance of one industry or sector is down the other high performing sector will compensate for the loss ensuring that the organization is not severely impacted (USnews,2019). Berkshire Hathaway is one such very well diversified company with investments across multiple industries from Food to Aviation. So, whilst it may lose on its investments in some sectors like in aviation around this Covid time, it potentially could be making up for those losses in other sectors like food as people are staying at home more and invariably eating more. The ongoing Covid 19 pandemic has highlighted some of the benefits of diversification. As some sectors like hospitality has plummeted other sectors such as healthcare and safety products are doing very well.
Acquisition diversification could also be diversification of location to enter into new markets or territories. An African focused company may decide to expand its operations to other continents or regions to reduce its risk exposure to a location. For instance, currently over 80% of Tullow oil Plc’s, oil production and by extension revenue sources comes from two projects in Ghana (Tullowoil,2020). This in effect means if anything affects the operations in Ghana, the company could virtually collapse. It could be a strategic move to look to other locations for additional sources of revenue and this can be achieved quickly through acquisition.
There is ample evidence to support the assertion though that diversification causes companies to lose focus and that firms perform better when they are focused on a specific industry (Hyland & Diltz,2002). So, diversification may not be for every company and care must be taken not to spread one’s wings too wide, particularly in areas where managerial expertise to supervise is limited (Villalonga,2004).
There are occasions where acquisitions may also be triggered by what competition is doing. For instance, if a major competitor makes an acquisition that seeks to offer it an advantage, there will be pressure to follow suit to neutralize the new threats posed by the competitor’s acquisition (Cio,2015). There are clear risks with such reactive acquisitions, as the acquisition may not be well thought through.
Sometimes a small unlisted company may also choose an acquisition as a route to get onto the stock market by acquiring an already listed company, granting it immediate access to the stock market. An acquisition could also be made to gain a firm’s brand name. So instead of the target company becoming a subsidiary of the acquiring company, the acquiring company rather becomes the subsidiary of the target. This may be because the subsidiary may have name recognition the acquiring company may benefit from or will like to maintain.
The decision to acquire another company to maximise shareholder value though is not without risks. Key personnel who are critical to the success of the target company may leave after the acquisition taking with them the experience and know how that made the company successful in the first place. Also, integration challenges may affect it performance. A case in point is the DaimlerChrysler merger where the merger of the luxury brand Mercedes Daimler with a profitable and nimble car manufacturer Chrysler affected shareholder value due to integration issues. The integration challenges resulting after the merger affected their ability to benefit from the positives both entities brought into the merger (Badrtalei & Bates, 2007). The numerous interventions by the US government stopping transactions involving some US companies and Chinese companies on the grounds of protecting national security is also indicative of the challenges with using acquisition as a tool to maximise shareholder wealth.
Forms of Takeovers
Having made the decision to make an acquisition, it is important the company takes steps to improve its chances of success knowing clearly what the object for the acquisition is. Is it going to acquire another company in the same industry, a competitor, a supplier, a customer or its just to grow the organization? It does a lot of damage to the company in view of the cost and resources involved including management time spent in pursuing and completing an acquisition. More importantly if the acquisition does not add value to the entities involve the shareholders are not going to be happy and will be asking tough questions of those, they have entrusted the affairs of the company to.
The different forms of takeovers are Horizontal, Vertical, and Conglomerate (Gaughan,2007). The choice used and the approach adopted depends on the object of the transaction as planned by the acquiring company, and the market conditions at the time of acquisition. If the object is to gain market share by reducing competition to gain a competitive advantage the takeover form usually used is what is referred to as a horizontal acquisition (Gaughan,2007).
This involves either the acquisition or merger with a similar entity in the same industry and typically a competitor. The benefit to the acquiring company is that it can increase its market presence and share potentially improving its influence in the market and profitability. It is also easier to consolidate the new acquisition into the new business because of the experience management already have of the industry. This form of acquisition approach is common in matured markets where consolidation is needed to reduce competition and improve competitiveness (Clark & Mills,2013). However, this form of acquisition usually attracts the attention of regulators and anti-competition agencies as it is viewed as reducing competition to the detriment of customers and other competitors. It is therefore not uncommon to find included in the pre-acquisition process agreement a fee to be paid to the target company if approval is denied by regulators. Exposing the acquiring company to a financial loss if the deal fails to go through (BBC,2015). Office supplies chain Staples attempted acquisition of Office Depot is an example of horizontal acquisition involving two companies in the same industry. The consolidation of the two attracted some interest partly because a prior consolidation attempt in 1997 which failed on competition concerns (BBC,2015). The recent merger attempt was yet again blocked on competition concerns costing Stables some $300M. this was an amount it had agreed to pay to Office Depot if the merger was rejected by the Federal Trade Commission, FTC (CNN,2016). This shows that not only does an acquirer have to be concern about the advantages of its acquisition, but also it needs to be sure regulators will approve of the transaction.
