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This deal season, avoid post-merger missteps
Even in the best of times, many deals that are strategically sound fail to live up to expectations.
John Sequeira and Ted Rouse
Emerging stronger from last year's downturn and boosted by a rebounding domestic economy, many Indian companies are cash-rich. In fact, even at the height of the downturn, the Bombay Stock Exchange's top 100 non-banking companies were sitting on a cash pile of around $41 billion at the end of fiscal year 2008-09. With cash in hand, Indian firms are once again looking outwards to the still-turbulent global economy for M&A deals.
Take, for example, Bharti Airtel's $300-million purchase of Bangladesh's Warid Telecom last month—the largest investment by an Indian company in Bangladesh—or its $10.7-billion bid this month for most of the African assets of Kuwaiti telecom firm Zain. Another example of this increased Indian M&A appetite is the acquisition by Shree Renuka Sugars, India's biggest sugar refiner, of Brazilian sugar-ethanol company Vale Do Ivai SA for $240 million.
History tells us that deals done during turbulent periods can turn out particularly well. Our analysis of 24,000-plus transactions between 1996 and 2006 shows that acquisitions completed during or just after the 2001-02 recession generated almost triple the excess returns of acquisitions made during the preceding boom years. Excess returns refers to shareholder returns from four weeks before to four weeks after the deal, compared with peers.
This held true regardless of industry or deal size. Meanwhile, many companies are also getting better at M&As. In 1995, about 50% of US mergers underperformed their industry index. Ten years later, the figure was about 30%. We link this mostly to the experience gained by frequent acquirers, along with the increasing use of cash—instead of stock—to finance deals, a practice that seems to encourage better due diligence and more-realistic prices.
But even in the best of times, many deals that are strategically sound fail to live up to expectations. Too often, the fault lies in post-merger integration missteps. Many acquirers forfeit large amounts of value as they stumble over three broad areas of post-merger integration: missed targets, loss of key people and poor performance in the core business. Let's examine each:
The failure to define a deal's payoffs—and risks—in crystal-clear terms is more than an oversight. It shows there are no clear priorities for integration, leading to missed targets. Avoiding such a misstep is a major consideration for deals like Bharti Airtel-Warid Telecom, as it was for computer hardware companies buying services businesses. In 2008, it was Hewlett-Packard buying EDS. More recently, Dell acquired Perot Systems, and Xerox made a bold move for ACS that will more than double its workforce. Understanding whether deals are to boost 'scope' or 'scale' is vital. All these computer hardware company mergers are scope deals aimed at helping the companies move up the value chain into more profitable lines of business. Scope deals require a different approach to integration than scale deals, with the aim of fostering some capabilities of the acquired company and integrating where it matters most. In contrast, scale deals focus on combining two similar companies for maximum efficiency.
When it comes to people issues, many companies wait too long on organisational and leadership decisions. Consider what happened when GE Capital agreed to buy Chicago-based Heller Financial in 2001. Paying a 49% premium over Heller's shares, GE Capital let it be known that it would reduce Heller's workforce by some 35% to make the deal viable. Key personnel didn't wait to find out who would survive. Several helped Merrill Lynch create a rival firm. One benefit of being experienced in M&A is that you earn a reputation for creating opportunities for individuals, which keeps the best people interested in staying put until they hear what's in it for them. In India, the Tata group has a reputation of
going the extra mile to build confidence among the employees of the company it is acquiring. Such an approach—developed during the acquisition of UK's Tetley Tea, in which jobs were protected in the acquired firm—helped it in winning union support in Britain for its purchase of Land Rover and Jaguar from Ford.
Poor performance in the base business occurs when integration soaks up too much energy or drags on, distracting managers from the core business. Typically, at least 90% of the organisation should be focused on the base business, with clear targets and incentives to keep those businesses humming. As a side personnel benefit, the few rising stars assigned to manage integration details can absorb priceless experience and grooming for future promotions.
When it comes to post-merger integration, experienced acquirers have the best track record for avoiding these missteps. Consider USbased Danaher Corp, once a tiny industrial tools maker. Danaher has purchased diverse industrial businesses at reasonable prices and consistently boosted earnings and cash flow through operating improvements. Today, it is an industrial conglomerate, with $3.1-billion sales in the last quarter. Often beginning before the close of the deal—and tailored to the original deal thesis based on key financial metrics—Danaher's repeatable M&A model maps all the processes and frequently alters the acquired company's plant layout to a more-efficient cellular assembly process. Despite economic headwinds in 2009, Danaher continued to acquire, recently signing deals for a total of $1.1 billion.
Our studies show that frequent acquirers like Danaher consistently outperform infrequent acquirers. If you had invested $1 in each group, the returns from the frequent-acquirer group would be 25% greater than the infrequent group over a 20-year period. Over the last 15 years, a number of companies, including Cisco Systems and Olam International, have shown that you can substantially beat the odds if you get the integration process right and make it a core competency.
Meanwhile, the rise of cross-border deals has shed light on unique integration issues. Bain research has found cross-border deals carry a similar rate of success to domestic deals, but integration typically is more complex. Among the unique challenges: the need to tailor the integration thesis to each region's circumstances, to quickly tackle actual and perceived cultural differences, to account for geographically-dispersed operations and stakeholders as well as complex legal and regulatory frameworks that can derail integration.
As M&A opportunities for cash-flush Indian companies emerge, savvy acquirers will look beyond deals to avoid post-merger integration missteps. That's the best way to ensure smart acquisitions live up to their potential.
Co-authored by Ted Rouse. Mr Sequeira is a Hong Kong-based partner with Bain & Co who leads the firm's Asia-Pacific M&A practice. Mr Rouse is the co-leader of Bain's global M&A practice and is based in Boston.
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