C Gopinath

Saying no to a merger

C. Gopinath | Updated on May 12, 2011 Published on May 09, 2011

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Wisdom lies in detecting the warning signs during due diligence of M&A proposals and taking hard-nosed decisions.

Mergers and acquisitions (M & A) are a popular method for corporations pursuing rapid growth. In many industries, changes in technology and consumer preferences imply that firms do not have the time to grow organically — start operations and build the product or service up from scratch.

Instead, they try to acquire or merge with another firm, in the process both acquiring resources they lack as well as gaining a presence in markets they would like to be. Although the two terms are used virtually as synonyms, merger usually means that the two parties are creating a new entity, while an acquisition means that one firm absorbs another into its fold. Of course, to satisfy the ego of the acquired party, sometimes an acquisition may be presented as a merger.

Yet, enough studies have thrown doubts about the success of these M&A efforts. Some show that only 20 per cent of M&As are ultimately successful, and at best about one third of them may be said to have achieved their objectives. That is a pretty large failure rate, but M&As continue unabated and while justifying each one, the CEOs are full of hope and promise.

CULTURE CLASH

The main problems arise from an inability to meld the culture and structure of the two organisations. When two firms with strong individual cultures come together, they find it difficult to adjust and form a new third one. When one ends up dominating the other, it can result in de-motivation in the acquired or merged entity. Critical executives exit, leaving a weakened enterprise as leadership issues are left unresolved. Systems and procedures that an organisation builds over time will have to adjust to a new one, which results in costs becoming higher than originally envisaged. These problems get exacerbated when the two firms are about the same size.

There are some important questions that a firm needs to answer before contemplating an M&A. For instance, if the premium being paid is too high, it may result in a poor return on investment. If the firms are not clear about the value they are adding to the combined firm, then it becomes difficult to achieve that value addition.

A common justification that companies offer for coming together is synergy, the idea that the whole is greater than the parts. Unfortunately, synergy is not an automatic event that arises from an M&A; it requires hard work to generate the potential savings and efficiencies.

When these mergers are cross-border, they wander into more uncertainties. These include regulatory approvals, and national cultures (apart from organisational cultures) that can upset the calculation. Recall the collapse of the Daimler-Benz and Chrysler marriage.

MAKING SOUND CHOICES

Currently, there is much talk about the acquisition of T-Mobile USA by AT&T, both in the field of telecommunication. The US market is so saturated that buying someone else's customers seems among the few available venues for growth of a customer base.

The planned acquisition would result in a near duopoly with the combined company, along with Verizon, controlling nearly 70 per cent of the market. This will certainly reduce consumer choice and we should hopefully expect the regulator to reject it.

My own research showed how firms often confuse the objectives of their corporate strategy when they go in for M&A. Sometimes they believe they are in related businesses but realise late that they have gotten into a different business altogether. Also, the inability to manage the new entity ends up being an enormous sunk cost, leading to losses when they change their minds. One recent case that stands out as an example of rare wisdom is when two health insurance companies in Massachusetts announced that they were not going forward with their planned merger.

Harvard Pilgrim Health Care and Tufts Health Plan, with about one million and 750,000 members, respectively, announced in January this year that they were in merger talks.

As the number two and number three in the industry, it would have given them the clout to deal with the market leader, Blue Cross Blue Shield, which had three million members. They would certainly have benefited from economies of scale from combining the administration of their health plans.

But after five weeks of due diligence the companies called it off. They figured that the savings that they expected would be much less and the costs much greater, not making the merger worthwhile.

AGAINST THE GRAIN

Even without inside knowledge of the two companies, it strikes me as amazing that they were able to come to that decision. After all, the two companies had even settled leadership issues, usually a stumbling block. When they made the initial announcement of intent, they had announced that the head of Tufts would be the CEO of the combined company for the first two years and the head of Harvard would be president and COO.

CEOs stake their reputation in such deals. Subordinates usually feed CEOs with data that will support the decision the bosses are leaning towards, as they do not want to be the messengers of bad news.

As part of due diligence, teams from these two firms would have visited each other and pored over documents, getting a handle on whether their combination would work. In the process, they would have also gathered information that gave them insights into the strengths of the other. So the problems must have shown up early for them to have stopped further delving. On paper, the deal may have seemed good but if the respective CEOs decided that the process of combining would not have justified the potential gains, they must be applauded. They now remain competitors, albeit with a better knowledge of each other, but possibly relieved that they stepped back from the brink. I hope their respective boards are considering bonuses for them.

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Published on May 09, 2011
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