A recent article in the New York Times noted the first fruits of the Chrysler and Fiat merger (see A Merger Once Scoffed At Bears Fruit in Detroit and Will the Dodge Dart be a high-caliber replacement?). Fiat seems to be experiencing some early success in its Chrysler acquisition, as the company introduced two new models last week: the Maserati Kubang and the Dodge Dart.

Auto analysts have heaped praise on both the Kubang (the Maserati SUV) and the Dart (a fuel-efficient small car offering). They view these products as evidence of the types of synergies that exist between Chrysler and Fiat. The Kubang brings together Maserati styling with Jeep technology (notably, the platform). The Dodge Dart brings Alfa Romeo small-car technology to Chrysler.

On the Kubang:

…the marriage of an all-American Jeep with the Italian luxury heritage of a Maserati is the best evidence yet that Chrysler and Fiat can create products together that they could not afford to make independently… “the closest thing to a truly symbiotic relationship that the industry has ever seen,” said Jim Hall, managing director of the automotive consulting firm 2953 Analytics.

On the Dart:

The Dart gives Chrysler a competitive product in the important small-car segment of the American market, where the company has had little success…From a marketing standpoint, the Dart should be a big boost to Chrysler’s dealers, who have been hard-pressed to attract younger, first-time car buyers.

I was one of those who didn’t think Fiat-Chrysler was such a great combination (see Fiat/Chrysler Revisited, Can Fiat Really Pull It Off, Is Fiat Nuts?). I remain a bit skeptical that this deal will succeed due to the challenges associated with deriving value from Chrysler, and integrating it into Fiat’s global operations. But who knows, …maybe I’ll be proved wrong.

For me, the success of the Fiat-Chrysler deal depends critically on this first set of offerings (e.g., the Dodge Dart and the Maserati Kubang).

Personally, I think they’re both pretty good-looking cars. We’ll just have to wait and see if there’s more to it than just looks…

Last week I appeared on Xinhua’s CNC World Report discussing the Kodak bankruptcy.

The discussion centered on Kodak’s history and its response to industry change. As I mentioned in the interview, Kodak was unable to change its internal culture so as to benefit from the shift to digital photography – technological change that, paradoxically, it helped usher in. Kodak did not realize the potential of digital photography early enough and it reacted late, by which time it was far too late to play catch up.

A little snippet:

As film began its path to obsolescence, Kodak missed the opportunity on several occasions to jump into the digital world. It first underestimated the impact that digital would have on its business and then it ignored what it might mean…Once it tried to jump in it was far too late.

You can watch the full clip below (or by clicking on this link):

OK, spoiler alert: I’m going to disappoint by not providing the “secret” to doing good deals. I just wanted to take the opportunity to highlight a typical popular press article offering such snake oil.

Exhibit A: A recent Forbes article suggests that mergers and acquisitions (M&A) create shareholder value when they are done at the right price, with the right vision, and with proper planning (see Do Mergers and Acquisitions Enhance or Destroy Shareholder Value).

[Does M&A] enhance or destroy shareholder value? It depends on how the M&A is planned and executed. M&A that begin with the right vision and executed at the right price enhance shareholder value.

Awesome! That’s really insightful. Now can you please tell me what you mean by right price, right vision, and proper planning?? Oh wait, never mind, that information is in there too, …and with specific examples:

Oracle’s and IBM’s string of software acquisitions that have allowed the two companies to ride the rising demand for enterprise software is a case in point—both Oracle and IBM have [sic] rewarded handsomely their stockholders.

By contrast, M&A that begin with the wrong vision and executed at the wrong price destroy shareholder value. Cisco Systems wave of acquisitions in the late 1990s is a case in point.  Over the period 1993-2000, Cisco acquired seventy companies, including Cresendo Communications (1993), Newport Systems Solutions (1994), Network Translation (1995), Netsys Technologies (1996), Net Speed (1998), and Growth Networks (1999), etc. The problem with this strategy, however, is that Cisco [sic] end up paying top prices for Net Speed and Growth Networks acquired at the peak of the high-tech bubble.

