Wrong target, wrong price and poor integration – that’s where M&A goes wrong
By Mathieu Luypaert
Professor of Corporate Finance
Every company has the ambition to grow – and acquisitions offer great opportunities. But what seems like a dream scenario can quickly turn into a nightmare too. In the process of targeting a company down to buying and integration, there are many hurdles to overcome. But where exactly does it go wrong? That was the topic of the keynote speech by Henri Servaes at the latest Mergers, Acquisitions and Buyouts Conference by Vlerick Business School. As a Professor of Finance and the Richard Brealey Professor of Corporate Governance at London Business School, Henri has almost 40 years of experience in research, teaching and consulting on M&A. “What surprises me most, over and over again, is that often all rational thinking seems to be thrown overboard when people are in the middle of an M&A process. Many mistakes can be prevented by just simply keeping a cool head and not deviating from your initial plan,” Henri says.
The potential of M&A is huge
In general, there are at least three ways through which M&A can offer added value.
- To grow and transform your business: whether you want to add products to complete the product line or expand geographically, an acquisition allows you to reach scale at a speed that would take many years to achieve internally.
- To create revenue, profits, and ultimately shareholder value often through economies of scale.
- To get the right people on board: even without achieving any other types of synergies, attracting human capital can add tremendous value in itself. Sometimes, people are so tied to a company that they don’t want to leave, and buying the company is the only way to attract this talent.
Although the why of M&A is very straightforward, deals often don’t reach their full potential due to three mistakes that are often intertwined.
Mistake 1: going after the wrong target
Selecting the wrong target ties in with the wrong underlying motive. Buying a company should be no different from any other investment decision made in an organisation. And the million-dollar question is: does it create value? If you translate that to M&A, the question becomes: can you buy the company for less than what it is worth to you?
Henri is always surprised by how little this question is being asked: “People always talk about fantastic opportunities that will allow them to grow and expand. But growth alone is just not good enough and growth for growth’s sake is a wrong motive for M&A. The actual goal is whether you can create value for your investors. Very broadly, there are only two big sources of value creation in M&A. Firstly, you believe that you can operate the existing assets better than the current management. Secondly, you can achieve synergies with your current business, through operations, cross-selling, economies of scale, … If the growth you aim to achieve with the deal is not associated with either of these two sources, you’re setting the organisation up for failure because you’ll never be able to create value from the company you want to buy. So, make sure there’s a value story and not just a growth story.”
How can you avoid this mistake?
Explain in words why the company you want to buy is worth more than the purchase price. You need to have a clear story of what you will be able to achieve with the target company under your management that is not already incorporated into the price.
- Additionally, dare to ask yourself why the current management team is not taking the actions that you have in mind should you acquire the company.
- Designate a devil’s advocate before you embark upon the deal. The role of this messenger is to argue the ‘no deal’ case and articulate without over-optimism, confirmation bias, or groupthink pressure all the arguments that other people don’t dare to articulate. Sometimes the best deal is a deal that does not happen.
Mistake 2: paying the wrong price
The biggest M&A enabler is strategy, as acquisitions are often necessary to meet strategic goals that cannot be reached internally, such as international expansion, diversification of product offerings, certain growth targets… People often get evaluated based on whether they can deliver on the strategy that was set – and this results in the price becoming of secondary importance.
“If a deal does not crystalise, there can be a sense of blame or failure. So, when things don’t go according to plan, the solution is often to adjust the price upwards,” Henri explains. “The answer to the question ‘can it be done?’ is yes. You can always deliver a higher valuation by playing with ratios and projections to make the new price work, but then you end up buying a spreadsheet that does not match reality anymore. The solution comes from Greek mythology. When returning home after the Trojan War, Odysseus instructed his oarsmen to stuff their ears with candle wax and tie him to the mast of the boat. And so they were able to safely pass and resist the alluring call of the sirens. When you’re in the middle of an M&A negotiation, the temptation to close the deal is very high. Don’t listen to the song of the sirens but stick to your course.”
How can you avoid this mistake?
- Be disciplined and stick to the maximum valuation you have set for yourself. It’s better not to do the deal than to do the deal at an inflated price.
- Walk away if needed – and clearly convey that ‘take it or leave it’ message to the seller.
- Watch out for hockey stick projections and ask about competitive advantage in words, not spreadsheets.
- Enterprise value is not EBITDA x some multiple. It may give you a rough indication of what the seller is expecting but don’t buy a company based on the product of two numbers.
- An acquisition should not be an outlet for cash, as it generally leads to overpaying. Research shows that cash-rich firms make more acquisitions compared to other companies, and the more cash they hold the more they overpay.
- Don’t anchor your valuation to private equity – or even go beyond that valuation – as private equity is under a lot of pressure from their LPs to invest the abundantly available money.
Mistake 3: executing a poor integration
- The integration starts on day one when you approach the target, and not when you close the deal. Make sure you know what you’ll be doing with the company you’re buying right from the start as the first 100 days are crucial.
- Communication is key. A good integration is not possible without the buy-in from all your stakeholders. Make sure they know what the deal means to them, as uncertainty will cause damage. If your best employees leave the company, or if your customers lose interest, you’ll not be able to create the value you had foreseen.
- Make sure that your prime focus for integration is always on value creation, not on rebranding. The logos can wait.
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Vlerick’s Centre for Mergers, Acquisitions & Buyouts develops and collates insights and best practice from across the M&A field – covering everything from the end-to-end deal process to financing and integration. The Centre brings its research and knowledge together to share with anyone involved in mergers, acquisitions or sales.