‘M&A SUCCESS IN THE REAL WORLD’

Company takeovers usually end in failure – but this is rarely the case for the best corporate acquirers.

Almost nine in ten M&A deals do not create value for the acquirer. Yet still some corporate acquirers enjoy repeat success from their company takeovers. So, what exactly is it that the ‘successful’ M&A elite is doing right where all others seem to fail?

This article summarizes some of the extensive research carried out on the global M&A elite, and how they create M&A success in the real world.

(Also published via www.issuu.com - this is a reader friendly version for Linkedin only!)

Thanks to the professors, whose years of research were summarized in the book THE M&A FORMULA. They are: Dr. Florian Bauer University of Innsbruck; Dr. Svante Schriber, Associate Professor at University of Stockholm; Dr. David R. King, Associate Professor at Iowa University; and Dr. Kurt Matzler, Professor at University of Bozen, Italy. For this article I would also like to thank Professor Thomas Plenborg and Professor Ken L. Bechmann, Copenhagen Business School for valuable input and guidance (Published in Finans/Invest no. 2 April 2018).

A key takeaway for all companies considering growth through mergers and acquisitions is to avoid the deals that are not expected to create value. It is always important that the acquisition has a solid business model that fits the acquiring company’s extant business model. There should also be a focus on distinct value creation before any acquisitions are considered, through the acquisition phase and also after the acquisition.

(By the author – Peter Zink Secher):

In order to demonstrate this principle, let me share a recent story…

On a crisp winter’s day in 2018, Danish telco company TDC announced a merger with MTG Nordics. The transaction - according to TDC - would work to seriously strengthen the financial muscles of the company and lead to hugely increased competitiveness. Investors promptly reacted to this optimistic forecasting by hammering down the price of the company’s shares.

Generally, the world’s largest professional investors do not like mergers and acquisitions. Investors are acutely aware that billions of dollars are wasted every year on ruined M&A deals that should never have been executed. The high global failure rate in M&A devalues large companies, destroys many SMEs, and can prove to be the ruin of individual careers.

For many investors, the M&A process is akin to flipping a coin with regards to success and failure – but in reality, this could not be further from the truth.

 

What drives M&A performance is not necessarily the opposite of what causes M&A failure

The analogy of a coin flip may appear exaggerated but - in practice - the true odds can be even worse. In 2011 the Harvard Business Review published a paper showing that between 70% and 90% of all M&A deals do not create value for shareholders. Even more worryingly, the research also suggested that 60-80% of all the deals were outright failures.

It is therefore not unusual to see the share price of the buying entity go down after the announcement of an M&A deal.

However, during my research I interviewed a professional investor who reacted completely differently to the rest of the market when a pre-defined group of companies announced an M&A transaction. While the capital markets reacted negatively to any M&A announcement, she acted as contrarian investor and saw a unique value proposition, as any set-back in company price was to her a buying opportunity. Interestingly, she did not follow this investment strategy indiscriminately - only deploying it where the CEO and their team had a proven track-record of creating value through mergers and acquisitions. These were companies with a long-term commitment to corporate M&A activities, and they tended to focus on a series of deals and not a single M&A transaction. While this is a remarkable practice, it is also worth mentioning that the investor in question has been ranked Europe’s #1 and the world’s #7 - accolades that would not have been won if her investment strategy didn’t pay. 

So, clearly some companies create value through M&A, which also means that some kind of formula must prevail when it comes to successful corporate M&A. As a practitioner, my professional goal has always been to lower the global M&A failure rate. And after many years in the capital markets, I have found that there are certain clues or tells that make certain companies successful in M&A again and again.  

Our analysis covered a period from 2007 to 2017. On one hand, the data proved to be surprisingly negative, with only about 10-30% of all M&A deals creating value for shareholders. On the other hand, our research also identified a small number of companies that repeatedly succeeded with M&A and created tremendous value for their shareholders.

**************************************************************************

Research Methodology - BOOK: THE M&A FORMULA

(Wiley – first published 2018, Fixcorp)

Research Insight

Title:                                 The M&A performance miracle

 

Case Insight to Discuss:                             

This book does not investigate the performance of an individual acquisition, but rather the contribution of a bundle of coupled M&A activities on corporate performance. This seems to be a highly relevant issue.

Context from the Author:     

We wanted to kill the myth that the ‘at least 50%’ failure rate applies in any given case.

Research Insight content      

Point:

Stock market data reflects on the expectations of shareholders and is often associated with the real and true value. Similarly, accounting-based measures seem to be accurate and objective.