The other form of takeover is a Vertical takeover, which involves the takeover of a company in the same industry but at different levels of the value chain (Nasdaq,2020). For example, the acquisition by AT&T of Time Warner is an example of a vertical acquisition as AT&T distributes media content whilst Time Warner produces media content (CNN,2018). These are two companies involved with media content albeit at different levels of the supply chain. Indeed, AT&Ts acquisition is referred to as a reverse vertical acquisition as AT&T is taking over an upstream company in terms of the media value chain. A forward takeover will be for instance Time Warner taking over AT&T.
Some of the advantages of Vertical takeovers are that it allows the acquiring company to be more in control of its supply chain which could benefit consumers. For instance, it allows the acquiring company to take out the retailer and deal directly with customers like Costco Wholesale does in the US selling directly to final consumers. Vertical takeovers also help to improve on inefficiencies within the supply chain that can lead to some cost savings. For instance, AT&T as a distributor of media content can now directly resolve some of the challenges, they had with some of the processes at Time Warner that impacted on their efficient delivery to clients. Also, a vertical takeover is seldom blocked by regulators, and on occasions when regulators have attempted to block the transaction, the courts have ruled against them as was the case with the AT&T Time Warner Transaction.
One disadvantage of vertical acquisition is that it means the company is taking on more risk in the same industry, as it is now involved in other parts of the supply chain it hitherto wasn’t responsible for. The additional role may dilute the companies known specialty as management time will also be required in the newly acquired areas of operation. It may also lose some of its previous suppliers and or customers who may now see them as competition depending on whether it’s a forward vertical acquisition or a Reverse of Backward integration.
The third form of takeover is the conglomerate merger where both the acquirer and target are in unrelated businesses. In a sense it is neither a vertical or horizontal acquisition but rather an addition of another business under the umbrella of an overarching entity (Gaughan,2007). The various companies under the conglomerate may have different operations with different management teams and in different industries. One of the most recognizable conglomerates is General Electric. This monster of a conglomerate owns multiple businesses across multiple industries and locations. One of the advantages of running such a diversified company is having the backbone of a parent company with a strong balance sheet, and the ability to use excess cash from other operations to support new ventures. Conglomerates are also able to reduce their investment risk as they can be evenly spread across different sectors reducing their risk concentration to any sector (Forbes,2015). Some of the disadvantages of a conglomerate is the issue of the governance structure to put in place, and whether the head office team has enough experience across the multiple sectors. The absence of an accountable governance structure could lead to bad head office decision making for subsidiaries impacting on their efficient running.
There are also Market extension mergers where an M&A transaction involving two companies providing similar services or good but operate at different locations consolidate to gain access to the market. This maybe as a result of entry barriers resulting from legislation or just by choice to overcome new entrant challenges (Investmentbank,2019). In some locations government regulation required a partnership with a local company to be able to participate in a sector. However sometimes a market extension becomes an easier way to gain a foothold into a new market. For example, Tullow Oil Plc’s acquisition of Energy Africa allowed it to gain entry into Ghana by virtue of the fact that Energy African owned assets in Ghana (Irishtimes,2004). Indeed, it was a quick and effective way to gain access to petroleum exploration blocks across Africa. Allowing Tullow to become one of the largest African focused oil and Gas companies (Petroleumafrica,2004). The challenge though is a Merger transaction involving the wrong partner could be disastrous. The reputational impact of a deal gone bad could impact negatively on the fortunes of shareholders. Also, if it’s a merger with a local entity who is more familiar with the local politics and market that could have far reaching impact. The advantage of this form of takeover is that it quickly opens up new markets which can be a win-win situation for all.
The key to all these forms of takeovers though is how to achieve a successful acquisition that allows a seamless and smooth integration into the operations of the acquiring company. Some observers have identified some identifying qualities that makes a successful acquisition deal (Clark & Mills, 2013). In their book ‘Masterminding the deal: breakthroughs in M&A strategy’ Clark and Mills provide percentage success rates for different types of M&A deals.
In first place with the best percentage of success, almost 90% (Clark & Mills, 2013) is the acquisition of a struggling competitor that requires much needed investment to get back on its feet. This type of acquisition is deemed to be the acquisition with the greatest chance of success. The opportunity to acquire such targets occasionally become available and at a reasonable price which reduces the acquisition purchase premium. Such acquisitions provide an opportunity to consolidate the market and to gain some market share. An example was when Kogan.com of Australia, an online business acquired Dick Smith an online retail store. Dick Smith was under receivership when Kogan.com acquired it with huge plans to revive it (Shortpress,2016). The real threat to such transactions though, is how much market share gain can be derived from a struggling business that is in desperate need of investment and is struggling.