Get it? Got it? Good.

Wait. Come again??? It seems to me that the author arbitrarily picks cases that match his thesis. This is a scientific no-no. It’s called “sampling on the dependent variable” – choosing among outcomes that are consistent with a particular viewpoint without identifying potentially disconfirming counterfactuals. Not only that, but he doesn’t, at any point, mention execution prices, premiums paid, synergies identified, and/or anything about the due diligence processes. So in addition to sampling on the dependent variable, none of the data presented can speak to whether these deals were planned, executed, and/or priced well.

But wait, there’s a really profound take-away:

“The bottom line: M&A do not always deliver what they promise to stockholders, especially if they are pursued without a clear vision [sic] at a too high price.”

Again, not much useful there. All I really learned is that the article is in significant need of editing.

That aside, what we do know from research is that most deals fail – an overwhelming number of deals fail to create value for shareholders (see Great Shareholder Ripoff, Why M&A Deals Go Bad, The Deal that Worked). If doing M&A deals were as simple as the author makes it seem, everyone would get it right. And in the end, these kinds of articles bum me out because they are based on conjecture, not science.

It’s been over two years since Fiat acquired a 35% stake in Chrysler, and 3 months since it acquired its 51% controlling stake. As you may recall from my earlier posts, I was (and remain) skeptical that this deal would succeed due to the challenges associated with deriving value from Chrysler, and integrating it into Fiat’s global operations (see Appearance on Cavuto, Now Introducing Fiat/Chrysler, Can Fiat Pull it Off, Is Fiat Nuts?).

Given the recent downgrades of Fiat’s debt by Fitch and Moody’s, the ratings agencies increasingly seem to agree with my opinion. Here’s a recent article from The Detroit News that discusses some of the reasons why Fitch downgraded Fiat to BB from BB+, outlook negative, earlier this month (see Fitch Downgrades Fiat Over Chrysler).

While the agency acknowledged the marriage of the two companies should ultimately lead to increased sales and greater economies of scale, it expressed concern about the challenge of integrating a still-struggling Chrysler with Fiat when both companies remain under tremendous pressure.

“The current ratings are based on Fiat’s standalone credit profile, but incorporate heightened short-term risks for Fiat from its combination with Chrysler LLC in an increasingly challenging environment for the group,” said Fitch analyst Emmanuel Bulle, citing continuing softness in the European and American car markets. “Chrysler has a weaker credit profile than Fiat, and sustained benefits to Fiat from this deal should only accrue in the medium to long term.”

As I recognized in my earlier posts, there are some strategic reasons this acquisition makes sense, including, as the article states:

“Chrysler’s technology, product range and geographic diversification have become central to Fiat’s strategy…”

But it is important to remember that, even in the best of circumstances, acquisition integration is difficult. Lingering weakness in the automotive sector and broader macroeconomic environment make it even more challenging.

The Economist recently published a Special Report focusing on developing country growth (see The World Economy – A Game of Catch-up for the entire special report). The report focuses on the shift in economic power from developed to emerging economies. As much of the developed world continues to grapple with the aftermath of the financial crisis, the special report argues that the emerging world is catching up. The articles address various topics including the East catching up with the West, changes in the global labor market, trends in global M&A, and the U.S. dollar’s status as the world’s reserve currency.

Within this Special Report, I’d highlight two articles:

1. A Game of Catch-up: Many are beginning to predict that China, India and other emerging markets will catch up with the West at a faster pace than previously assumed.

A “great convergence” in living standards is under way as poorer countries speedily adopt the technology, know-how and policies that made the West rich. China and India are the biggest and fastest-growing of the catch-up countries, but the emerging-market boom has spread to embrace Latin America and Africa, too.

If emerging markets keep on growing three percentage points a year faster than America (a conservative estimate), they will account for two-thirds of the world’s output by 2030. Today’s four most populous emerging markets—China, India, Indonesia and Brazil—will make up two-fifths of global GDP, measured at PPP. The combined weight in the world economy of America and the European Union will shrink from more than a third to less than a quarter.