Counterpoint:

Stock market data is highly sensitive to the environment and internal developments. Furthermore, it is a unidimensional measure for a multidimensional concept. Accounting-based performance measures lack comparability across various countries (due to different valuation standards), and they reflect on the past and not the future. There is empirical evidence that short- and long-term stock market, as well as accounting-based, measures share only little variance. As the performance of acquisitions is highly motive-specific, research often suggests that managerial assessments (e.g. with surveys) are superior.

Contingency:

M&A is a strategic pathway for corporate development and thus, it is not a single acquisition that matters, rather a bundle of coupled M&A activities that contributes to corporate performance.

References                         

Point:

Zollo, M., & Meider, D. (2008) What is M&A performance? Academy of Management Perspectives, August: 55–77.

Counterpoint:

Cording, M., Christmann, P., & Weigelt, C. (2010) Measuring theoretically complex constructs: The case of acquisition performance. Strategic Organization, 8(1): 11–41.

Contingency:

Almor, R., Tarba, S.Y., & Margalit, A. (2014) Maturing, technology-based, born-global companies: Surviving through mergers and acquisitions. Management International Review, 54: k 421–444. Meglio, O., & Risberg, A. (2011) The (mis)measurement of M&A performance—a systematic narrative literature review. Scandinavian Journal of Management, 27: 418–433.

Context from author:            

The Case Insights in this article are based on ‘Financial Economic’ school using a Total-Return-Analysis (TRA) with a 10-year horizon of 2007 to 2017. ‘TRA’ draws an interdisciplinary and integrative perspective on M&A. However, other generic examples of M&A success are shown, drawing on the three other schools of thought in M&A. The choice reduces the complexity of the research field and thus allows for an in-depth analysis and understanding.

************************************************************************* 

 

Case Studies

In our book ‘THE M&A FORMULA’, I ended up focusing on seven companies to illustrate the core building blocks of the ‘Business Model Canvas’ which was used as an illustration throughout the text. While there are more companies with a globally proven track record of M&A success, the chosen seven companies (which we dubbed the global ‘M&A Elite’) had delivered a very high total return to their shareholders during the research period and were highly regarded among the world’s professional investors. These companies have carried out more than 500 M&A deals and the acquired companies have delivered considerably post-merger.

The seven companies include: household and healthcare producer RB (formerly known as Reckitt Benckiser); lock and entrance company AssaAbloy; luxury goods manufacturer LVMH; logistics firm DSV; industrials/medical investor Danaher; dairy firm FrieslandCampina; and a global brewing company. The portfolio of these M&A elite companies would have provided an investor with a total return of 331.4% across the period between 2007 to 2017. As a comparison, the Eurostoxx index would have given investors a return of 121.1%.

Table 1: Case Insights

 

After conducting our initial research, I also covered a completely different ranking of corporate performance called ‘Accelerating Performance’, as published by Heidrick & Struggles. This research eschewed M&A practice and focused on the best-performing 23 companies, with at least 20% annual revenue growth out of the FT500 defined as revenue growth (compounded annual growth rate in revenues). A look at the total return of these 23 super accelerator firms illustrates that these companies do no better a job in creating value for their shareholders than the global M&A elite.

For example: Google is one of the world’s best-known brands. If its success is measured by revenue growth, the company is truly a high achiever. However, this has nothing to do with what the shareholders want, which is a total return on their investment.

The best performing company of our global M&A elite companies is AssaAbloy with a 427.9% total return – a striking value when stacked up against Google’s +343.9% in 2017. And what is perhaps even more impressive is that the global M&A elite has delivered almost the same value to shareholders as Google across our 10-year research period.

This highlights that the M&A elite has clearly found a formula for M&A success - but what is it?

 

 

 

 

M&A success starts with a NO!

The first step to success in corporate finance is to simply stop doing the wrong M&A deals. If there is one key takeaway from our research and interviews, it is that half of M&A success is in the deals you don’t do.

 

Why Is It Hard to Say “No” and How Can You Get Better At It?

One of the most difficult words to say is “No”. When a company considers an acquisition or a merger, it is often accompanied by a group of enthusiastic cheerleaders who have their own interests at heart. Commonly, these include external advisors who are often extremely interested in a company carrying out of mergers and acquisitions. Simply put, more M&A means more money for the advisor. Their price is often represented by a monthly retainer and a so called ‘success-fee’ which tends to be in the region of 1-3% or higher. This fee will be paid at the culmination of the process, even though the M&A transaction may end up being a complete failure for the company and its shareholders. Even where no value has been created, the bank will still get its M&A ‘success’ fee.

This means that external advisors cannot solve the problem of high M&A failure rates as they have a vested interest in companies doing as many M&A deals as possible. Potential returns from forging ahead simply mean that it is not in their interest for a company to say no to a deal.

