In 2011, investment bank Berkery Noyes reported that more than 21,000 mergers and acquisitions were completed, with a collective price tag estimated at more than $1.9 trillion. And although they are known as highly effective means of achieving growth and a strategic advantage, these transactions are fraught with pitfalls. Statistics indicate that a third of these deals will fail, and another third will not bear out the expectations of the merger partners. If you are considering an acquisition, what can you do to ensure that you don’t fall victim to confusion, million dollar losses, declining market share and profits, or any number of other negative results of failed transactions?
Several factors are influencing merger and acquisition (M&A) activity. Achieving economies of scale, broadening geographic market coverage, and more effectively competing have helped to create a flurry of acquisitions in the marketplace. In addition, the search for cost reductions through M&A, particularly in the mature market conditions we have in the HVACR industry, are being used to offset companies’ inability to grow profit through price increases.
My own experience in the late 1990s with a major HVAC conglomerate showed that M&As are usually easy to envision but incredibly complex to execute. This article is by no means a complete guide to M&A, as my formal education is in organizational behavior.
However, I want to share with you my experience and touch on highlights to provide you with knowledge and tools that can contribute to a productive M&A experience.
Due Diligence
Due diligence is the series of exploratory activities used in evaluating a company prior to finalization of the M&A. The traditional approach to due diligence focuses on several key areas: financial, legal and regulatory, and accounting and tax. Without question, each of these areas is highly complex, and scores of business and academic textbooks have been devoted to the topics. Broad treatment of them is beyond this article, yet it is important for you to understand the fundamental financial and legal orientation toward due diligence investigations in order to identify an M&A’s principal shortcomings and pitfalls.
When an M&A is first envisioned, the focus is on whether or not it makes financial sense. In due diligence, legal and accounting experts are retained to identify potential fiscal, regulatory, and tax-related liabilities of the target company. Concurrently, investment bankers are devising the financing strategy, determining where and how much capital must be raised to complete the trans- action, while auditors pore over the books of the target to arrive at the most accurate valuation.
Clearly, traditional due diligence is largely focused on making the numbers work.
You should not pursue a transaction unless assurances are provided that a detailed examination of the tar- get company’s financial affairs has been conducted. In the broadest sense, the goal of due diligence is to look at and beyond the numbers to identify hid- den vulnerabilities. One of the main purposes of due diligence is to identify under- or overvalued assets and liabilities, which could be property, plant, and equipment: inventory levels; marketable equity securities; work in progress; excess pension plan assets; and intangible assets such as licenses, franchises, trademarks, and patented technology. As you see, accountants and attorneys play a critical role in determining how a successful transaction needs to be financed and structured.
When everything in the examination process checks out from a financial, legal, and regulatory standpoint, the merger partners typically move forward.
Strategic Drivers
There are several strategic drivers or reasons why you would want to get involved in an M&A, according to Mark N. Clemente and David S. Greenspan, authors of the book Winning at Mergers and Acquisitions: The Guide to Market Focused Planning and Integration. These are:
I will briefly examine these key drivers so you can get a sense of their valuable role in devising a successful, growth- driven acquisition strategy. There are several other reasons for M&A, but these will get you thinking if a strategy of M&A s right for you and your company.
Effecting organizational growth: Often, we envision the opportunity to increase our scope and leverage simply by becoming bigger. This usually in- creases liquidity and access to capital and broadens name or brand awareness in additional markets. On its own, actualizing the strategic advantage of size can improve financial performance through leveraging basic economies of scale. Yet, when combined with other strategic synergies, the advantage of size can act as the foundation and a means for increased market share, product enlargement, and new market penetration that can, in turn, lead to a distinct competitive advantage.
Obviously, in every M&A, the immediate hope is to increase the company’s size. However, after duplication in operations is eliminated, workforces downsized, and noncore operations spun off, the resultant company may not necessarily be bigger. In a large number of cases, the streamlined M&A entity is a smaller yet more effective operation with more muscle and less fat.
Increasing market share: The battle for customers over products and services is a zero-sum game in which customer bases shift as product and service loyalty is strengthened or weakened. To in- crease market share requires seizing al- ready established customer loyalty from a competitor and then building on it to increase your own share further. Just as growing in size does not guarantee success, simply adding market share via an M&A does not make you immediately more competitive. Conducting an investigation of market due diligence to indentify the areas of competitiveness — which is still contingent on effective integration — will help you to make the leap to market share gains.
Gaining entry into new markets: It is exciting to make a purchase that allows you to target a broader or more responsive audience that gives you a greater number of potential buyers. It can also help bring about enhanced distribution capabilities in new territories. Entering new markets for the first time, however, is an act fraught with multiple risks. Acquiring another company that already has a foothold in a market and knows the ropes can ease the process of entering a new market and minimize your risks.
