Don’t just do something! M&A and the Bias to Action

The McKinsey Quarterly recently featured an article entitled ‘M&A as Competitive Advantage’.

“At many companies, strategy provides only vague direction on where and where not to use M&A—and an unspecific idea of the expected source of value creation. We often find companies using M&A indiscriminately to purchase growth or an asset, without a thorough understanding of how to create value in a deal relative to others, a so-called “best owner” mind-set. Rarely is there an explicit link to organic investments or the business cases for broader growth initiatives, such as developing new products or building a sales force to deliver an acquired product. As a result, companies waste time and resources on targets that are ultimately unsuccessful and end up juggling a broad set of unfocused deals.”
Put in plain(er) English: many of McKinsey’s clients undertake M&A without having a clear logic for the deal, nor a structured set of goals for the deal and a plan on how to attain them.
Others have found that M&A failure is not for a lack of strategy, but for a confusion of strategy. Clayton Christensen and his co-authors have written of the staggering M&A failure rates that they stem from a failure to distinguish between deals that incrementally improve or protect an acquirer’s competitive advantage from deals that reinvent the acquirer’s business model. Others have similarly found various weaknesses in strategic logic as underlying M&A failure.

No doubt there is some truth to both McKinsey’s impressions, and those expressed by Christensen et al. However, in both cases, there is a further layer to be peeled back. What would make smart, seasoned, business executives undertake major deals with less forethought and planning than their winter vacation elicits? Well, obviously there are many factors – apart from the importance they attach to their winter vacation – and many of these have been discussed in this Merjerz blog before. This short post discusses one of them: the Bias for Action.

A few years ago Harvard Business Press published a book called ‘A Bias for Action: How Effective Managers Harness Their Willpower, Achieve Results, and Stop Wasting Time’. Business school classes on organizational behavior, entrepreneurship and more preach the value of ‘bias to action’. And truly, by not taking action, one will never reach results. Multiple studies have developed Richard Roll’s hubris hypothesis’ and demonstrated that senior executives are overconfident, and that this is a major driver of (ill-advised) M&A. Herein lies one of the great ironies of executive development: some of the characteristics that are optimal for helping a person create and build a business, are not conducive to success in a big, successful business. Very few executives are able to develop themselves along with their businesses. Curiously, gender plays a role here – since male executives are more overconfident than female executives (see here). In short, senior executives need to unlearn some of their bias for action, and at least in relation to M&A, a better mantra would be: “Don’t just do something, Sit there!”

Apple, for example, has exercised admirable restraint. Though it has increased dividends and buybacks, it has largely avoided the kind of massive M&A that we frequently see in companies that are cash heavy. Compare that with LinkedIn, which despite successful organic is raising upto $1B largely to fuel acquisitions – according to rumor.

We’re just beginning to scratch the surface of the interplay of organizational behavior, behavioral economics, and corporate finance.  Many more studies will no doubt surface in the coming years on executive bias-to-action and other behavioral factors in powering M&A. In the meantime, several innovative companies – Merjerz included – continue to innovate in new and better ways of doing M&A, ways that help neutralize the many strong biases that shape M&A and make it such a poor prospect in most cases.

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Crowd >> M&A ‘thought leaders’

We at Merjerz follow a number of M&A ‘thought leaders’. We’ve slowly discovered that there are very, very few people out there who really see where the winds are blowing in M&A. There’s a senior M&A leader in a Big 4 accounting-consulting firm we follow. In 2009 he thought 2010 would be a breakout year. In 2011 he said looking forward to 2012: “Corporates are starting to put fundamentals over continued economic uncertainty and are acting on these dynamics to execute deals”. In 2012 he said “I think there’s great desire, and it’s backed by strong fundamentals”. E&Y predicted: “fundamentals will finally prevail over uncertainty to get deals rolling in 2012”.
Then, in July 2013 he said M&A is in a long-term slump!

We’ve noted before: if someone was good at predicting M&A trends, they’d make lots of money on it trading derivatives of M&A activity, or even buying stocks of M&A candidates. Some people may occasionally make some money on arbitrage of this kind, but look at the chart below. EMAAX invests in equities believed to be M&A targets in the next 12-18 months; MERFX invests in companies already engaged in M&A. See how dramatically they’re under-performing the S&P:

S&P compared with M&A arbitrage funds, last year

All this strengthens what we’ve been saying all along… M&A advisers, M&A investors and all other forms of M&A wizards have not, yet, been able to predict M&A that will happen, or M&A that will succeed.