However, this does not mean that companies should not use external advisors - when it comes to lowering M&A failure rates, change has to come from within. Any company and its shareholders have to be aware that the biggest cheerleaders often reside within the company itself. The CEO can be tempted to commit to a deal because of an expected higher salary, prestige, better location, office or headquarters, which can impact their judgement.

Seasoned professionals such as Warren Buffet recently focused on this principal-agent problem, addressing it directly in his yearly newsletter from Berkshire Hathaway. In this, Buffet believed that when a CEO hungers for a deal, they will start looking for figures that justify it. Confirmation bias soon sweeps in and all decision making becomes clouded and circumspect. This means that if the performance of the M&A target does not match the required valuation, the acquirer’s team will often go back and revise their assumptions and increase expected synergies or the future revenue growth. And then, all of a sudden, the result is that the new valuation fits the seller’s asking price. “A spreadsheet never lies,” states Warren Buffet.

Another element that makes it harder for companies to say ‘No’ is the media focus on deals that don’t come through after they have been announced. No matter what reasons the acquirer may have to not finish a deal, the media will look for dramatic headlines and focus on ‘breakdowns’, ‘waste’, and ‘failure of leadership’. Sadly leaving out the less attractive, responsible reasons for walking away such as due diligence. 

 

The company still has to say NO!

Corporate acquirers increasingly need to learn to ‘fail fast’ in M&A transactions to avoid a real failure. For example, in the proposed Heinz/Kraft merger with Unilever, the buyer and seller fundamentally did not agree on their future joint business model. In this case, making a clean break saves time and resources, and prevents the transaction from turning into a real M&A failure if carried out.

There is no need to be ashamed or heavy hearted as ‘failing fast’ is a responsible and tough decision to make, no matter what the financial papers may think about aborting mid-negotiation.

A red flag for any deal is if the planned M&A transaction starts coming up to a price level so high that the buyer no longer expects the deal to create value for their shareholders.

This could easily have been the reason behind a failed deal at Novo - the pharma company that is the world’s largest producer of insulin. At the start of this year, Novo decided not to increase its ca.$3.3bn bid for Belgian biotech company Ablynx and instead watched a competitor acquire the company for $5bn.

In doing so, Novo did not receive any positive press. These observers concluded that Novo was the loser, running unflattering headlines like: “Sanofi to buy Ablynx leaving Novo in the cold”, “Sanofi leapfrogs Novo”, or “Sanofi beats Novo”. However, this does not account for the possibility Novo had calculated that the price of $5bn was too high for Ablynx - in which case Novo did the right thing by not bidding any higher.

A rarer reason to drop an M&A deal is due to sudden externalities that simply could not be planned for. A prime example is the British population voting in favour of Brexit, or the Swiss Franc appreciating 20% overnight, or the stock market falling drastically. In those circumstances, the best M&A acquirers are smart enough to conclude that even though the initial business model fit was favourable, the total valuation may no longer support the deal. In response to this, the most experienced corporate acquirers often demand various clauses making it possible to step out of the deal. Currency, stock market fluctuations, or geo-political uncertainty are mostly represented as MAC (Material Adverse Change) clauses which provide a way to exit a deal with minimal cost to resource and time.

However, one of the reasons that many companies do not use MAC clauses in M&A deals is that they are rarely proffered by M&A sell-side advisors at it lowers their chance of the so-called M&A ‘success’ fee. Any measure or attempt to lower the likelihood of a deal is not a natural consideration from someone who makes at least 95% of their total income through successfully making deals, regardless of what the eventual outcome may be for their client.

M&A success requires focus and processes

We asked some of the global M&A elite how they became so successful in their execution of mergers and acquisitions. What business model determined their M&A targets? What were their primary processes? And how did they avoid the normal high global failure rate?

We found that the global M&A elite have incorporated multiple rules-based decision-making systems and processes to actively eliminate individual bias towards a target.  

This degree of impartial focus ensures that successful acquirers keep their overall purpose in mind when it comes to conducting M&A activities and evaluating how they will work to create value. Naturally, this involves asking simple but searching questions: What is our business model driver (with a maximum of two business model drivers recommended when undertaking M&A)? Does this acquisition or merger mean that we can do things better, faster, or cheaper? Do we get access to new clients or new technology? What is it actually worth?

Before any of these acquirers considers contacting an external advisor, they would also rigidly consider the M&A complementarity between the two companies. This involves asking: Do our business models actually fit together and do we want to do the same with the new and joint business model going forward? Do we have both employee groups with us 100% in this plan (or at least the people who are planned to stay after the transaction)?

