The Synergy Trap, Asia-Pacific Edition
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About this ebook
-- Charles R. Shoemate,
Chairman and CEO, Bestfoods
With global acquisition activity running into the trillions of dollars, the acquisition alternative continues to be the favorite corporate growth strategy of this generation's executives. Unfortunately, creating shareholder value remains the most elusive outcome of these corporate strategies. After decades of research and billions of dollars paid in advisory fees, why do these major decisions continue to destroy value?
Building on his groundbreaking research first cited in Business Week, Mark L. Sirower explains how companies often pay too much -- and predictably never realize the promises of increased performance and competitiveness -- in their quest to acquire other companies. Armed with extensive evidence, Sirower destroys the popular notion that the acquisition premium represents potential value. He provides the first formal and functional definition for synergy -- the specific increases in performance beyond those already expected for companies to achieve independently. Sirower's refreshing nuts-and-bolts analysis of the fundamentals behind acquisition performance cuts sharply through the existing folklore surrounding failed acquisitions, such as lack of "strategic fit" or corporate culture problems, and gives managers the tools to avoid predictable losses in acquisition decisions.
Using several detailed examples of recent major acquisitions and through his masterful integration and extension of techniques from finance and business strategy, Sirower reveals:
- The unique business gamble that acquisitions represent
- The managerial challenges already embedded in current stock prices
- The competitive conditions that must be met and the organizational cornerstones that must be in place for any possibility of synergy
- The precise Required Performance Improvements (RPIs) implicitly embedded in acquisition premiums and the reasons why these RPIs normally dwarf realistic performance gains
- The seductiveness and danger of sophisticated valuation models so often used by advisors
The Synergy Trap is the first expose of its kind to prove that the tendency of managers to succumb to the "up the ante" philosophy in acquisitions often leads to disastrous ends for their shareholders. Sirower shows that companies must meticulously plan -- and account for huge uncertainties -- before deciding to enter the acquisition game. To date, Sirower's work is the most comprehensive and rigorous, yet practical, analysis of the drivers of acquisition performance. This definitive book will become required reading for managers, corporate directors, consultants, investors, bankers, and academics involved in the mergers and acquisitions arena.
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The Synergy Trap, Asia-Pacific Edition - Mark L. Sirower
THE FREE PRESS
A Division of Simon & Schuster Inc.
1230 Avenue of the Americas
New York, NY 10020
www.SimonandSchuster.com
Copyright © 1997 by Mark L. Sirower
Foreword copyright © 2000 by Thomas Lewis
All rights reserved, including the right of reproduction in whole or in part in any form.
THE FREE PRESS and colophon are trademarks of Simon & Schuster Inc.
Manufactured in the United States of America
10 9 8 7 6 5 4 3 2
Library of Congress Cataloging-in-Publication Data
Sirower, Mark L., 1962-
The synergy trap : how companies lose the acquisition game / Mark L. Sirower ; foreword by Thomas Lewis and Chris Hasson.—Asia-Pacific ed.
p. cm.
Includes index.
1. Consolidation and merger of corporations—United States. 2. Tender offers (Securities)—United States. 3. Management buyouts—United States. 4. Competition—United States. 5. Risk—United States. I. Title.