No country, or group of countries, stays on top forever. History and economic theory suggest that sooner or later others will catch up. But this special report will caution against relying on linear extrapolation from recent growth rates. Instead, it will suggest that the transfer of economic power from rich countries to emerging markets is likely to take longer than generally expected. Rich countries will be cursed indeed if they cannot put on an occasional growth spurt. China, for its part, will be lucky to avoid a bad stumble in the next decade or two. Emerging-market crises have been too quickly forgotten, which only makes them more likely to recur.

The force of economic convergence depends on the income gap between developing and developed countries. Going from poor to less poor is the easy part. The trickier bit is making the jump from middle-income to reasonably rich.

MY COMMENT: I agree that growth in many developing countries has been nothing short of remarkable; however I can’t help but side with the more cautious points in the article. Emerging markets have a long way to go, and their development path are fraught with serious downside institutional (cultural, political, and economic) risks. It therefore remains to be seen if the recent explosive growth in the emerging world is sustainable.

2. South-North FDI: Role Reversal: As I noted in my post India Buys Global, emerging market firm are increasingly buying developed market firms. The motivations include access to markets, basic resources, and advanced technology.

Their (emerging market firms) share of cross-border mergers and acquisitions (M&A) rose to 17% in the seven years to 2010, up from just 4% in the previous seven years, according to a recent report by the World Bank. They are the source of more than a third of foreign direct investment (FDI) in other emerging markets. Typically this sort of FDI is “organic”, which involves setting up a local factory or branch office. By contrast, direct investment by emerging-market firms in rich countries (so-called south-north FDI) tends to be “acquisitive”, which means one company buying another.

The bulk of the emerging-markets’ M&A in rich countries comes from five countries, led by China but also including India. America is the rich world’s main recipient, with Britain not far behind, even though its economy is only around one-sixth America’s size. Other big targets are commodity-rich Canada and Australia.

An acquisition is often the quickest (and sometimes the only) way to gain a foothold in a country.

Emerging-market firms may also want to limit their exposure to their lively but often brittle home market. Growth in the rich world may be slow but the investment climate is often warmer. There are better regulations; the tax laws are easier to live with; the courts are less capricious.

Brands are a consideration too. Building a brand can take years and pots of money; buying an established one is often cheaper. Acquiring a rich-world company can also be a quick way to get hold of technology as well as the tacit know-how that comes with operating a firm in mature markets.

Moreover, a corporate presence in the rich world offers access to cheaper and more reliable financing. Corporate bond markets in places like China and India are still underdeveloped, so a big, globally financed M&A deal paves the way for future capital-raising.

MY COMMENT: As I stated last week, I’m not convinced these investments will succeed, as these kinds of acquisitions are especially difficult. Given that they’ve been fueled by an abundance of foreign exchange reserves, in addition to the typical acquisition integration problems that these firms will face, questions could (and should) be raised about the prices at which they have been executed. Nevertheless, as I mentioned last week, the trend is not only interesting, but also worth monitoring.

Although I’ve highlighted only two of the articles in the Special Report, I’d encourage you to take a look at the entire set. They’re worth the read!

A recent NY Times article highlights an increasing trend: emerging market firms expanding into developed markets. Although the trend reflects a broader emerging market phenomena, the Times article focuses in particular on the global expansion of Indian companies (see With Growing Confidence, India Pursues Mergers Abroad).

Recent Indian deals include auto maker Mahindra buying South Korean SUV maker Ssangyong Motor and energy and gas conglomerate Essar buying an oil refinery from Shell. These follow Tata’s widely-publicized acquisitions of Corus Steel and Jaguar Land Rover.

In addition to the typical motivations for foreign expansion including market access and/or access to basic resources, firms from emerging markets often expand in an effort to tap into, and assimilate, state of the art technologies available in developed markets.

According to the article:

Long kept away from the rest of the world by protectionist government policies, Indian companies are increasingly going global. In the last 18 months, Indian companies spent $28.4 billion on outbound mergers and acquisitions, a little more than the $26.4 billion that foreign companies spent on Indian deals

“As Indian companies move into more frontline products, they need specialized technology,” said Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce in New Delhi. “They are also seeking market access. And third, they are buying natural resources.”