In reality, many companies fail to clearly define and agree on this focus as an integrated part of their business and therefore it is not clear why they are actually undertaking the M&A process. The result is as predictable as it is inevitable: management is not ready when opportunity presents itself and it becomes difficult to explain to the individuals in both companies. Therefore, M&A success depends on the preparations before, during, and after the individual transaction

 

Choosing the right target companies

When it comes to the selection process, the acquirer chooses 1-2 Business Model Drivers and tests the chosen values against M&A Complementarity as a final business model fit test, which is a test comprising of 16 individual questions. The higher the complementarity, the higher chance of M&A success. In this article there are examples of a company (Danaher) with an unusually low M&A complementarity of 1.5 – despite the fact that the company has repeatedly created M&A success through various take overs of industrial companies (see table 1).

Once a company’s target list has been created - based on its business model drivers and M&A Complementarity - it is time to carry out an even more rigid scoring of each individual M&A target using the ‘Goldman Gates’.

This is a typical approach for validating an individual target for an M&A elite company. Just like the world’s best money managers, the formula for success in choosing the right investment requires a dedicated deep dive analysis of each target – a very formal and rules-based target selection with a long-term focus of at least 5 to 10 years. The acquirer sticks to its chosen business model drivers.

Subsequent valuation is - as always - based on a bottom-up model that revolves around free cash flow. Financial projections with a profitability focus first 10 years – all cost synergies are compared with similar deals to determine the likelihood of reaping exactly those synergies. And remember to continuously ask, “are you on a realistic mission”?

At this point, the M&A elite do not go back to Goldman Gates scoring or valuation if the outcome of their process is that “the price is not high enough to win the bid”. A decision to ‘have another look’ is more likely to occur if a downward adjustment may be considered in lieu of financial or legal due diligence that wasn’t quite as expected. Furthermore, the management of the target must also be thoroughly examined alongside its size – if it doesn’t move the needle then why bother in the first place?

In addition, feasibility will often play a role when teams start to ask: “is it at all likely we will actually be able to buy this company?” Other factors such as macro and political issues are critically scored. In some cases where the interloper risk is high, it’s often worth looking at the potential competition; particularly if it’s the biggest competitor who stands poised to become the new market leader further down the line.

Above all – merely taking part in the transaction does not equal success. By all means get the valuation right and do the deal under the right terms and conditions, but it’s just articulate knowledge. We have all read the same books about company valuations. Valuation is often paramount as a subject for external advisors, but the M&A elite does not create value on this subject.

 

Facts: THE M&A FORMULA – Implementation

The seven case insights in the book ‘THE M&A FORMULA’ consider M&A activities to be a logical part of corporate activity, as they barely consider if growth is coming from acquired entities or homegrown entities. It’s not important for them. Build or buy are two options used interchangeably and one is not better than the other. The focus is on creating value for their shareholders. In some cases a small acquisition could have a great impact. As such, the global M&A elite will rarely calculate future growth on acquired or organic growth. You cannot separate cold and hot water.

A company must always be able to clearly identify why M&A should be part of the corporate strategy and the best way to do this is to become business model driven. Companies of any size can increase their chances of M&A success by creating a feeling of ownership throughout the organization; this means engendering a clear responsibility towards ‘who should be doing what’ in regards to the current acquisition. Ultimately, leadership and communication are crucial and these skills are easier to handle when using the M&A formula.

 

Summing up

The Publication of the book ‘THE M&A FORMULA’ - and this article - has involved a lot of myth killing. And some commonly held beliefs are tougher to shed than others.

Firstly, that the way to M&A success relies on the external advisor and particularly the investment bank. There is no evidence whatsoever that using even the highest ranked investment banks leads to M&A success. The world’s M&A elite all follow their own M&A formula for success.

Secondly, that the traditional ‘strategy driven’ M&A process is the way to success. Research suggests that a much granular approach to acquiring companies is a more convincing tool. This shows that companies with a stringent focus on just one or two business model drivers are more likely to create M&A success because this facilitates a much stronger communication and leadership methodology in the M&A process. This means making it clear that employees know what is expected from them, when, and why.  

For us, the most important factor in a successful M&A process is people, and that change must come from within the company itself. A recommended place to start is with the CEO. This is the person who defines - together with their team – the rationale and justification why the company should do M&A. Involving them is absolutely crucial in this process, and ensures that the company truly understands its own business model before inviting other businesses to its platform. Without this degree of self-knowledge and clarification on a firm’s working environment it is not necessarily a good idea to begin M&A activities.

Once a firm has a clear understanding of its own business model and how it actually adds value to its clients, the M&A formula can easily be applied in three easy steps.  