HD2746.55.U5S57 1997
338.8′3′0973—dc20 96-44862
CIP
ISBN 0-7432-0130-2 (alk. paper)
eISBN: 978-1-451-60344-6
To Mom and Dad
You will always be my greatest teachers
Contents
Foreword
Preface
PART 1. UNCOVERING THE RULES OF THE GAME
1. Introduction: The Acquisition Game
The M&A Phenomenon
Back to First Principles: The Acquisition Game
A Brief History of the Research on Acquisitions
2. Can You Run Harder? Synergy
Synergy and the Acquisition Game
The Performance Requirements of Pre-Acquisition Market Values
The Competitive Challenge of Synergy
The Cornerstones of Synergy
Predictable Overpayment
3. Do You Feel Lucky? The Acquisition Premium
The Synergy Concept: Expectations versus Realizations
The Resource Allocation Decision: An Introduction
Required Performance Improvements: A Simulation Approach
The Seductiveness of Financial Valuation Models
4. Tools and Lessons for the Acquisition Game
Prior Expectations and Additional Resource Requirements
Competitors
Time, Value, and the Premium
PART 2. AN ANALYSIS OF CORPORATE ACQUISITION STRATEGIES
5. Acquirer Performance and Risk Taking
Corporate Acquisitions as a Strategy for Value Creation
Acquisition Premiums
Strategic Relatedness of Acquisitions
Method of Payment
The Performance Effects of Mergers versus Tender Offers
Relative Size of the Acquisition
Managerial Risk Taking Following Acquisition
6. Methodology
Sample
Acquiring Firm Performance
Independent Variables
Changes in Risk Taking Following Acquisition
Empirical Techniques
7. Discussion of Results
Aggregate Results on Acquisitions
Traditional Tests and Replications of Evidence on Relatedness
Testing the Acquiring Firm Performance Model
Tests for Changes in Risk Taking
8. Implications of the Analysis
Theoretical Contributions
Public Policy Implications
Practical Implications
Appendix A: Review and Critique of Prior Research on Mergers and Acquisitions
Appendix B: Detailed Results of the Analysis in Part 2
Appendix C: Sample and Descriptions of Targets and Acquirers Used in the Analysis
Notes
Bibliography
Index
About the Author
Foreword
Acquisitions and the Pursuit of Synergy: An Asia-Pacific Perspective
In this era of megadeals, mergers and acquisitions are no longer just about boardroom battles, newspaper headlines, and investment banking league tables. For better or worse, they have become an integral part of modern corporate life and often affect customers, suppliers, competitors, local communities, and employees on a scale unimaginable just five or ten years ago.
Although acquisitions can be a highly effective tool for corporate development and value creation, Mark Sirower’s The Synergy Trap reminds us that they are fraught with formidable risks and managerial challenges before, during, and after the deal is struck.
In documenting the recent performance of major acquisitions, Mr. Sirower demonstrates conclusively what has long been suspected but never fully understood: that most acquisitions have destroyed value for the shareholders of the acquiring companies. A major reason, he observes, is the willingness of senior executives to overpay for seemingly attractive targets in the pursuit of synergies that do not exist or cannot be achieved. To justify paying a premium over the existing market price, managers must overcome a burden of proof to show that the financial benefits from the expected synergies—that is, performance gains over preexisting market expectations—will at least offset any premium in a reasonable period of time. Whether or not a premium is paid, management must also make sure that the merger does not disrupt existing business activities.
Mr. Sirower concludes that the most successful acquirers are also the most disciplined. Before making an acquisition, they satisfy themselves that all strategic alternatives have been carefully explored and their potential for creating value quantified. They understand which of their existing businesses should be developed organically, which should be sold, and which would benefit from growth through acquisition. If acquisition is the chosen strategy, they are prepared to walk away from a deal when the price reaches a point at which the required benefits cannot possibly be realized.
With merger and acquisition activity rapidly picking up steam in the Asia-Pacific region, The Synergy Trap provides local managers with an opportunity to learn from the mistakes of their counterparts in supposedly more developed economies where the M&A boom has been raging for years.
Recent Trends in Mergers and Acquisitions
Global merger mania reached record levels in the latter half of the 1990s. In 1999, the value of announced transactions surged to over US$3 trillion compared to the US$2.5 trillion recorded the year before.
This phenomenon has occurred because many companies in North America and Europe, after years of organizational streamlining and reengineering, are looking beyond their own businesses for growth opportunities. Spurred on by historically low interest rates and soaring equity markets, top managers are contemplating deals that would have appeared unthinkable a few short years ago.
Headline-grabbing megamergers of the past two years include the combinations of oil giants Exxon-Mobil (US$80 billion) and BP-Amoco (US$50 billion); Travelers-Citicorp (US$70 billion), the financial services conglomerates; automakers Daimler-Chrysler (US$40 billion); and MCI WorldCom-Sprint (US$115 billion), the telecommunications providers. A number of other multibillion-dollar marriages in the banking, telecommunications, pharmaceutical, and energy sectors also promise to alter the global competitive landscape radically in the years ahead.
North America is by far the largest merger and acquisition market, and the highest-profile deals have generally involved U.S. companies. The number of completed transactions in North America rose at a 10 percent compound annual rate through the 1990s. Still, as seen in Figure A, M&A activity outside North America has been growing at a much faster rate. In Europe, several developments, including the move toward a single currency, the lowering of economic boundaries between countries, and industry deregulation, together have triggered a surge in the number and size of transactions.