As I have written in the past, I am generally skeptical of these kinds of moves, as effectively integrating advanced technological knowledge is challenging. Closing the skills gap with advanced countries is no easy task (see Technological Ascendancy). Not only that, but in many of these deals, emerging market firms often overpay for the assets of struggling developed market firms (see Chinese Acquisitions in the Auto Industry, Tata and JLR I, Tata and JLR II, Tata and JLR III, Tata and JLR IIII).

That notwithstanding, it is certainly a trend worth monitoring…

For those of you who have been following this blog, you know I have had an interest in the development of Tata as an automobile entity, and especially the plight of the Nano and Jaguar/Land Rover (see Is Nano the New Yugo?, Tata and JLR I, Tata and JLR II, Tata and JLR III, Tata and JLR IIII).

Anyhow, this week’s issue of The Economist provides a nice review of the most recent Nano developments (see Stuck in Low Gear). Their conclusion: So far, it’s been a marketing disaster!

Since its launch with great fanfare in 2009, the Nano has swerved from one crisis to another. There was opposition to Tata’s original plans to site the factory in West Bengal, forcing a last-minute scramble to switch the site to Sanand. It opened last summer, but not enough cars came off the production line to meet a huge surge of early orders. The orders then petered out. To make matters worse, a few cars burst into flames, raising fears about the Nano’s safety. Sales, which had been predicted to be 20,000 a month, fell as low as 509 in November last year. Sales recovered to 10,000 a month in the spring, but have fallen back again this summer: 3,260 in July, amid a slump in the Indian car market caused by rising interest rates and fuel prices.

Carl-Peter Forster…head of Tata Motors…admitted earlier this year that he was having to reinvent the Nano business model. There was no real national distribution scheme, very little marketing and advertising, and no effective system of consumer finance.

The Nano’s marketing problems began with its product positioning. The price crept up by around 15%, putting it out of the reach of first-time buyers with no regular employment or payslips to back an application for credit. And by emphasising its cheapness rather than its basic but appealing qualities, it deterred slightly better-off consumers who could afford one but aspired to more sophisticated vehicles…

Interesting stuff, and fully consistent with my priors.

Although the Nano is a wonderful concept in theory. In practice, it has turned out to be much harder to turn into a successful reality.

Nice article in this week’s Economist about the downside of outsourcing (see Trouble with Outsourcing). This is a topic I’ve recently discussed in this blog (see Reevaluating Outsourcing).

According to the Economist:

Outsourcing has transformed global business. Over the past few decades companies have contracted out everything from mopping the floors to spotting the flaws in their internet security. TPI, a company that specialises in the sector, estimates that $100 billion-worth of new contracts are signed every year. Oxford Economics reckons that in Britain, one of the world’s most mature economies, 10% of workers toil away in “outsourced” jobs and companies spend $200 billion a year on outsourcing. Even war is being outsourced: America employs more contract workers in Afghanistan than regular troops.

Can the outsourcing boom go on indefinitely? And is the practice as useful as its advocates claim, or is the popular suspicion that it leads to cut corners and dismal service correct? There are signs that outsourcing often goes wrong, and that companies are rethinking their approach to it.

These are not new questions. These issues are central to the fields of international business and strategy (see also Williamson and Transaction Cost Economics). In fact, outsourcing has been one of the hottest topics in both literatures for at least the last 25 years.

But the topic is certainly worth revisiting every once in awhile. And although the economics of outsourcing can be compelling, it is also important for managers to keep in mind that outsourcing is not without strategic consequences.

As the Economist recognizes:

Outsourcing can go wrong in a colourful variety of ways. Sometimes companies squeeze their contractors so hard that they are forced to cut corners…Sometimes vendors overpromise in order to win a contract and then fail to deliver. Sometimes both parties write sloppy contracts. And some companies undermine their overall strategies with injudicious outsourcing.