The process begins with the company choosing one or two building blocks from its business model and setting them as key M&A drivers. This move to secure a clear target helps unlock the critical “why M&A” questions, creating a broader sense of ownership across the organization as a while. Successful M&A firms have a dedicated team to take ownership and secure this across the organization. This is often called an M&A Deal Committee, and this team will rank the various M&A targets without the executive board having a direct involvement. Once fully detailed, the executive committee will then step in to approve the final targets. The importance of having the whole organization onboard cannot be understated. 

When it comes to measurable statistics, M&A success is measured by the total-return analysis (TRA) to shareholders. This has proven critical as a considerable share of the total compensation earned by the employees relies on the organization creating value to shareholders out of their M&A activities. A company like RB states, that “the single most important factor for M&A success could be the alignment between shareholders and top management”.

Finally, it is crucial to build objective internal decision-making processes to identify deals that should never have been carried out at an early stage due to a high likelihood of failure. In practice, many M&A projects live too long and even more are executed despite the fact that the global failure rate is alarming high - perhaps higher than ever.

By looking at the current state of M&A success, we can see that the M&A elite companies work to use their acquisition resources in an optimal way. This means applying rigid internal procedures that enable them to very quickly - and at the very earliest stage - give an indication of ‘deal or no-deal’. Statistics suggest that companies doing many M&A deals have the highest success rate and return the most to their shareholders. In the words of the golfer Gary Player: “The more I practice, the luckier I get.

 

Company takeovers usually end in failure – but this is rarely the case for the best corporate acquirers.

Almost nine in ten M&A deals do not create value for the acquirer. Yet still some corporate acquirers enjoy repeat success from their company takeovers. So, what exactly is it that the ‘successful’ M&A elite is doing right where all others seem to fail?

This article summarizes some of the extensive research carried out on the global M&A elite, and how they create M&A success in the real world.

Thanks to the professors, whose years of research were summarized in the book THE M&A FORMULA. They are: Dr. Florian Bauer University of Innsbruck; Dr. Svante Schriber, Associate Professor at University of Stockholm; Dr. David R. King, Associate Professor at Iowa University; and Dr. Kurt Matzler, Professor at University of Bozen, Italy. For this article I would also like to thank Professor Thomas Plenborg and Professor Ken L. Bechmann, Copenhagen Business School for valuable input and guidance (Published in Finans/Invest no. 2 April 2018).

A key takeaway for all companies considering growth through mergers and acquisitions is to avoid the deals that are not expected to create value. It is always important that the acquisition has a solid business model that fits the acquiring company’s extant business model. There should also be a focus on distinct value creation before any acquisitions are considered, through the acquisition phase and also after the acquisition.

(By the author – Peter Zink Secher):

In order to demonstrate this principle, let me share a recent story…

On a crisp winter’s day in 2018, Danish telco company TDC announced a merger with MTG Nordics. The transaction - according to TDC - would work to seriously strengthen the financial muscles of the company and lead to hugely increased competitiveness. Investors promptly reacted to this optimistic forecasting by hammering down the price of the company’s shares.

Generally, the world’s largest professional investors do not like mergers and acquisitions. Investors are acutely aware that billions of dollars are wasted every year on ruined M&A deals that should never have been executed. The high global failure rate in M&A devalues large companies, destroys many SMEs, and can prove to be the ruin of individual careers.

For many investors, the M&A process is akin to flipping a coin with regards to success and failure – but in reality, this could not be further from the truth.

 

What drives M&A performance is not necessarily the opposite of what causes M&A failure

The analogy of a coin flip may appear exaggerated but - in practice - the true odds can be even worse. In 2011 the Harvard Business Review published a paper showing that between 70% and 90% of all M&A deals do not create value for shareholders. Even more worryingly, the research also suggested that 60-80% of all the deals were outright failures.

It is therefore not unusual to see the share price of the buying entity go down after the announcement of an M&A deal.

However, during my research I interviewed a professional investor who reacted completely differently to the rest of the market when a pre-defined group of companies announced an M&A transaction. While the capital markets reacted negatively to any M&A announcement, she acted as contrarian investor and saw a unique value proposition, as any set-back in company price was to her a buying opportunity. Interestingly, she did not follow this investment strategy indiscriminately - only deploying it where the CEO and their team had a proven track-record of creating value through mergers and acquisitions. These were companies with a long-term commitment to corporate M&A activities, and they tended to focus on a series of deals and not a single M&A transaction. While this is a remarkable practice, it is also worth mentioning that the investor in question has been ranked Europe’s #1 and the world’s #7 - accolades that would not have been won if her investment strategy didn’t pay. 

So, clearly some companies create value through M&A, which also means that some kind of formula must prevail when it comes to successful corporate M&A. As a practitioner, my professional goal has always been to lower the global M&A failure rate. And after many years in the capital markets, I have found that there are certain clues or tells that make certain companies successful in M&A again and again.  