FIGURE A Merger and Acquisition Activity: Asia-Pacific, Europe, and North America
During the 1990s, most of the largest deals were friendly, strategic transactions and often mergers of equals. That represents a dramatic change from the leveraged buyouts (LBOs) of the 1980s, when predatory corporate raiders—Barbarians at the Gate
—borrowed heavily to acquire bloated, slow-moving competitors. They then broke them up and sold the pieces in frequently unsuccessful attempts to pay off the debt. The shift to more friendly mergers was driven by several forces, including the establishment by many publicly held corporations of legal defenses against hostile takeover bids. More important, however, corporations simply concluded that bigger was better. While today’s deals aim to achieve cost savings, they are driven mostly by the view that long-term competitive advantage requires global scale and presence.
The Rise of M&A in the Asia-Pacific Region
Historically, Asia-Pacific companies have preferred to grow organically rather than through merger and acquisition, so these transactions have figured much less prominently in the region than in North America or Europe. A major reason is that rapid economic growth generated plenty of business opportunities, at least until recently. Additionally, widespread family ownership of large corporations in many Asian countries, governmental restrictions on foreign investment in certain industry sectors, and relatively underdeveloped regional capital markets dampened interest in such combinations.
Over the last several years, however, mergers and acquisitions have become a much more important part of the Asia-Pacific business scene, as reflected in the rapid growth in transactions during this period. Asian corporations recognize that they need to improve their business fundamentals and competitive position, while more and more multinational corporations are looking for ways to enter this growing, dynamic market.
The Asian financial crisis that followed the collapse of the asset bubbles in Japan and in the New Tiger
economies after the July 1997 devaluation of the Thai baht has clearly accelerated this trend. From South Korea to India, many companies, including some of the region’s largest diversified corporations, are reexamining their business portfolios and restructuring their operations through asset sales, refinancing, divestment, and merger and acquisition. Meanwhile, Asian governments are pushing for the privatization and deregulation of their economies in order to restore investor confidence and encourage foreign investment.
North American and European Acquisitions in Asia-Pacific
For many years, North American and European multinational corporations (MNCs) have been attracted to the Asia-Pacific region by its huge, and increasingly affluent, consumer population. Some MNCs gradually built up their regional operations by opening representative offices and establishing plants on a country-by-country basis. Others chose joint ventures or alliances with local players as their entry strategy. Until recently, opportunities to acquire control of large local businesses were extremely rare—because of either the refusal of family owners to sell or legal restrictions on foreign ownership. That situation is now changing, however, because local corporations are being forced to restructure to pay down debt, restore profitability, or raise new capital, which is often difficult to obtain from local banks.
Given their familiarity with the region, it is not surprising that the MNCs have been among the first to take advantage of the more open post-crisis merger and acquisition market. Nowhere is this trend more evident than in Japan, where U.S. and European MNCs recently have made multibillion-dollar investments in major sectors of the economy that were previously off-limits to foreigners. Recent high-profile transactions in Japan include Renault’s acquisition of a 36.8 percent stake in Nissan Motors, Merrill Lynch’s acquisition of Yamaichi’s retail stocking business, and an unprecedented hostile takeover of IDC, a local telecommunications company, by the United Kingdom’s Cable & Wireless.
Similarly, in South Korea and Southeast Asia, MNCs have been actively increasing their stakes in existing joint ventures and bidding aggressively to acquire financially troubled businesses in several key sectors, including banking, cement, consumer products, food retailing, and industrial goods. Moreover, private equity groups that invest on behalf of international institutional investors have boosted their holdings in the region with purchases ranging from Korean and Japanese banks to Chinese Internet companies.
Intraregional Transactions
Within the Asia-Pacific corporate sector as well, merger and acquisition activity is growing rapidly. By the late 1990s, the number of intraregional transactions completed annually had risen to more than seven times the comparable figure a decade earlier. Once again, the pressure to restructure and compete more efficiently appears to be the driving force. In fact, a number of merger and acquisition experts now anticipate that domestic consolidations will dominate the Asia-Pacific M&A scene in the early part of the twenty-first century.