In second place with a success rate of within the lower eighties percentage range (Clark & Mills, 2013) is the acquisition of a target company that adds to the already existing portfolio of businesses and perhaps complements the acquiring company’s operations. Such targets are usually smaller size businesses that are easier to integrate into the acquiring company’s business and becomes an additional line of revenue for the business (Capital,2020). An example is Akzo Nobels acquisition of Mapaero which is also a paints manufacturer. The acquisition allowed Akzo entry into the aerospace surface coating business to add to its vast portfolio of coating businesses. (Akzonobel,2019). The challenge with this is the potential for challenges in absorbing the new business into the organizational culture in existence at the acquiring company. If not properly managed the integration of the two companies can affect the success of the acquisition.
The next type of acquisition with the next likelihood of success within the upper sixty’s percentage range (Clark & Mills, 2013) in third place is a target company that is focused on adding new product lines to complement existing product or service lines. This could kickstart the growth of a company particularly, if the new product lines complement existing product lines or services. An example is the acquisition of Mobilink by Broadcom. Broadcom acquired Mobilink which was a mobile semiconductor chip supplier to be able to complement its Bluetooth products (EDN,2002). The advantages of such acquisitions as indicated earlier can be a game changer for the acquiring company. But if it turns out to be a wrong product line acquisition it could have lasting impact on the acquirer’s own products, as customer confidence in the acquirer may fall. However, the benefit to the acquirer is the added benefit of gaining new set of customers.
Following closely the acquisition of a product line with the next likelihood of success within the upper fifty’s percentage range (Clark & Mills, 2013) is an acquisition that is focused on market consolidation. This type of acquisition is directly aimed at fighting off new competition brought about by technology and changed consumer habits. Most matured industries are under attack by new technology and competition from new and cheap locations. Consolidation has therefore become a means to survival. For example, Staples the US office stationery and equipment’s retailer’s pursuit of Office Depot another office equipment retailer is an attempt to consolidate to be able to survive the pressures brought about by online stores. The old regular trips to a stationary store in most developed markets to mark the beginning of the academic year has been replaced by a few clicks online from the comfort of one’s home. Most people find it easy ordering stationary either for school or the office on the internet. Therefore, consolidation by these brick-and-mortar businesses is a must to survive. The advent of Covid has emphasized the new shift in consumer behaviour towards online shopping to the disadvantage of brick-and-mortar retailers.
The benefits of such acquisitions are that the acquiring business grows in scale with a potentially increased customer base and sometimes market share. It also helps to reduce cost and cut out redundancies. Acquisition purchase premium may be high depending on the size of the target company and the timing of the acquisition. Acquiring a large established business may also be acquiring its problems and the risk of that is real. Particularly as research indicates that over 70 percent of large acquisition transactions fail (Coley and Reinton,1988). Consolidation allows businesses to close down non-profitable locations, reduce rental costs and benefit from economies of scale.
Below 50%, that is lower forties percentage transaction success rates (Clark & Mills, 2013) are transactions that attract a high Acquisition Purchase Premium (APP) either because the acquiring company was desperate in the market for a target or did a poor evaluation of the target. So, paid over the odds without evaluating critically what the acquisition will deliver (Clark and Mills,2013). AT&T’s disastrous acquisition of NCR in 1991 is one such example where AT&T was generally believed to have overpaid when it paid $7.5Billion for NCR yet didn’t achieved the expected synergies. It was also speculated that AT&T were overly eager to acquire a computer business to boost its own flagging computer operations unit (Sciencedirect,1995). Any transaction that has a less than 50% chance of success is inherently risky. However, if such acquisition can push the company to becoming a market leader because it can deliver new innovative products, then maybe a higher APP may be a price worth paying.
Another type of transaction that has a success rate of around 40% is one involving two companies that have both not been firmly established in its market (Clark & Mills, 2013). As a result, they have neither the financial clout or the managerial experience to survive a sudden jolt in the market. When two of such companies decide to merge the chances of this merger being a success is low. This is common in the information technology field where a lot of young gifted IT professionals come up with new ideas but lack the experience of running business in a complex market. This manifest itself sometimes along the way in the way their passion for their inventions drives business decisions leading to some bad decision making (Forbes,2014). A typical example was the acquisition of Homegrocer an online grocery delivery company, which had been in business for 13 years, by Webvan another online grocery delivery company that had also been in business for 14 years in 2000 (CNN,2000). Just a year after the acquisition Webvan collapsed under mounting debt due to rapid expansion. Something a more experienced management team could have foreseen in view of what was happening to other online grocers at the time (CNN,2000).
