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Past Issue • Oct-Dec 2009

Value Creation in Mergers and Acquisitions

This article details some of the factors critical to the success of an M&A, based on a comparison between failed and successful deals.

While mergers and acquisitions are a very important tool in a CEO’s strategic toolkit, value creation in mergers and acquisitions (M&A) remains a mirage. Firms invariably tout “synergies” as the reason compelling them to seek this medium of inorganic growth. Synergy implies that the whole is greater than the sum of parts. In other words, a merger or an acquisition makes sense only if it leads to certain operational and/or financial advantages that the individual entities could not harness by themselves, thereby creating value for shareholders of both protagonist firms. Academic research shows that firms invariably overestimate possible synergies from a merger or an acquisition – particularly revenue-based synergies. As a result, acquirers lose value on average while the targets rake in the moolah.

A merger or an acquisition makes sense only if it leads to certain operational and/or financial advantages that the individual entities could not harness by themselves, thereby creating value for shareholders of both protagonist firms.

Given such damaging evidence on M&As, what are some of the factors critical to deal success? Could contrasting a successful M&A transaction with a failed one unearth common themes? Could it inform us about the ingredients that go to make a successful transaction?

Over fifty teams, comprised of five ISB students each, set about answering these questions in an elective course on Corporate Control, Mergers and Acquisitions. Using frameworks learnt in class , the teams picked and contrasted a successful deal with a failed one, to separate credible sources of synergies from the dubious ones. Their findings provide illuminating insights into M&As as a potentially value enhancing, yet very challenging instrument of corporate financial strategy.

In this article, we summarize the broad findings from these studies. Also, we pick two of the most insightful projects to highlight and illustrate the specific findings unearthed by ISB students. The first of these groups comprised Dipali Gupta, Dushyant Sharma, Kamaldeep Raina, Manpreet Singh, Rashmi Gupta and Toshal Sakhare, while the second group was formed by Rohit Bhagwat, Venkataprasad Vedam, Niranjan Janardhanan, Gaurav Bansal, Saurabh Jhawar and Aarti Ganesh.

Our findings suggest that while the expected synergies from most M&As are similar to begin with, the ultimate success of the deal is determined by the implementation of marketing and business strategies for the combined entity, and the effective integration of the diverse organisation cultures.

Our findings suggest that while the expected synergies from most M&As are similar to begin with, the ultimate success of the deal is determined by the implementation of marketing and business strategies for the combined entity, and the effective integration of the diverse organisation cultures. The contrast of successful and failed mergers and acquisitions reveal the following:

  • M&As undertaken with the intention of increasing market share can be value enhancing if the deal leads to one or more of the following: (i) increases the firm’s pricing power vis-à-vis competitors; (ii) enhances the combined entity’s bargaining power with customers and/ or suppliers; and (iii) is instrumental in enacting entry barriers.
  • When firms merge to sell multiple products using a set of common distribution channels, and thereby reap operational synergies, consolidation of such channels leads to greater success compared to attempts at combining diverse kinds of distribution channels.
  • Revenue synergies stemming from cross-selling of the acquirer’s products to the target’s, and vice versa are often unduly aggressive. Assumptions relating to cross-selling of products must be carefully scrutinized by senior management.
  • When financial synergies stemming from tax benefits are the motivating factor in a deal, thorough due diligence must be undertaken to ensure that the value generated from tax savings is not dwarfed by value destruction in other parts of the deal.
  • Since people make or break a deal, key personnel in both combining entities must be identified. Furthermore, compensation and incentive schemes must be designed so as to ensure that key personnel in both companies are retained.
  • Last but not the least, adequate attention must be paid to cultural integration to provide a suitable environment to realize synergies.

Given below are examples which highlight the underlying assumptions of the firms approaching the deals, the projected synergies and the differences in implementation strategies that led to success in one case and failure in the other. ArcelorMittal (AM) and DaimlerChrysler (DC) were pathbreaking mergers seeking creation of large-scale synergies. The second example, from the beverage industry, contrasts United Spirits Limited’s slow consolidation with Shaw Wallace and Quaker Oats failed acquisition of Snapple.

ArcelorMittal and DaimlerChrysler Mergers
With careful planning and excellent execution, ArcelorMittal turned out to be a success while DaimlerChrysler remained mired in various cultural, operational and financial issues.

While ArcelorMittal and DaimlerChrysler experienced very different outcomes eventually, the deals were similar in many respects to start with. Therefore, contrasting these two deals enables one to control for several factors that may confound inference about the effect of the M&A event. Both ArcelorMittal and DaimlerChrysler deals were characterized by the coming together of two market leaders. In both the cases, one of the partners was operating in a low margin volume-based business (Mittal and Chrysler) and the other in the premium segment (Arcelor and Daimler-Benz). Synergies were expected from increased geographical presence by utilizing the distribution channels of the partner entities. Both the entities were expecting cost synergies by consolidating support functions. For ArcelorMittal, the value of expected synergy was pegged at $1.6bn whereas in case of DaimlerChrysler, it was pegged at $1.4 billion in Phase I and $3 billion in Phase II. Both the deals were valued at approximately at $37 billion. Merged entities in both deals operated in similar macro environments – cross-border presence, capital-intensive industries, high industry-wide leverage.