Reflecting its Anglo-Saxon roots, Australia is the region’s most active merger and acquisition market. One key reason is that Australian corporate law is more predictable than legal systems elsewhere in Asia and the Pacific, and therefore more hospitable to acquisitions, including unsolicited takeovers of publicly listed firms.
In the wake of the Asian financial crisis, Australian corporations generally avoided investments in Southeast Asia and instead focused on domestic deals. As in the United States and Europe, institutional shareholders have encouraged consolidation in several industries by pressuring Australian managers to improve their financial performance. Because most Australian publicly listed corporations are widely held and not controlled by family interests, they are much more susceptible to takeover or merger proposals than companies headquartered in other Asia-Pacific nations.
The decision to concentrate on opportunities closer to home, however, did not eliminate the risks inherent in growth through acquisition. For example, AMP Limited, the insurance and financial services group, encountered significant problems following its contested takeover bid for rival insurer GIO Australia. Although AMP was successful in securing control of 57 percent of the company, its share price fell sharply after GIO subsequently announced that it had incurred unexpected losses of over US$500 million in its reinsurance division.
Elsewhere in Asia, governments are encouraging mergers, acquisitions, and divestments as part of the economic restructuring process. The governments of both Malaysia and Thailand, for example, are supporting mergers of financial institutions in order to stabilize and recapitalize their domestic banking sectors. Similarly, the South Korean government has pressured the giant chaebol business groups to speed up their restructuring, as was evident in early 1999 when the LG Group sold its semiconductor division to the Hyundai Group, its primary domestic competitor. Mergers have even become a feature of economic policy in mainland China, where the need to reform state-owned enterprises is requiring large-scale industry restructuring.
Global Expansion of Asia-Pacific Companies
In all likelihood, Asia-Pacific corporations will continue to concentrate on achieving growth in their home markets rather than prospecting for it in unfamiliar territory. To the extent that these strategies call for mergers and acquisitions, most such marriages will involve other domestic or intraregional companies. There’s good reason for this. During the 1980s, when the Japanese economy was booming, a few major Japanese corporations made significant acquisitions in North America and Europe in an attempt to diversify and extend their global reach. Sadly, however, as Mr. Sirower notes in this book, several of these investments are now among the many cross-border deals that destroyed rather than created value for the acquirers’ shareholders. Besides wanting to avoid the mistakes of the past, local corporations also realize the need for additional restructuring. And they recognize that Asia offers considerably more growth potential than the fiercely competitive North American and European markets.
But there have been and will always be exceptions. These may include certain Asia-Pacific companies that have achieved a global competitive advantage by finding ways to sell goods and services at low cost to their Western customers. Some of Taiwan’s high-technology companies, for instance, have recently begun to make selective acquisitions in the United States to secure long-term access to new technology.
Similarly, Asian industrial goods companies may find opportunities to get closer to their North American and European customers as multinational corporations shed nonessential manufacturing facilities in these key markets. For example, in 1999 Johnson Electric Holdings, a leading Hong Kong-based manufacturer of small precision motors, purchased an automotive components unit from United Technologies’ automotive division. This acquisition effectively doubled Johnson Electric’s sales and gave it an opportunity to broaden its global reach and product offerings in the automotive industry.
Winning the Acquisition Game: Tips for Asia-Pacific Managers
Even for managers in North America, where mergers and acquisitions have been part of the business culture for over a century, executing successful deals has been a slippery slope. But managers in the Asia-Pacific arena face an especially tough challenge because relatively few of them have extensive M&A experience, for all the reasons previously cited. And even those that do will often find that executing a major transaction places a severe strain on management teams that are already stretched thin. Whether the venue is Boston or Brussels or Bangkok, executing a successful acquisition must stem from a well-defined corporate development process, as shown in Figure B.
Once a merger or acquisition is determined to be an appropriate alternative for growing the business, it typically calls for a five-step process. The first three steps are concerned with pre-deal activities: identifying acquisition prospects, evaluating likely targets, and determining a realistic price. Step 4 is the negotiation phase, and the final step consists of integrating the two companies. If an acquirer fumbles the first four steps, the likelihood of success will be diminished substantially. A smooth, well-planned post-merger integration (PMI) strategy cannot make a bad deal good. On the other hand, a poorly executed PMI plan will invariably undermine an otherwise strategically sound, realistically priced transaction.
