Mergers and Acquisitions

The basic message in mergers and acquisitions is that most M&A destroys value. We look at the data over and over again, and most acquisitions simply don’t pay off. Yet corporations still consistently make large-scale acquisitions. Trying to persuade senior executives not to pay 30 percent to 40 percent premiums to buy other companies is extremely difficult, but we know from all of the evidence gathered over the last 20 to 30 years that it is extremely difficult to generate enough extra profits out of the acquired company’s assets to pay for the 30 percent to 40 percent acquisition premium required to buy the company.

However, there are some rules about what types of acquisitions are more likely to make sense. Basically, big companies buying small companies in the same line of business, acting very quickly to remove unwanted senior management, integrating as quickly as possible, and creating teams to make sure the acquisition strategy still makes sense after the purchase is made – these things are key for successful acquisitions. Generally they are the rules for industry roll-ups or consolidations within the same business.

That type of successful M&A generally has a small immediate impact on the firm, since it is generally part of an ongoing strategy. The type of M&A that generally doesn’t make sense is the “one-off” blockbuster deal between dissimilar companies made in the name of synergy, that somehow one plus one equals three. In these cases, cultural differences make it difficult to integrate the two companies; there are often management succession problems, and the synergies usually fail to materialize. Yet it is these blockbuster deals that grab the headlines, since they offer a chief executive officer the chance of turning a moribund company around. What were the supposed synergies between a Marathon Oil and a US Steel or an AOL and a Time-Warner?

The fact is that to justify a 30 percent to 40 percent takeover premium, the profitability of the target’s assets has to increase significantly, ceteris paribus, by 30 percent to 40 percent, just to break even. In a roll up this can be achieved simply by removing the fixed costs of the target and consolidating production, although in two equally sized but disparate businesses, this is not possible. However, persuading a senior executive that an acquisition doesn’t make sense is difficult, particularly when everyone else involved, from the lawyers to the investment bankers, has a vested interest in generating fees from cutting a deal!