It is this last outcome that poses the greatest strategic threat. When firms outsource important value-creating activities, it often portends a phased exit from a part of the business that later precludes them from reentering that business.

Think Apple.

For a long time, Apple refused to follow the industry trend to outsource elements of the value chain – operating system, hardware, peripherals. Instead, they remained staunchly closed and proprietary. Apple was roundly criticized for doing so. Most industry analysts had written them off, and Apple was, at one point, on the verge of extinction.

However, it is Apple that got the last laugh.

Apple was ultimately able to benefit from their decision to keep much of their value chain in-house. Indeed, they experienced a miraculous recovery sparked by the innovation that their integrated approach allowed. Their competitors, by contrast, had jettisoned many of the complementary value-chain activities that, in the long run, helped differentiate Apple. As a result, many are now struggling.

One extreme example: IBM. The mighty IBM, king of the PC, fell prey to the very industry outsourcing trend that they helped create, …and they are now completely out of the PC business.

The moral of the story: Beware the long-term consequences of outsourcing.

Japan’s Panasonic announced its plans to sell its Sanyo unit to the Chinese white-goods firm Haier last week (see Haier Acquires Sanyo). According to Reuters:

China’s Haier will buy Panasonic Corp’s Sanyo Electric washing machine and refrigerator units in Japan and Southeast Asia for about $130 million, in a move that will give the Chinese appliance giant better access to the world’s third-largest economy, sources said.

At face value, this news seemed rather uneventful. Companies sell divisions all the time. It is not at all uncommon for companies to divest small divisions in an effort to restructure operations and rationalize businesses in order to focus on more strategic, and profitable, business segments.

However, there were several facets of this deal that caught my attention.

1. Although M&A deals have increased in recent years, it is still relatively rare for large Japanese firms to divest assets.
2. Not only did a large, Japanese firm (Panasonic) decide to sell a division, but it sold the division to a foreign firm
3. And finally, not only did Panasonic decide to sell to a foreign buyer, but to a Chinese buyer (Haier) no less. Given the history of tempestuous relations between China and Japan, this struck me as most surprising.

Given that background, it will be interesting to follow this deal in the coming years to see whether Haier is able to capitalize on this purchase to make inroads in the broader Asian white-goods market…

According to a recent issue of Bloomberg Businessweek, acquirers are currently creating value through acquisition (see Markets Love a Buyer, ht Ajay).

Bloomberg analyzed takeovers worth at least $200 million in which the buyer was a public company and no more than 10 times as large as the target. For each transaction it calculated the stock market return from the day before the announcement to the day after, minus the return in a benchmark stock index, to eliminate the impact of broad market movements. Last year the median share price gain for companies that announced an acquisition was 1.11 percent, the most for any full year in the study. So far this year, the figure is 1.18 percent. The worst performance was in 2000, when the median decline was 1.77 percent.

The increase challenges the notion on Wall Street that acquirers are punished for spending money…

Or does it?

As I’ve mentioned on this site many times, over long periods of time, the evidence suggests that acquisitions generally fail to create value for shareholders (see Where Have the Strategic Bidders Gone?, More Deals Gone Bad, Great Shareholder Ripoff, Why M&A Deals Go Bad, Dumbfounded by the Data, and The Complexity of Strategic Acquisitions)

So what gives??

It could very well be, as the Bloomberg Businessweek article suggests, that acquisitions have, on average, created value for shareholders over the past two years. I have not had a chance to evaluate the specifics of the event study methodology the authors use. And I do not dispute the evidence.

Indeed, there is evidence in the literature that under certain conditions, or at certain times, acquisitions generally perform better. For example, literature demonstrates that acquisitions generally perform better when managers of the acquiring company own a greater percentage of the outstanding shares in their company.

The bottom line: Acquisitions do not uniformly destroy value.

In my opinion, therefore, the key take-away from the Bloomberg Businessweek article is that in depressed markets (like we’ve experienced the past few years), there are some real bargains to be had, …and it helps to be a cash rich, counter-cyclical buyer.