Step 1. Identification of suitable acquisition candidates through rigorous industry and company screening. Frequently this step is bypassed as a result of one-off opportunistic situations or because candidates are submitted through an auction orchestrated by an investment bank. While attractive potential acquisitions may indeed present themselves this way, it is also important to remember that the best candidates will be those offering the best strategic fit and not simply those businesses that are for sale.
It is for this reason that many leading corporations integrate acquisition searches into their ongoing strategic planning process ensuring their ability to compare multiple growth opportunities.
Step 2. Detailed analysis and assessment of target. A thoughtful acquirer performs this step to make sure its early assumptions concerning strategic fit and business potential are well founded. The focus of this strategic due diligence exercise is to understand the competitive strengths, weaknesses, and growth potential of the target in order to determine its potential value to the acquirer. The same target can have vastly different values to different acquirers because the capabilities of the acquirers may be very different.
FIGURE B Key Steps in the Merger and Acquisition Process
Managers must determine whether the perceived synergies associated with the deal are real or wishful thinking. This requires careful analysis of the performance of the two businesses on a pre-merger (or stand-alone
) basis and of the specific, quantifiable performance improvements expected to result from the merger.
Step 3. Financial evaluation. Using the findings obtained in Step 2, acquirers must undertake a thorough, hard-nosed financial analysis of the target and the value of the synergies it can reasonably be expected to deliver. This is done, of course, with a view to establishing a realistic acquisition price range. An attractive acquisition candidate can become a successful acquisition only if the purchase price is right. Of course, determining a fair value for a business—especially if its stock is not publicly traded—is never a simple, mechanical exercise. This is especially true in emerging Asia-Pacific markets where inadequate financial information, an unpredictable regulatory environment, and volatile foreign exchange rates make cash flow forecasting a daunting task at best.
That does not mean that companies should abandon rigorous cash flow analysis in favor of simpler valuation techniques. Financial modeling is essential to understand the business economics of the target, particularly in the hands of a given acquirer. Along with comparable transaction pricing data, this process helps to identify financing options and establish a realistic purchase price. Moreover, it leads to a better understanding of the impact of market dynamics, such as volume growth, pricing, and cost structure, on the target’s financial performance.
Step 4. Negotiating the deal. Sellers obviously have a fiduciary duty to their shareholders to get the highest possible price for their company or assets. So when prospective acquirers sit down at the bargaining table, they must keep in mind one of the principal tenets of The Synergy Trap: that if they are persuaded to pay a price premium that exceeds the value of the potential synergies, then shareholder value of the company will be destroyed. Consequently, successful negotiation calls for a cool head and the discipline to walk away from a strategic
deal that will hurt the shareholders.
It is important to enter negotiations with the confidence of having other strategic alternatives to the particular transaction under consideration. Otherwise, with no fallback position, the acquirer may run the risk of being committed to doing the deal at any price, driving up the risk of poor financial performance. In an era of global investors, bad bidders may become good targets.
Step 5. Post-merger integration. This is arguably the most critical step of all. It is the careful work of the previous four steps that forms the foundation for integration. A well-defined and carefully managed post-merger integration (PMI) process typically makes the difference between a truly successful deal and one that fails or falls short of its goals. In fact, experienced acquirers begin planning the PMI phase well before the deal is closed.
After the transaction is signed, managers should probably brew plenty of tea or coffee rather than pop the champagne corks. That is because they must now turn their attention to developing a strategy for the combined company that will enable it to generate the revenue enhancements, operational improvements, and cost savings that prompted the acquisition in the first place.
Top management must demonstrate clear, consistent leadership of the integration effort, which should be separated as a discrete process from day-to-day business activities. A fast integration is vastly preferable to a slow one—it actually reduces organizational strain in addition to realizing benefits more quickly. Accordingly, senior managers should move quickly to appoint and structure the coordination team and empowered integration teams, organize decision-making processes, and outline key integration activities and milestones.
Post-merger integration is a highly complex process. Combining two organizations, each with its own distinctive culture, while trying to manage business as usual
and protect the day-to-day cash flow, is an awesome task. Many decisions, large and small, must be addressed at once, from evaluating the capabilities of individual executives and selecting new management, to harmonizing compensation plans, blending research, consolidating sales organizations, and choosing or integrating information technology systems—to name but a few. And unlike many other change programs, organizational minutia really matters if integration benefits are to be fully achieved. You can’t let these things just work themselves out,
says John Browne, BP-Amoco chief executive and veteran of several major deals.