Our analysis covered a period from 2007 to 2017. On one hand, the data proved to be surprisingly negative, with only about 10-30% of all M&A deals creating value for shareholders. On the other hand, our research also identified a small number of companies that repeatedly succeeded with M&A and created tremendous value for their shareholders.

 

 

 

 

Case Studies

In our book ‘THE M&A FORMULA’, I ended up focusing on seven companies to illustrate the core building blocks of the ‘Business Model Canvas’ which was used as an illustration throughout the text. While there are more companies with a globally proven track record of M&A success, the chosen seven companies (which we dubbed the global ‘M&A Elite’) had delivered a very high total return to their shareholders during the research period and were highly regarded among the world’s professional investors. These companies have carried out more than 500 M&A deals and the acquired companies have delivered considerably post-merger.

The seven companies include: household and healthcare producer RB (formerly known as Reckitt Benckiser); lock and entrance company AssaAbloy; luxury goods manufacturer LVMH; logistics firm DSV; industrials/medical investor Danaher; dairy firm FrieslandCampina; and a global brewing company. The portfolio of these M&A elite companies would have provided an investor with a total return of 331.4% across the period between 2007 to 2017. As a comparison, the Eurostoxx index would have given investors a return of 121.1%.

Table 1: Case Insights

 

After conducting our initial research, I also covered a completely different ranking of corporate performance called ‘Accelerating Performance’, as published by Heidrick & Struggles. This research eschewed M&A practice and focused on the best-performing 23 companies, with at least 20% annual revenue growth out of the FT500 defined as revenue growth (compounded annual growth rate in revenues). A look at the total return of these 23 super accelerator firms illustrates that these companies do no better a job in creating value for their shareholders than the global M&A elite.

For example: Google is one of the world’s best-known brands. If its success is measured by revenue growth, the company is truly a high achiever. However, this has nothing to do with what the shareholders want, which is a total return on their investment.

The best performing company of our global M&A elite companies is AssaAbloy with a 427.9% total return – a striking value when stacked up against Google’s +343.9% in 2017. And what is perhaps even more impressive is that the global M&A elite has delivered almost the same value to shareholders as Google across our 10-year research period.

This highlights that the M&A elite has clearly found a formula for M&A success - but what is it?

 

 

 

 

M&A success starts with a NO!

The first step to success in corporate finance is to simply stop doing the wrong M&A deals. If there is one key takeaway from our research and interviews, it is that half of M&A success is in the deals you don’t do.

 

Why Is It Hard to Say “No” and How Can You Get Better At It?

One of the most difficult words to say is “No”. When a company considers an acquisition or a merger, it is often accompanied by a group of enthusiastic cheerleaders who have their own interests at heart. Commonly, these include external advisors who are often extremely interested in a company carrying out of mergers and acquisitions. Simply put, more M&A means more money for the advisor. Their price is often represented by a monthly retainer and a so called ‘success-fee’ which tends to be in the region of 1-3% or higher. This fee will be paid at the culmination of the process, even though the M&A transaction may end up being a complete failure for the company and its shareholders. Even where no value has been created, the bank will still get its M&A ‘success’ fee.

This means that external advisors cannot solve the problem of high M&A failure rates as they have a vested interest in companies doing as many M&A deals as possible. Potential returns from forging ahead simply mean that it is not in their interest for a company to say no to a deal.

However, this does not mean that companies should not use external advisors - when it comes to lowering M&A failure rates, change has to come from within. Any company and its shareholders have to be aware that the biggest cheerleaders often reside within the company itself. The CEO can be tempted to commit to a deal because of an expected higher salary, prestige, better location, office or headquarters, which can impact their judgement.

Seasoned professionals such as Warren Buffet recently focused on this principal-agent problem, addressing it directly in his yearly newsletter from Berkshire Hathaway. In this, Buffet believed that when a CEO hungers for a deal, they will start looking for figures that justify it. Confirmation bias soon sweeps in and all decision making becomes clouded and circumspect. This means that if the performance of the M&A target does not match the required valuation, the acquirer’s team will often go back and revise their assumptions and increase expected synergies or the future revenue growth. And then, all of a sudden, the result is that the new valuation fits the seller’s asking price. “A spreadsheet never lies,” states Warren Buffet.

Another element that makes it harder for companies to say ‘No’ is the media focus on deals that don’t come through after they have been announced. No matter what reasons the acquirer may have to not finish a deal, the media will look for dramatic headlines and focus on ‘breakdowns’, ‘waste’, and ‘failure of leadership’. Sadly leaving out the less attractive, responsible reasons for walking away such as due diligence. 

 

The company still has to say NO!

