Extracting value from mergers and acquisitions

The 2008 sub-prime crisis triggered quantitative easing (QE), intensifying covenant-light lending by banks at competitive interest rates to prime-rated corporates and private equity firms. These firms invested their cash and credit hoards and undertook equity swaps – either to strengthen growth via mergers, acquisitions and alliances (M&A) or to build investments.

Intense rivalry and financial clout also provoked M&A decisions at exaggerated valuations, which in recent years have strained financial performance, credit ratings and shareholder value.

From 2008 through 2015, about 340,000 mega-M&A global deals – collectively valued at US$25 trillion according to the Institute for Mergers, Acquisitions and Alliances* (IIMA) – occurred in industries such as resources and commodities, agriculture, telecoms, biotech, manufacturing, IT, beverages and tourism.

China and India upped the ante from 2012 onwards, with corporate values surging further in 2015-16. Asian deals primarily focused on sourcing commodities, technology and intellectual property (IP) and supply chain, in order to aid local markets and bridge technology gaps.

Global deals with significant Asian implications included the 2013 union of mining groups Glencore and Xtrasata; the impending takeover by brewing giant Anheuser-Busch of rival InbevSABMiller, and the producer trio merging to form global commodities giant Cofco-Noble-Nidera.

Asian companies had similar experiences to their Organisation for Economic Co-operation and Development (OECD) counterparts in assessing, implementing and integrating M&A deals. However, protectionist and cultural challenges – especially in Europe and North America – were daunting. All transactions allowed technology or commodity access and market expansion in Asia, Africa and Latin America. They also involved dealing with multi-regional intricacies, covering accounting standard; the Foreign Corrupt Practices Act (FCPA); anti-trust; tax litigation; currency translations; and regulation.

In response to the growth in corporate and consumer activism, China, India and Indonesia strengthened their enforcement of anti-trust legislation. Seeking anti-trust approvals in these markets is now a norm.

Perceived synergies: M&A allegedly helps companies procure strategic assets, IP and resources; gain insights and knowledge; rationalise corporate structures; acquire new markets; and improve financial performance. Perceived synergies form the basis for valuations, assumptions, projections and deal structures.

Complex implementation facilitated by transition and implementation teams: Successful deals require best practices in negotiating the right valuation; corporate structuring; devising commercial agreements; understanding the impact of currencies and contingent liabilities; approvals from authorities, shareholders and creditors; transfer of assets; and IP. Transition teams with unambiguous mandates facilitate a seamless integration and nurture collaboration.

Success rate less than 40%: Despite best efforts on deal structuring and implementation, less than 40% of attempted M&A deals are successfully concluded. In their zest to optimise valuation and close deals, companies often overlook critical factors such implementation, execution, and their strategic and cultural compatibility, which leads to many proposed unions falling apart.

Most valuations also underestimate the significant financial impact of systemic economic, financial and geopolitical risks as well as factors such as environment health and safety, brand equity and reputation.

Twenty-five percent of valuation is assured; the rest is harnessed by talent, process, system and culture:

About 25% of projected value derives from tangible assets, customer loyalty and brand equity, and market share occurs in the initial years of the M&A.

The balance of the valuation is long-term and futuristic, nurtured and harnessed by customer-focused high-performing corporate talent and culture, as well as dedication to realising the corporate vision and to building brand equity, reputation, a sustainable business and institutionalised systems.

A well-managed integration process delivers value:

Value Delivered with High Performance = [I x % T] ^ [C]

Investments (I) is the value of tangible assets; robust processes and systems; corporate competency and skills; satisfied customers; engaged talent; IP and innovation; an enriched community and preserved environment.

Talent (T) is the multiplier and a derivative of a high degree of engagement and commitment of talent as well as collaboration, integrity, agility, and enterprise risk management and incentive plans.

Culture (C) is the geometrical multiplier that is comprised of customer, people and a brand equity-oriented attitude to realising the corporate vision.

Well managed M&A needs commitment and tenacity to implement best practices:

• Get factual and accurate valuations, assumptions and forecasts; due diligence; compatibility; corporate brand and reputation.
• Paying the right price for enterprise value requires an objective and unemotional attitude. An exaggerated valuation is disastrous to the company’s future performance, its talent, lenders, and stakeholders.
• Keep a backup plan. Patiently weighing and calibrating various options, including organic growth and the impact of currency translations, helps avoid errors in the negotiation and valuation processes.
• An inventory of culture and local norms; compensation plans; behaviours and differences helps understanding and calibration of human and organisational behaviour; all of these aid improved communication, collaboration and cooperation.
• Competent transition, integration and execution teams underpin a successful M&A plan. Make business strategy teams accountable for integration and extracting value.
• Welcome new talent, leadership and culture. Value their strength, expertise, and differences. Trusting, empowering and employing talent fosters an engaged, satisfied and high-performing culture.
• Embrace and institutionalise a superior culture, leadership and management style within the M&A target to deliver sustainable value. Leaders must identify, adapt, pollinate and institutionalise superior practices, values, behaviours and culture.
• Weed out incompatible culture, disengaged leadership and talent that behave and works at cross purposes, disengages employees, destroys organisation value and reputation.
• Let it go at a right price. Spin off business segments or remove management that threatens or destroys core business values and reputation.

Unforeseen systemic economic risks weighing on corporate debts, ratings, liquidity, and returns:

Despite best efforts, corporate earnings and returns have declined since 2014, lowering the success rate of M&A to below 30%. Primary contributors include slow global growth, faltering commodity prices, regulatory hurdles and market volatility.

Market, credit and enterprise risk management (ERM) moderated the financial impact. However, tough decisions have ensued to mitigate systemic risk and to boost liquidity, returns, credit ratings and shareholder value.

More recently, managements have – either voluntarily or in response to pressure from lenders and shareholders – employed various ingenious tactics, such as initiating divestures and spin-offs, splitting the entity into speciality firms or shutting business or geographies. They have also pared down or refinanced debt, outsourced and created shared services, initiated management and pension fund buyouts, and stripped out assets and talent.

Noble recently sold its agricultural business to Cofco and Glencore sold a 40% stake to the Canada Pension Plan Investment Board (CPPIB), while India’s Tata-Corus is seeking bidders for its UK steelmaking operations, healthcare specialist BTG is seeking investors and Germany’s chemicals giant Bayer has launched a US$62bn bid for rival Monsanto.

* This reference has been amended since publication as it incorrectly showed the source as the Indian Institute of Management Ahmedabad.

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