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  Pareto Merge
IT Cortex approach to mergers and acquisitions.

He that will not apply new remedies must expect new evils; for time is the greatest innovator.

Francis Bacon

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Most published advice on mergers and acquisitions begin by reciting the "notoriously poor track record of M&A". Several surveys on that topic are worthwhile considering before embarking on that high stake crusade. The sirens' songs of consultants praising the benefits of cross-selling, new market access, organizational integration, know-how cross-fertilization, improved purchasing, marketing, and distribution power might sound quite attractive. But in mergers and acquisitions it is vital to do both the right thing (that's why we are presenting the results of three major surveys on that topic) and to do things right (that's why IT Cortex "Pareto Merge" service enables companies engaged in a M&A to maximize the Pareto efficiency of the consolidated organization).

The Sudi Sudarsanam, Peter Holl and Ayo Salami Survey

That survey has been published in the Journal of Business Finance & Accounting, vol. 23, parts 5 & 6, 1996. It analyses a sample of 429 completed UK acquisitions, take-over and mergers between 1980 and 1990. Changes in shareholder wealth were calculated from share price changes around the announcement date (± 40 days). 

Key finding

Target shareholders gained cumulative returns of 29 % whereas bidder shareholders lost 4 %. The combined value of the bidder - target pair increased by 2.34 % on average. However since targets gain and bidders lose, there is a wealth transfer from the bidder organization to the target shareholders indicating that bidders have overpaid their acquisition.

Additional findings

bulletthe most consistently achieved synergy type was financial synergy (as opposed to operational and managerial synergy). It arose from complementary financial resources and sales growth;
bulletthere is no evidence supporting that operational synergy creates value;
bulletthe smaller the target, the greater the wealth gains;
bulletlarge block shareholdings decreased the returns to targets (as expected) but surprisingly also reduced the returns to bidders;
bullettarget resistance consistently increased the returns to targets and, surprisingly, to bidders as well;
bulletequity offers generated smaller wealth gains than pure cash or hybrid offers.

The Sirower Survey

Using publicly available information, Sirower assessed 168 companies listed on the New York Stock Exchange or the American Stock Exchange. In all 168 acquisitions, the acquired firm was at least 10 % of the size of the buyer. All acquisitions were made between 1979 and 1990.

Key finding

Acquisitions reduce the shareholder value of the acquiring firm on average. About 2/3 of the companies experienced significant value destruction whereas about 1/3 actually created value.

Additional findings

bulletthe initial positive or negative market reaction reaction to the announcement of a deal is a good predictor of what shareholder returns would actually be over the longer term;
bulletshareholders of acquired firm do very well out of acquisitions;
bulletthe larger the premium paid for an acquisition the worse the subsequent returns to the shareholders of the acquiring firm;
bullethostile acquisitions result in higher premium;
bulletstrategic relatedness made no difference to the success of the acquisition;
bulletcash payments were found to result in better performance for the acquiring firms than payment in equity;
bulletthere is some evidence that the greater the size of the acquired company relative to the buyer, the more damaging the effect of the premium on the buyer

The Survey by Mercer Management Consulting in Toronto 

They examined 300 large acquisitions during the period 1986 to 1996. Shareholder returns were measured at 36 months post-deal.

Key finding

In the 1990s, 52 % of M&A deals produced shareholder returns that outperformed the industry in which each deal took place, while in the 1980s only 37 % outperformed the industry.

Additional findings

bulletthe average premium paid on top of the pre-deal market capitalization, was about 60 % in the 1980s but about 75 % in the 1990s;
bulletevidence abounds that high premiums can be recovered;
bulletthe level of shareholder returns was not affected by the suitability of the strategy;
bulletthe caliber of the post-merger management contributed to enhance significantly shareholder returns. Companies, like General Electric, that complete six or more deals per year succeed more often than less experienced acquirers.

Technology Megamergers

More than in any other sector, technology megamergers have a dreadful history of systematic failure. No large-scale, high-tech merger of companies of comparable size has ever worked. This emphasizes dramatically the challenge of integrating both different technologies and different business processes on a large scale. Even though companies like CISCO or General Electric have been successful in gobbling much smaller preys, when it comes to merging companies of comparable size the outcome looks terrible :

bulletin 1969 Xerox diversifies in the computer business by absorbing Scientific Data Systems for $900 million. In 1975 Xerox exits that business after writing off $85 million and racking up $264 million in total losses.
bulletin 1984 IBM merges with telecom company Rölm in a $1.3 billion deal. In 1989, after loosing hundreds of millions of dollars, IBM resells its acquisition to Siemens for considerably less than it paid.
bulletin 1986 mainframe makers Burroughs and Sperry form Unisys in a $4.8 billion merger of equal. Right after the merger Unisys had annual revenue of $10.8 billion. Last year the firm tallied sales of $6 billion most of which coming from its service business. The stock prize goes in free fall and in a few years the headcount shrinks to one fourth of its post merger size.
bulletin 1991 AT&T buys computer maker NCR for $7.5 billion. In 1996, after raking up $4 billion in losses, AT&T spins off NCR.
bulletin 1998 Compaq merges with Digital in a $9.6 billion deal. The result : management and personnel turnover, drop of consolidated market share in all segments, much thinner earnings and depressed stock price.
bulletin 2002 the bets are open for the outcome of the HP and Compaq merger.

Overall Conclusion

Those studies are all rather coarse grained. Indicators such as the precise industrial classification or whether the bid was hostile or convivial are hard to gather reliably.

Like for large IT projects the chances of M&A failure (measured by the shareholder value created) are above 50 % (see also IT Projects failure rates). However, the causes of success or failure of a M&A are less well identified than for large IT projects (see also our statistics over the causes of IT failure). The business literature over post-deal integration is still in its infancy. It is very hard to get relevant factual evidence of the key success factors because many of the M&A dealings and effects happen inside the company away from public gaze. The alchemy of merging two companies looks even more subtle than succeeding at delivering large scale IT projects.

More than for any other management decision merging two companies has to be weighted against its main alternative : use the resources planned for the merge to grow a new business in markets complementary or related to one's core business.

IT Cortex Approach to M&A

IT Cortex "Pareto merge" is a post-merger integration approach. Contrary to the objective generally pursued after a merger it does not target full operational integration. It does not aim at redesigning business processes to a level of genericity fulfilling the two organizations operational requirements because this inevitably increases the Pareto inefficiency of the consolidated group. 

Rather than looking for a "one size fits all" target solution, the IT Cortex "Pareto Merge" alternative approach consists in : 
bulletexploiting complementarities while retaining specificities wherever necessary,
bulletre-allocating the product portfolio over partially overlapping organizations,
bulletre-focusing the global sales force,
bulletstreamlining the market approach,
bulletmaintaining an optimal trade-off between collaboration and competition within the merged organization,
bulletre-harmonizing the overall supply chain,
bulletdetermining the optimum fit for the IT systems of the two organizations

The key focus of the methodology that we follow throughout the revamping of the business processes is to maximize the overall Pareto efficiency. A key advantage of our approach is that it minimizes the cost of exiting the deal should this appear as the only sensible outcome.

Should you want to discuss this approach at greater length for your specific situation, do not hesitate to contact us.

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