Corporate acquirers increasingly need to learn to ‘fail fast’ in M&A transactions to avoid a real failure. For example, in the proposed Heinz/Kraft merger with Unilever, the buyer and seller fundamentally did not agree on their future joint business model. In this case, making a clean break saves time and resources, and prevents the transaction from turning into a real M&A failure if carried out.

There is no need to be ashamed or heavy hearted as ‘failing fast’ is a responsible and tough decision to make, no matter what the financial papers may think about aborting mid-negotiation.

A red flag for any deal is if the planned M&A transaction starts coming up to a price level so high that the buyer no longer expects the deal to create value for their shareholders.

This could easily have been the reason behind a failed deal at Novo - the pharma company that is the world’s largest producer of insulin. At the start of this year, Novo decided not to increase its ca.$3.3bn bid for Belgian biotech company Ablynx and instead watched a competitor acquire the company for $5bn.

In doing so, Novo did not receive any positive press. These observers concluded that Novo was the loser, running unflattering headlines like: “Sanofi to buy Ablynx leaving Novo in the cold”, “Sanofi leapfrogs Novo”, or “Sanofi beats Novo”. However, this does not account for the possibility Novo had calculated that the price of $5bn was too high for Ablynx - in which case Novo did the right thing by not bidding any higher.

A rarer reason to drop an M&A deal is due to sudden externalities that simply could not be planned for. A prime example is the British population voting in favour of Brexit, or the Swiss Franc appreciating 20% overnight, or the stock market falling drastically. In those circumstances, the best M&A acquirers are smart enough to conclude that even though the initial business model fit was favourable, the total valuation may no longer support the deal. In response to this, the most experienced corporate acquirers often demand various clauses making it possible to step out of the deal. Currency, stock market fluctuations, or geo-political uncertainty are mostly represented as MAC (Material Adverse Change) clauses which provide a way to exit a deal with minimal cost to resource and time.

However, one of the reasons that many companies do not use MAC clauses in M&A deals is that they are rarely proffered by M&A sell-side advisors at it lowers their chance of the so-called M&A ‘success’ fee. Any measure or attempt to lower the likelihood of a deal is not a natural consideration from someone who makes at least 95% of their total income through successfully making deals, regardless of what the eventual outcome may be for their client.

M&A success requires focus and processes

We asked some of the global M&A elite how they became so successful in their execution of mergers and acquisitions. What business model determined their M&A targets? What were their primary processes? And how did they avoid the normal high global failure rate?

We found that the global M&A elite have incorporated multiple rules-based decision-making systems and processes to actively eliminate individual bias towards a target.  

This degree of impartial focus ensures that successful acquirers keep their overall purpose in mind when it comes to conducting M&A activities and evaluating how they will work to create value. Naturally, this involves asking simple but searching questions: What is our business model driver (with a maximum of two business model drivers recommended when undertaking M&A)? Does this acquisition or merger mean that we can do things better, faster, or cheaper? Do we get access to new clients or new technology? What is it actually worth?

Before any of these acquirers considers contacting an external advisor, they would also rigidly consider the M&A complementarity between the two companies. This involves asking: Do our business models actually fit together and do we want to do the same with the new and joint business model going forward? Do we have both employee groups with us 100% in this plan (or at least the people who are planned to stay after the transaction)?

In reality, many companies fail to clearly define and agree on this focus as an integrated part of their business and therefore it is not clear why they are actually undertaking the M&A process. The result is as predictable as it is inevitable: management is not ready when opportunity presents itself and it becomes difficult to explain to the individuals in both companies. Therefore, M&A success depends on the preparations before, during, and after the individual transaction

 

Choosing the right target companies

When it comes to the selection process, the acquirer chooses 1-2 Business Model Drivers and tests the chosen values against M&A Complementarity as a final business model fit test, which is a test comprising of 16 individual questions. The higher the complementarity, the higher chance of M&A success. In this article there are examples of a company (Danaher) with an unusually low M&A complementarity of 1.5 – despite the fact that the company has repeatedly created M&A success through various take overs of industrial companies (see table 1).

Once a company’s target list has been created - based on its business model drivers and M&A Complementarity - it is time to carry out an even more rigid scoring of each individual M&A target using the ‘Goldman Gates’.

This is a typical approach for validating an individual target for an M&A elite company. Just like the world’s best money managers, the formula for success in choosing the right investment requires a dedicated deep dive analysis of each target – a very formal and rules-based target selection with a long-term focus of at least 5 to 10 years. The acquirer sticks to its chosen business model drivers.

Subsequent valuation is - as always - based on a bottom-up model that revolves around free cash flow. Financial projections with a profitability focus first 10 years – all cost synergies are compared with similar deals to determine the likelihood of reaping exactly those synergies. And remember to continuously ask, “are you on a realistic mission”?

