I am sure you must have heard them before, these statistics that 2 out of 3 acquisitions fail and that the average deal destroys value.
Fortunately, research allows us to nuance these findings a little bit, because it mostly seems to concern public firms only (whereas private deals on average do appear to create value), is really only true for large acquisitions, and it appears that quite a few deals make strategic sense – the companies are more valuable together than they were as separate entities – but the problem is that the premium the acquiring firm paid is too high relatively to the value created.
Yet, despite these nuances, overall, what remains clear is that many firms continue to struggle to create value through their acquisitions.
What is going wrong? Most firms – particularly serial acquirers – nowadays realize that integration is easier said than done, and that you need to be careful in your communication planning, make sure to not chase away key people, and that you should be cognizant of cultural differences.
That is why heads of acquisition – or whatever they’re called in your firm – these days not only spend a lot of time on closing the deal but also on careful post-merger integration; selecting integration managers, making play-books, and creating cultural integration programs, among others.
However, notwithstanding these justified efforts, I see that it often goes wrong much earlier in the process, namely already in the stage of target selection. Simply put, firms often seem buy the wrong things. That is because many use an appealing but oversimplified logic: they buy companies in lines of business that are growing and divest businesses that are shrinking.
Recently, for example, I spoke to the head of acquisitions of a large FMCG company and he said “we sell businesses that are in decline and use the money to buy into segments that are growing”. It is an appealingly simple argument, but unfortunately also flawed.
If the market is even somewhat efficient – and we know financial markets are – businesses in shrinking market segments would not be worth much, simply because the market will also have anticipated this decline and it will be reflected in its price. Hence, you won’t get much for it.
Conversely, unless you have a crystal ball and can predict the future better than anyone else, companies in growing lines of business will be very expensive, and you will be paying the price for all its potential future value. Thus, there is little to be gained from buying them.
Instead, the question that this head of acquisition should have been asking is “what do we have that would enable this business to become worth more than it would if we did not purchase it? In other words: what are our complementary resources?
Any firm who buys another company needs to have something – some resource, asset, or capability – that enables it to create more value than the target would ever be able to create on its own, or if it were owned by some other company. And this “something” needs to be made explicit. In the absence of it, you cannot create value.
Take, for example, the large supermarket corporation Ahold. Two decades ago it grew rapidly, in a consolidating industry, almost exclusively through acquisitions. Its explicit strategy was to buy top-performing companies in growth markets. The company initially grew fast, but it also paid hefty premiums, did not create any excess value, and collapsed several years later.
By contrast, around the same time, the large beer brewer Heineken was also growing in a consolidating industry. Yet, it mainly relied on small deals, but ones that enabled it to grow organically as a result of them. Specifically, it only bought companies where it could create additional value by adding technical knowledge, marketing skills, purchasing power, and use the acquisition’s local distribution channel to grow the Heineken brand. The company emerged as one of the dominant firms in the industry. That’s because it offered complimentary resources: the specific combination of skills and assets created more value than anyone else could.
Nick Varney, the long-serving CEO of Merlin Entertainments (the second largest theme park owner in the world, which it seems is about to be acquired for £5.9b itself) told me he was once offered to acquire Center Parcs.
He visited the holiday park with a group of his executives, they carefully examined all aspects of the business, sniffed around in the kitchen, slept in the bungalows, and splashed around in the waterpark. In the end, he fully agreed with the seller: it was really wonderful, top-notch business. “Therefore” he concluded, “we could not buy it”.
His conclusion may seem odd but his logic was correct. As he explained, he simply did not see how Merlin could possibly add any value to Center Parcs – which was already performing very well on its own – which made it a unattractive target, despite it being an admittedly wonderful business.
Most companies on the look-out for acquisitions, by contrast, focus on top-performing companies. They are eager to purchase firms because they are performing well, however, these are rarely available and are expensive.
Yet, the question should not be “is this a good company?”; the relevant question is “what unique thing do we have that would make it worth more?” Complementary resources are necessary for any deal to create value. In the absence of it, all that can save you is a crystal ball.
The views expressed by the author are his own and not the views of the publisher.
This article is authored by Prof. Freek Vermeulen. Freek Vermeulen is an Associate Professor of Strategy and Entrepreneurship at the London Business School. Follow him on Twitter @Freek_Vermeulen.
This article appeared in https://hbr.org on November 08, 2017
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