Overpriced acquisitions are not a new phenomenon. But what makes a firm ignore evidence and overpay for acquisitions? The answer lies mostly in behavioural theories
It is well-known that 70-90 per cent of mergers and acquisitions (M&As) fail to create value for shareholders, yet the deals are getting bigger by the year. According to the India M&A Report 2019 by Bain & Company, M&A activity has remained buoyant from 2015 well into 2019 with more than 3,600 deals with an aggregate value of more than $310 billion. During this period, several developments led to an unprecedented re-organisation of asset ownership in corporate India. The present landscape offers a tremendous opportunity for well-managed businesses with a strong deal thesis, looking for new avenues of growth and/or improving profitability. Large deals doubled in value between 2015 and 2016 to $23 billion. Over 2017 to 2018, large deal value doubled again, to $56 billion. Deal size also grew during this period, averaging $0.7 billion in 2015 to more than $2.6 billion in 2017 and 2018. Deal volume has been robust across sectors, with industrial goods, energy and telecom and media representing more than 60 per cent deals by volume and value.
Although deal values and volumes increase every year, most of them eventually fail to create synergy. Among other reasons, like nasty surprises due to poor due-diligence, poor governance, poor communication channels, weak leadership, paying a high price for acquisition and non-integration of culture, are the main reason why M&As fail. There are many examples of companies that have destroyed shareholder value by overpaying to acquire other companies. Quaker Oats’ acquisition of Snapple for $1.7 billion in 1994 still rings a bell as it sold Snapple to Triarc for $300 million 27 months after buying it, losing a whopping $1.4 billion, making it one of the worst flops in corporate-merger history. India Inc also has countless examples of overpriced purchases. Subex, once a fairy well-known, Bengaluru-based telecom software maker, tipped into bankruptcy by the disastrous acquisition of Canadian telecom software company Syndesis for $164 million in 2007, which was four times its annual revenue. This deal turned out to be overpriced as the revenue of Syndesis in the following year halved.
Overpriced acquisitions are not a new phenomenon. But what makes a company ignore evidence and overpay for acquisitions? The answer lies mostly in behavioural theories. Agency problem is one of the main reasons for this, as in most of the cases, senior executives earn bonuses and stock grants based on metrics that have no real connect to value. Corporate governance and activist shareholders take a backseat as executives have a higher influence on the process. So, they push the deals where they can make more money. Second, when valuations are generally high, as in India, companies fall into the overvaluation trap and end up making flashy acquisitions. Proposed by Michael Jensen of Harvard Business School, it is a behavioural trap, where managers try to generate the expected performance in the short run, all the way knowing, that maintaining higher performance is not possible, and in turn making investments that will ultimately fall short. By making such investments, companies postpone the consequences of their bad investment decision. Too much money chasing relatively scarce investment opportunities, is also one of the reasons why companies end up paying more for their acquisitions. Ego, the driving force that helps individuals reach the top of any organisation, is at play, when it comes to acquisitions as well. It pushes executives to overpay for acquisitions so they can get bigger and bigger, or so that they can stop a competitor from getting bigger than them. In addition, managers are also susceptible to the Pollyanna Principle, a psychological bias that overrates positive memories and discounts negative ones. This means that executives take a cue from a few overpriced deals that were successful — like buying of PayPal by eBay for $1.5 billion or Google paying $1.6 billion for YouTube — and turn a blind eye towards scores of overpriced deals that went kaput such as the disastrous AOL/Time Warner merger that led to a $45 billion write-down.
Even experienced managers, sometimes, get attached to a deal, making them susceptible to bad decisions. In this situation, how should managers decide how much to pay or when to walk away? In this flashy corporate world, executives routinely get caught up in the excitement of the race, fall prey to it and offer more than they should. So the first criterion is to be disciplined and detached and the key to success in buying another company is knowing the maximum price one can pay and then having the discipline not to pay a penny more. A company should be able to walk way from a deal if the synergy value is not being created. In addition to overpriced acquisitions, culture has also emerged as one of the dominant barriers to effective integrations and more than half of the mergers fail due to lack of cultural integration. Culture is the long-standing, largely implicit shared values, beliefs, and assumptions that influence behaviour, attitudes and meaning in a company or society. Since, it is a soft concept having a set of implicit influences, and it is difficult to account for completely or accurately, therefore, it becomes the responsibility of the top management to stop culture clashes from undermining their desired goals.
History is replete with examples of well-analysed and thought-of mergers having failed due to cultural clashes as they play a role in preventing post-integration plans from being properly executed. January happens to be the 18th anniversary of one of the worst mergers in corporate history — Time Warner and AOL. Merging the cultures of these two companies was problematic from the word go. The aggressive and, apparently “arrogant” AOL people shocked the sober and corporate Time Warner side. Cooperation and promised synergies failed to materialise as mutual disrespect came to colour their relationships. When German Daimler (the makers of Mercedes-Benz) merged with American company Chrysler in the late 1990s, it was called a “merger of equals.” A few years later, due to discordant company cultures like differences in the level of formality, philosophy on issues such as pay and expenses, and operating styles, the merger turned into a fiasco. After major losses and layoffs, in 2007, Daimler sold Chrysler to Cerberus Capital Management for $6 billion. Taking an example from India, the merger between Kingfisher Airlines and Air Deccan failed due to their cultural differences with Kingfisher being a full-flight service catering to premium segment and Air Deccan’s vision to empower every Indian to fly.
Meanwhile, some mergers endured the cultural challenges to turn failures into success stories. One such example is that of Hewlett Packard and Compaq. In 2001, struggling computing giant Hewlett Packard acquired similarly struggling competitor Compaq. There were major cultural differences as HP’s engineering-driven culture was based on consensus and the sales-driven Compaq culture on rapid decision making. This poor cultural fit resulted in years of bitter infighting in the new company, and resulted in a loss of an estimated $13 billion in market capitalisation. However, the company hung on, and by making significant cultural and leadership changes, resulted in long-term success.
Since integrating and redefining the culture and corporate values and reconciling the differences is essential for success of mergers, companies should avoid the “bear hug” i.e. to impose their culture on the acquired firm. To integrate cultures, the first step is to define the cultural objective based on where the deal’s greatest value lies. An acquirer can assimilate the acquired company and continue with its own organisational values or it can even use the merger to import the acquired company’s beliefs into its own organisation. In some cases, it can create a blend.
The next step is to diagnose the cultural differences between the two companies to identify and measure the differences among people, units, geographical regions and functions using a variety of tools like process flow maps, customer interviews and employee surveys. The third step after setting the agenda and diagnosing the gaps is to create an actionable plan that is much more than the vision and values statements, and is concrete enough to be executed by managers. Finally, senior leadership should take the responsibility for communicating regularly and frequently using all new technological innovations and techniques such as social media, online platforms and web-based employee forums, so that the new defined cultural objectives percolate to all the departments and employees.
To summarise, although successful mergers and acquisitions must be primarily based on strategic, financial and other objective criteria, it should be more than just numbers and cash flow analysis; it has to be more human for it to survive and in turn create value and synergies for all stakeholders.
(The writer is Assistant Professor, Amity University)