At this point, the M&A elite do not go back to Goldman Gates scoring or valuation if the outcome of their process is that “the price is not high enough to win the bid”. A decision to ‘have another look’ is more likely to occur if a downward adjustment may be considered in lieu of financial or legal due diligence that wasn’t quite as expected. Furthermore, the management of the target must also be thoroughly examined alongside its size – if it doesn’t move the needle then why bother in the first place?

In addition, feasibility will often play a role when teams start to ask: “is it at all likely we will actually be able to buy this company?” Other factors such as macro and political issues are critically scored. In some cases where the interloper risk is high, it’s often worth looking at the potential competition; particularly if it’s the biggest competitor who stands poised to become the new market leader further down the line.

Above all – merely taking part in the transaction does not equal success. By all means get the valuation right and do the deal under the right terms and conditions, but it’s just articulate knowledge. We have all read the same books about company valuations. Valuation is often paramount as a subject for external advisors, but the M&A elite does not create value on this subject.

 

Facts: THE M&A FORMULA – Implementation

The seven case insights in the book ‘THE M&A FORMULA’ consider M&A activities to be a logical part of corporate activity, as they barely consider if growth is coming from acquired entities or homegrown entities. It’s not important for them. Build or buy are two options used interchangeably and one is not better than the other. The focus is on creating value for their shareholders. In some cases a small acquisition could have a great impact. As such, the global M&A elite will rarely calculate future growth on acquired or organic growth. You cannot separate cold and hot water.

A company must always be able to clearly identify why M&A should be part of the corporate strategy and the best way to do this is to become business model driven. Companies of any size can increase their chances of M&A success by creating a feeling of ownership throughout the organization; this means engendering a clear responsibility towards ‘who should be doing what’ in regards to the current acquisition. Ultimately, leadership and communication are crucial and these skills are easier to handle when using the M&A formula.

 

Summing up

The Publication of the book ‘THE M&A FORMULA’ - and this article - has involved a lot of myth killing. And some commonly held beliefs are tougher to shed than others.

Firstly, that the way to M&A success relies on the external advisor and particularly the investment bank. There is no evidence whatsoever that using even the highest ranked investment banks leads to M&A success. The world’s M&A elite all follow their own M&A formula for success.

Secondly, that the traditional ‘strategy driven’ M&A process is the way to success. Research suggests that a much granular approach to acquiring companies is a more convincing tool. This shows that companies with a stringent focus on just one or two business model drivers are more likely to create M&A success because this facilitates a much stronger communication and leadership methodology in the M&A process. This means making it clear that employees know what is expected from them, when, and why.  

For us, the most important factor in a successful M&A process is people, and that change must come from within the company itself. A recommended place to start is with the CEO. This is the person who defines - together with their team – the rationale and justification why the company should do M&A. Involving them is absolutely crucial in this process, and ensures that the company truly understands its own business model before inviting other businesses to its platform. Without this degree of self-knowledge and clarification on a firm’s working environment it is not necessarily a good idea to begin M&A activities.

Once a firm has a clear understanding of its own business model and how it actually adds value to its clients, the M&A formula can easily be applied in three easy steps.  

The process begins with the company choosing one or two building blocks from its business model and setting them as key M&A drivers. This move to secure a clear target helps unlock the critical “why M&A” questions, creating a broader sense of ownership across the organization as a while. Successful M&A firms have a dedicated team to take ownership and secure this across the organization. This is often called an M&A Deal Committee, and this team will rank the various M&A targets without the executive board having a direct involvement. Once fully detailed, the executive committee will then step in to approve the final targets. The importance of having the whole organization onboard cannot be understated. 

When it comes to measurable statistics, M&A success is measured by the total-return analysis (TRA) to shareholders. This has proven critical as a considerable share of the total compensation earned by the employees relies on the organization creating value to shareholders out of their M&A activities. A company like RB states, that “the single most important factor for M&A success could be the alignment between shareholders and top management”.

Finally, it is crucial to build objective internal decision-making processes to identify deals that should never have been carried out at an early stage due to a high likelihood of failure. In practice, many M&A projects live too long and even more are executed despite the fact that the global failure rate is alarming high - perhaps higher than ever.

By looking at the current state of M&A success, we can see that the M&A elite companies work to use their acquisition resources in an optimal way. This means applying rigid internal procedures that enable them to very quickly - and at the very earliest stage - give an indication of ‘deal or no-deal’. Statistics suggest that companies doing many M&A deals have the highest success rate and return the most to their shareholders. In the words of the golfer Gary Player: “The more I practice, the luckier I get.