The differences in eventual outcomes arose from several avenues. First, Mittal Steel invested substantial time and effort in due diligence before approaching Arcelor. Lakshmi Mittal made efforts to effect a friendly merger before launching a hostile bid to take over Arcelor. In contrast, Daimler seemed to have compromised due diligence to avail tax benefits ($1.3 billion every year) permitted under the German law, for a fast track deal.

Second, in the case of ArcelorMittal, the management consistently projected the deal as growth-oriented rather than capacity rationalization, which assuaged concerns about layoffs, enabling employee cooperation while also retaining top talent. Several channels were established to listen to and address the concerns of employees.

In contrast, in the DaimlerChrysler deal, the employees lived with a perpetual fear of job cuts due to lack of transparent communication. Top executives of Chrysler started leaving even before announcement of the merger. Also, the inequity in layoffs between German and American employees resulted in a feeling of distrust in American employees towards their German counterparts.

Third, in ArcelorMittal, all post-merger corporate bodies like the Board of Directors had equal representation from the two entities. The headquarters of the new entity was moved to Luxembourg, the former headquarters of Arcelor. This helped create a sense of trust between the two organizations.

ArcelorMittal was able to derive value from the synergies of the merger, which is evident from the increased levels of profitability compared to the pre-merger individual entities.

In contrast, for DaimlerChrysler, the executives bodies formed were skewed in favour of the Germans, which only got worse with the passage of time. The structure was to have a parallel management with two CEOs – Robert Eaton (Chrysler) and Juergen Schrempp (Daimler- Benz) and two headquarters – Auburn Hill (Chrysler) and Stuttgart (Daimler-Benz). However these plans were not executed in spirit. Robert Eaton left before his stipulated term got over and the functional headquarters remained at Stuttgart. This left Chrysler employees feeling shortchanged.

Fourth, ArcelorMittal made an effort to address

the concerns of various stakeholders through different communication channels. Similar transparency was absent in the communications of DaimlerChrysler. The DaimlerChrysler merger was touted as ‘a merger of equals’ but in 2000, the CEO of Daimler-Benz publicly said that the equal partnership was merely a psychological gimmick to close the deal.

Finally, ArcelorMittal was able to derive value from the synergies of the merger, which is evident from the increased levels of profitability compared to the pre-merger individual entities. In contrast, in 2007, the nine-year merger of the two auto giants – Daimler and Chrysler came to an end with Daimler selling its 80.1 percent stake in Chrysler to Cerberus Capital Management.

United Spirits Limited and Quaker Oats’ Mergers
On the one hand, United Spirits Limited’s (USL) phased acquisition of Shaw Wallace & Company (SWC) was a runaway success, thanks to effective consolidation and competitive advantages realized through operational, promotional and financial synergies. On the other hand, Quaker Oats’ acquisition of Snapple could be dubbed one of the classic disasters in the history of M&A, due to overestimation of revenue and operational synergies, as also integration challenges due to incompatible cultures.

When USL merged with SWC, it led to an entity with a market share of over 55 percent. This leadership position resulted in greater pricing and bargaining power. Further, margins were significantly improved, due to cost reductions resulting from consolidation of distribution channels and lower number of selling agents. As a result, the earnings before interest, taxes, depreciation, and amortization (EBITDA) grew from 8 percent to 18 percent in first half of fiscal year 2006-07.

In stark contrast, Quaker intended to combine its distribution network with Snapple’s existing cold distribution channel to achieve higher revenues through cross-selling. In addition, Quaker planned to capitalize on the presence of its energy drink, Gatorade, in international markets to sell Snapple. However, these synergies did not materialize because of resistance among the channels to cross-selling. The combination of two dissimilar distribution channels, cold and warm, instead led to increased costs.

SWC and USL were fierce competitors and annually spent close to Rs 200 crores on promotional offers to grab each other’s market share. Post acquisition, their promotional expenses went down drastically and their combined product portfolio and brand equity created formidable barriers to entry. In addition, SWC and USL positioned their spirits as premium and mass brands respectively to prevent cannibalization.

In the case of Quaker, Snapple and Gatorade together had 37 percent market share and were not in direct competition. However, after acquiring Snapple, Quaker was in direct competition with larger players like Coke and Pepsi, and this forced it to increase its promotional spending.

The USL–SWC deal was financed by borrowing $300 million from ICICI bank. USL paid approximately Rs 203 per share, against the expected synergy inclusive value of Rs 215.77, thereby retaining a significant portion of the expected value creation. USL also received a tax shield benefit of Rs 50.9 million because of the losses made by SWC in fiscal year 2005.

The Quaker–Snapple deal on the other hand was an all-cash deal. Snapple’s share value had plummeted due to its various acquisitions. The deal reduced the interest expense of the combined entity, but left no money on the table to provide Snapple an incentive to integrate successfully with Quaker.

The integration of USL and SWC was a cautious, phased process with employees given attractive incentives that helped achieve a smooth transition. In contrast, people problems were the key to the failure of the Quaker-Snapple deal. This was primarily because Snapple was quirky, entrepreneurial and off-beat while Quaker was more organized and Gatorade was considered a ‘lifestyle’ brand.
It is evident from the above examples that while USL systematically leveraged the resources and capabilities obtained from acquiring SWC, Quaker Oats failed to do the same because of incompatibility of resources and cultures .

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