The challenge is particularly daunting when the merger involves two large organizations of similar size and complexity. As Sanford I. Weill, Citigroup’s chairman and co-chief executive, commented in a recent Wall Street Journal interview, Mergers fail because the people who do them are not really on top of the details…. It’s like putting an engine in a car. If you don’t connect it right, the car is not going to move. Doing mergers requires a company to be precision-oriented.
In most organizations, PMI is not a core skill; a large PMI occurs once or twice in a typical manager’s career. Doing it right calls for skills that are very different from those required of conventional line managers. For one thing, managers will have to learn to operate in a fishbowl, since the whole exercise will be conducted in public, under the scrutiny of shareholders, investors, analysts, and the press, all of them eager for early results and signs of discord, weakness, or failure. Throughout this critical period, top management must be perceived by insiders and outsiders as being firmly in control.
From its experience in PMI assignments, The Boston Consulting Group has identified several ground rules that help acquirers avoid the most common pitfalls and enable the new organization to achieve its value-creation goals:
Develop clear merger goals and objectives. These objectives and principles provide a solid foundation for making decisions and resolving difficult issues. Executives must minimize uncertainty within the organization about strategic priorities and direction and must discuss concerns and issues openly as they arise. If there are long periods before the new entity is formed (for regulatory or other reasons), regular contact must be facilitated between senior executives of both organizations.
Define explicit PMI targets and track progress against them. This process helps to ensure that merger synergies are realized completely and on time. Effective target setting calls for top-down and bottom-up management input. Evaluation of merger benefits (what to measure and how to measure) should be separate and distinct from the measurement of baseline business performance. There should be clear schedules for target setting, target revisions, progress documentation, and progress tracking against targets.
Tackle information technology issues early and pragmatically. Effectively integrating information technology programs is a prerequisite for successfully integrating the rest of any newly merged corporation, and it is often a lengthier and far more complex process than most managers realize.
Design a clear organizational structure for the new company. The design of the new organization, notably its structure, shape, and size, is critical to the new company’s ability to realize fully the potential revenue and cost synergies. The organizational structure should facilitate the new enterprise’s strategy, enable it to serve its customers effectively, reinforce the core skills of the old organizations, and resolve such issues as span of control, layers, reporting relationships, and accountabilities.
Develop a constitution
or a written set of rules of the game, to guide top management decision making at the newly merged company. This document should cover company values, management processes, strategic development processes, expected norms and behaviors, resource allocation and budgeting, performance measurement, and target setting, as well as relationships between personnel in different businesses and functions. Launching the new organization without such a charter almost always leads to needless uncertainty, bad behaviors, and inefficiency.
Build objective and effective human resources processes. This must be done as quickly as possible in order to make key appointments in the new organization and thereby reduce uncertainty and retain key people. The overriding concern of all employees is whether they will have a job in the merged enterprise, and if not, what will happen to them. At publicly traded companies, stock options and equity-linked rewards can often be used to boost employee ownership and their sense of commitment to the new organization.
Design an explicit communications program to explain integration principles, goals, and progress. The difficulty of managing the logistics of communication—to both internal and external audiences—is invariably underestimated in corporate mergers. Communication is about setting appropriate expectations in an open, honest, and straightforward way. It should be aimed at finding ways to resolve troublesome issues and conflicts rather than making promises that may prove impossible to keep.
In combining two companies, it is easy for managers to become so caught up in the process that they lose sight of customers and competitors. Such a mistake can be fatal. At the end of the day, customers do not want to hear explanations about the stresses and strains of post-merger integration—they care only about getting the best possible quality and service. And competitors will look for every opportunity to win over dissatisfied customers.
A company that is not growing is dying, former Citicorp chairman and CEO Walter B. Wriston has observed. Done carefully, mergers and acquisitions are a legitimate, valuable mechanism for producing growth and attractive shareholder returns. But The Synergy Trap is a sober reminder that they can be a prescription for disaster if they are undertaken for the wrong reasons or executed in an undisciplined fashion. The great merger wave of the 1990s and 2000s may eventually crest, but the risks and challenges, as described in this