The other acquisition with a success rate of around 30% is an acquisition that seeks to dramatically change the strategy of an organization (Clark & Mills,2013). An example is what HP sought to do with its acquisition of Autonomy the UK based software company (Dataveristy,2012) The two companies were different in the sense that HP focused on hardware whilst Autonomy was a software company. This was going to be a major change in strategy for HP. No wonder the acquisition went bad and like bickering Ex’s they are still in court over the collapsed marriage.
Bottom of the merger success rates with success rates of below 25% are speculative acquisitions (Clark & Mills,2013) with very little to gain in terms of synergy to achieve a successful merger transaction. An example was Coca Cola’s acquisition of Columbia pictures which looked more like a doing a favour to Columbia management than an acquisition meant to deliver any real benefit to Coca cola (Washingtonpost,1982) Coca Cola dealt in beverage drinks whilst Columbia was a movie production company. Just five years later the honeymoon ended, just like pets for Christmas, Coca cola returned the Christmas ‘dog’ closer to home by divesting 51% to the public until it eventually sold its remaining shares off to Sony in 1989 albeit at a profit (latimes,1989).
Having decided on your target the actual process of acquiring the identified target isn’t straightforward. Whilst some target companies may welcome an approach from a prospective buyer other target companies may very well resist any such approach. There are therefore two forms of takeovers used; a Friendly Takeover and a Hostile Takeover.
A friendly takeover is one where management and board of the target company is made aware of the interest of the acquiring company before any offers are made (Schnitzer,1996). There is engagement between the acquiring company’s team and the target company’s team and an approach and price is agreed. The target team’s management then can even recommend acceptance of the offer to shareholders. Facebooks 2014 acquisition of WhatsApp is an example of a friendly takeover. Even Management of both companies issued a joint statement announcing the deal. The acquiring company is usually at a disadvantage in a friendly takeover as the management of the target company has more negotiating leverage as it has more information than the acquirer (Schnitzer,1996). Also, management may reject a potentially good offer for shareholders just because they may be losing their prestigious jobs and influence after the acquisition (Schnitzer,1996). Alternatively, a friendly takeover is more structured and makes it possible for the management of the target company to help with the transitioning process. Not all takeovers are friendly though.
The other form of takeover which isn’t so friendly is a Hostile Takeover. This form of takeover is where an offer is made directly to shareholders without any prior acceptance by management or board (Schnitzer,1996). Shareholders are approached with an offer with a view to pressure management to facilitate the transaction. Sanofi plc’s acquisition of Genzyme a biotechnology company in 2010 is one such example of a hostile takeover. For months management at Genzyme led by its CEO, who had been at the helm for 25years rebuffed Sanofi’s approach. Management finally agreed to a deal after pressure from some shareholders (Reuters,2011). To avoid hostile takeovers most organisations have in place measures to fight them off making such approaches more expensive to acquirer. The benefits of a hostile takeover though are that the acquiring company doesn’t become beholden to the target company’s management. Whichever approach is taken comes at a price regardless.
So far, I have looked at some of the different motives company’s have for entering into a merger and Acquisition transaction. Some are for clearly defined strategic reasons such as growing market share, entering a new market, gaining competitive advantage, among others. But it will be naïve to assume all acquisitions are for strategic reasons that benefit the owners of the business. I have referenced Coca Cola’s acquisition of Columbia pictures as one such example.
I reviewed some of the forms of takeovers, including Vertical, Horizontal, Conglomerate. Each of these have their own advantages and disadvantages. I have also reviewed the different types of takeovers and their rates of success. Starting from the acquisition of a struggling competitor that needs support to revive its operations which has almost 90% success rate to the so-called strategic acquisitions that often go bad with around 20% acquisition success rate. I briefly also looked at the two types of acquisition approaches; Friendly and Hostile.
An African proverb says; ‘No one gets married to their enemy’. Yet a growing number of marriages end up in divorce. Some Successful married couples say the secret to their marriage is identifying the right partner and working hard during the courtship and after the marriage. Perhaps Companies need to identify and evaluate the right target and devote resources to the merger transaction before during and after the transaction to have a chance at being successful. Organizations should also constantly review their strategy to define whether they may need an acquisition to remain competitive. This will help them identify and monitor potential targets well in advance to be able to pounce at the right time and price. Ultimately, it’s important to recognize the possibility of an acquisition going bad so contingent planning is made. Mergers and acquisitions are here to stay, and most will fail, but the right acquisition at the right price and time could be a game changer for any organisation.
This article was written as part of coursework towards a Masters at the University of London
The writer currently works as a Senior Auditor at GNPC