An Appreciation for the Complexity of Strategic Acquisitions
September 21st, 2007I’m often asked about my views on specific acquisitions. Yes, it’s true that most of them fail, or at the very least, under perform. And while it would be easy to categorically dismiss most as ill-timed and/or poorly thought-out, I believe that would be under appreciating their complexity. It’s much easier to be a Monday-morning quarterback and declare that they were a bad idea after the fact.
When it comes to strategic acquisitions (those made by strategic, industry buyers versus private equity buyers), there are several important parts of the process. First, buyers must identify the appropriate target. This is difficult, but seasoned managers generally have a good sense of the firms with which they would like to combine and those that would make the best fit.
After the target is identified the process becomes more complex because now it must be priced. The intrinsic value of the target must be determined, the synergies that could be generated identified, and a purchase price agreed upon. This is not easy, and this process is more art than exact science. But it can be done, and often done with some precision. I-bankers are pretty good at valuing targets – it’s fairly straightforward to look at comps and historical multiples. Moreover, sage managers know their businesses better than anyone and should be able to come up with some idea for the kinds of synergies that likely exist and a price ceiling that they would be willing to pay. Managers sometimes overpay because they get carried away with a deal as emotions get involved, but a rigorous process to determine a firm price above which managers will walk away can help avoid such emotional attachment.
In my opinion however, the most difficult part of the deal is the integration. How can we effectively bring the two companies together to capture the identified synergies? Although much has been written about how difficult integration can be, we still don’t fully appreciate the process. Deals often go wrong not in the identification of the target, the pricing of the deal, or in the identification of synergies, but in achieving those synergies. Often the synergies are real, yet the cost of realizing them swamps the benefits.
It’s no surprise that integration costs often get underestimated. For one, most acquisitions take place under such time pressure that it’s difficult to spend the appropriate time on pricing-out the integration. We tend to spend the majority of our time pricing the deal and pricing-out synergies. Likewise, even when we have carefully considered the integration, given confidentiality concerns surrounding the due diligence process, access to the appropriate people to help price the integration is limited. Although top managers negotiate the deals, the effectiveness of an integration is determined by the operational, day-to-day managers. These folks often don’t get included into the acquisition process until the deal has already been announced. Finally, we fail to appreciate the human element of the integration process – the resistance to change that is likely to be encountered along the way, and how the process can be deliberately undermined.
Once you put it all together, it’s no wonder that so many of these deals fail. And it’s not solely about integration (although that’s a big part). The real issue is that there are so many places along the way that it can potentially go wrong. First, the target might not be appropriately identified. Second, the intrinsic value calculations might be off, the pricing component might be off, and/or the synergies could be overestimated. Finally of course, the integration costs could be underestimated. But the interesting thing about the whole process is that the mistakes made in one part of the process don’t generally tend to offset the mistakes made in others. Rather, mistakes get amplified along the way. For example, an overly-optimistic intrinsic value might lead to a higher than expected price that an acquirer is willing to pay. Likewise, if the synergies are overestimated, the price an acquirer is willing to pay will mistakenly be pegged. Finally, if synergies are overestimated, this might lead to greater integration costs that the acquirer is willing to tolerate.
All of these things make strategic acquisitions risky, not to mention incredibly difficult to pull off. And true enough, somewhere between 50-85% of them fail. But to underestimate their complexity would be to under appreciate their creativity and the challenges facing managers. Good thing that they’re the ones compensated to take such risks.
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