Timothy Galpin shares his insights on the current mergers and acquisitions landscape.
After weeks of secretive talks, top London law firm Allen & Overy has agreed to merge with New York rival Shearman & Sterling, potentially creating a legal behemoth with 4,000 lawyers across 49 offices and combined revenues of some $3.4 billion. If approved, the major transatlantic tie-up would give Allen & Overy a way to crack the lucrative US legal market. But the combined firm needs to create value – or at least avoid eroding it – by applying proven, best-practice approaches across the deal process, especially during what will by all accounts be a complex post-merger integration effort.
For intermediaries – the bankers, lawyers and consultants who structure and facilitate business combinations, for sizeable fees – the deal is done once it's agreed by both parties, approved by regulators and the transaction is completed. However, for those on the ‘buy-side’ who merge with or acquire a target, deals are not successful until they are effectively implemented post-transaction.
Most companies today are acquired at an average premium of about 30% above current market value. The buyer doesn’t realise this projected value – usually achieved via cost reduction and/or revenue growth – until they successfully integrate the firms’ people, processes and systems.
To overcome the challenges and avoid destroying shareholder value, companies need a clear integration methodology – not just for the processes and systems but employees as well.
M&A activity comes in fits and starts. Currently, we’re at a low point for dealmaking due to high borrowing costs to fund acquisitions, owing to elevated interest rates. There’s also volatility in stock markets, an economic slowdown, and increased regulatory scrutiny, all factors restraining global M&A activity.
But because stock prices of many firms are depressed, there are some bargain assets available. Predictions are for another merger wave to start kicking in come 2024. To overcome the challenges and avoid destroying shareholder value, companies need a clear integration methodology – not just for the processes and systems but employees as well.
It’s worth noting that, according to extensive research, more than 60% of deals destroy shareholder value through customer and talent exits, and failure to capture projected cost synergies or revenue enhancement. Little wonder two-thirds of acquirers in my most recent research reported that their M&A efforts were average at best, and almost half said they were in need of ‘merger repair’ to fix a deal and gain value they haven’t yet captured some two or more years after transaction closed.
So what are the key challenges of the M&A integration process? What does success look like? And how do you manage integration to create maximum value?
Workforce motivation issues are one major roadblock to successful deal implementation, as companies are now faced with bringing together two workforces that are new to each other. That’s particularly the case when ‘acqui-hiring’, or acquiring firms who possess the talent you need. Another issue is retaining such talent in key positions; they may leave if they feel insecure about their ‘me issues’ including pay, benefits, roles and positions. Even if they don’t leave, productivity often falls off if people are worried about these issues for extended periods of time.
A further challenge is political game-playing and resistance to change, especially if there is a cultural mismatch. Swiss banks UBS and Credit Suisse face just such a challenge in integrating after their shotgun marriage was announced earlier this year. Cultural misalignment can kill the value creation of the deal if people start fighting internally for positions and ways of doing business. So you have to apply just as much rigour to addressing the people and cultural aspects of transactions as you do to analysing and planning the financial and operational aspects.
That does not make finance or operational considerations any less important – deals can unravel if financial terms cannot be agreed and the combining companies fail to keep day-to-day operations intact pre- and post-deal. You’ve got to run each business successfully while you’re trying to combine them, so there is a lot of concurrent activity.
Longer-term M&A performance can also be damaged because of funding arrangements, particularly if you load the company up with debt to fund takeovers. Brewer AB Inbev has recently come under investor scrutiny over its previous tactics throughout a fifteen-year period from 2006-2021 of doing debt-fuelled acquisitions and then ruthlessly cutting costs, leaving it with a towering debt pile.
So how can all these challenges – financial, operational, and cultural – be mitigated for deal success?
For the executives, a key step will be overcoming their cognitive limitations. No matter how smart you are, M&A is a team sport, so you need multiple viewpoints – financial, operational, regulatory, technological, people and cultural – about the potential value creation of proposed transactions. Hubris also needs to be avoided. Many executives think others make M&A mistakes but their deals will run smoothly without hiccups, which is rarely the case.
Another step is to avoid acquiring more than you can swallow. The data suggests that when you do big transformational deals, you have less chance of success than if you do more programmatic, smaller deals. That’s partly because small-deal failure can be absorbed more easily – you can make some mistakes without crashing the company.
By contrast, in large transactions – when you’re trying to ‘swallow an elephant’ or pull off a ‘merger of equals’ (which never actually exists) – there are bigger risks, as the future of the combined firm is riding on making the deal work. A well-known example is German conglomerate Bayer’s botched $63 billion takeover of US agrochemicals group Monsanto in 2018. Shortly after the takeover, Bayer’s share price dropped by more than a third, wiping out $28 billion in market value.
In comparison, when doing multiple smaller deals, you strengthen your M&A muscle and get better at repeating the pre- and post-deal playbook over and over, increasing your chances of not only projecting but also creating longer-term value from your transactions.
The thing executives have the most control over is the speed of integration – which protects against the inevitable productivity drop during transactions. Financial, operational and service productivity are all impacted because workers face uncertainty both pre- and post-deal close. According to US Department of Labor statistics, individual productivity declines by as much as 3.6 hours per day during a major organisational transition caused by a merger or acquisition. So the faster you integrate – with prudent speed – the lower the productivity drop because people get their ‘me issues’ answered quicker, and their productivity goes back up faster.
Deal success can, ultimately, be measured in terms of increased cash flow resulting from achieving or exceeding synergy targets and accelerating the timeline for integration and, in the case of public transactions, a rising stock price post-deal. Given the importance of post-deal integration, executives should be thinking about it in the earlier phases of the M&A process, and planning for it prior to deal completion.
Finally, there will be things you cannot control, such as economic uncertainty, which can damage post-deal performance. So focus on what you can control – chiefly, thoroughly evaluating your target, paying a sensible rather than inflated valuation, and conducting well-planned and managed post-deal integration of people, processes and systems, to accelerate the realisation of your projected synergies.
Timothy is an expert on mergers and acquisitions, and strategy formulation and execution and is the author of Winning at the Acquisition Game. He teaches on our Executive MBA programme as well as on our executive diploma programmes in Financial Strategy and Strategy and Innovation.