Obtaining new products: Today, one of the keys to gaining strategic advantage is products that have restricted access before the next wave of competition, which comes more quickly and more intensely every day. Some companies prepare for it, but most do not. Often, by the time a new product has cleared its beta stage, competitors and developers of knockoffs or cheaper versions are already releasing rival offerings, driving the price down so no one makes a decent margin.
Technological gains have helped to shorten the time it takes to promote — and ultimately deliver — a product or service to the marketplace. Consequently, competitors will quickly replicate the best new product ideas. It is for this primary reason that many companies opt to buy an existing producer rather than create products in order to avoid extended periods of marketing and procuring products that may be inordinately expensive and may not yield the desired results.
Keeping pace with change: A multitude of variables can act as catalysts for change within a given market or sec- tor. Social, economic, and demographic shifts result from factors beyond a company’s control and may be viewed as either opportunities or threats; and they must be acted upon accordingly. As change occurs, companies often are forced to modify their services and hone their products and perspectives in order to stay competitive. Sometimes employees must be retrained to create the behavioral shift that must accompany the new strategic direction. If a massive change in the marketplace prompts a massive change in the company’s vision, the culture must embrace the new vision in order to maintain focus and continue to create value for its customers. When this fails, even the most solidly grounded of businesses can run into trouble.
Change can be analyzed from the vantage points of both reactive companies that merge or acquire to keep pace; and proactive companies that make visionary decisions that anticipate change or even force it. In short, strategic acquisitions are those made from a position of strength rather than from a position of weakness. Experience shows that acquisitions done because they support the company’s growth strategy have a reasonably good chance of working out. On the other hand, acquisitions have tended not to work when management thought that, by doing a deal, it will overcome one or more threats posed by changing market conditions or by fundamental errors made in the past. You should not make any acquisition from a defensive posture.
In order for an M&A to succeed over the long term, more than one of the drivers I have mentioned should be motivating you. Indeed, there are many transactions that focus on one particular driver; the goal, however, should be to maximize your M&A investment by striving whenever possible to realize more than a single driver. However, each driver can complement other drivers, but each is unique and must be fully explored be- fore combining it with others.
Aligning Cultures
When two companies merge, the usual assumption is that there is a fit between them. Often that claim is based on a presumed cultural compatibility. The notion that two disparate groups of separately trained employees, working in a unique environment under varying circumstances will automatically coexist as a merged workforce is wishful thinking at its best.
So how do you evaluate and then act upon something as intangible as culture? The first step is to identify the variables that collectively define the concept of culture. Too often, people attempt to define culture by saying that it defies definition. However, I like one definition I heard above all the rest: Culture is simply how we do things around here.
My approach to defining corporate culture is based on viewing it on three levels, with both internal and external variables:
Think of culture as an iceberg. The visible part — such as how the office is structured, whether it is formal or in- formal — is generally not as important as what lies beneath the surface. What you don’t see are elements such as the assumptions that a group holds — assumptions about the nature of people, time, economics, business success, reality; fundamental assumptions that are seldom explicit, and less often elicited. Their significance doesn’t become apparent until they’re put beside another culture. It’s much like trying to combine two totally different automotive engines in an effort to make a bigger, better one. In fact, it won’t work at all.
Culture is another article for another day! What I would I like for you to take away from this section is that when you acquire people via a merger or acquisition, you are gaining employees who bring with them an entirely different set of beliefs and values than your existing workforce. Either those people’s former culture will gel with yours and there can be actualized alignment, or it will clash. But remember — the merged organization’s culture will ultimately define itself.
The real task of aligning the culture of two companies’ centers on a thought- ful and thorough analysis of the people you are acquiring. If you do not truly want them, do not go through with the transaction. If you want them to change, make sure they are malleable. And if you want them to be part of your vision, know that your vision must be inclusive and flexible.
Summary
No merger is perfect. There are special risks and challenges from analysis through integration in any deal. But in- tense trepidation is anathema to good decision making. The serious acquirer that keeps the market in view knows when to abort the bad deal and when to strike fast for a good deal.
Either way, a solid game plan based on the market is the blueprint for strengthening competitive advantage through the best means available. Deals don’t create value. Acquirers create value.
The best evidence of that came during the lame duck session in December when he bypassed his own party’s Congressional leadership and negotiated directly with Senate and House Republicans on extending several expiring tax incentives. While it angered his fellow Democrats, Obama shrewdly settled the issue of extending the popular tax cuts before the next Congress, when Republicans would take control of the House and become a stronger force in the Senate.
Tom East is President of Refrigeration Sales Corp., a wholesaler based in Valley View, OH.
Due diligence is important, but so is identifying a growth strategy in advance.