Despite fundamentals that seem aligned with M&A – especially high corporate cash reserves and low interest rates – something very basic is changing in the M&A world. Shareholders are become increasingly active, ask Michael Dell and Andy Mason. CEOs, even ones whose companies out-perform the markets consistently, such as JPMorgan’s Jamie Dimon, are coming under increased scrutiny. The age of the all-knowing CEO walked out the door with the Jack Welch’s halo (we can discuss Steve Jobs another time). The crowd, we now know, is a whole lot smarter than an expert – including M&A advisers and CEO – in many, many areas. In particular, where so many variables are at play, and experts and executives  have strong personal interests at stake, the crowd’s better judgement is a great source of impartial, insightful advice.

Join us as http://www.merjerz.com to change the way M&A is done, and bring crowd wisdom to strategic corporate decisions.

Acquihires – CorpDev, HR and R&D beginning to mesh

Acqui-hiring, typically acquiring a company for the target’s engineering talent, is very much the flavor of the day. Acquihires are not especially new, but major tech companies have accelerated the pace of acquihiring dramatically. Part of that is due to the apparent shortage of mobile-engineering developers. In the case of Yahoo, it is largely driven by the desire to reinvigorate the ranks of the company and rejuvenate the reputation of Yahoo as a fun, exciting, happening place to work. Just this year Yahoo has acquired Astrid, GoGoPoll, Milewise, Stamped, OntheAir, Snip.it, Alike, Jybe, Summly, Astrid, GoPollGo, Milewise and Loki, most of which are acqui-hires. Twitter, Facebook, Groupon and others have done the same.

Some decry acquihires as elimination of entrepreneurship, others celebrate acquihires as a way of allowing early investors to get their money back, mostly, and of allowing entrepreneurs to leave failing companies with their egos intact.

Two opinions merit particular attention, in our opinion.

First, Coyle and Polsky’s paper on acqui-hires in Duke Law Journal suggests that acqui-hires serve an important function in improving mobility of engineers; it enables engineers to leave a sinking ship without the appearance of leaving the sinking ship. To continue with the analogy – the whole ship is plucked out of the water, the crew is rescued, and ship is tossed back in.

Second, Mark Suster, general partner at GRP Partners, has written a particularly thought provoking blog on acquihires. Suster explains that acquihires are highly demotivating to current employees.

Acquihires are not necessarily M&A. Typically an acquihire deal is some form of asset purchase and employment agreements. However, a big part of the value of an acquihire is that it gives the entrepreneur and investors some PR protection, allows them to write ‘acquired by’ on their CV, and gives the veneer of success to what is essentially a job change. That’s real value to them and to industry, as it allows them to get back to the tough work of starting innovative, disruptive and risky ventures.

It may well be that with time the line between acquihire and M&A will be blurred; companies will be acquired for their great talent, but acquirers can give them a chance to build out their product. If it flies, the acquirer reaps the benefits, if not, it has the talent. This will give new significance to human resources being a company’s most valued resource, i.e. putting people front and center, a long term trend in tech environment. The lines between HR, CorpDev, R&D are blurring more and more with time. It looks like acquihires will evolve, but that they are a part of the evolution of resource allocation efficiency within companies, and as such represent a welcome increased awareness in the way people – employees – create value at companies.

The Distributed-Knowledge Goldmine

When many people each contribute a small bit of information or work, they can together create tremendous value that none of them could have produced alone. Today there are several publicly traded companies that are premised on this notion. For example: TripAdvisor (NASDAQ:TRIP) with a market cap of over $7B, Yelp (NASDAQ:YELP) and Zillow (NASDAQ:Z) with a $1.5B valuation; Angie’s List (NASDAQ:ANGI) valued at over $1B, and Trulia (NASDAQ:TRLA) valued at over $800M. All these are premised on the value of small pieces of information contributed by a mass of people, and collated and presented in a way that is actionable and therefore valuable.

Incidentally, these companies have been drastically outperforming the markets. Over the last 12 months, TripAdvisor is up 66%, Yelp is up 20%, Zillow is up 70%, Angie’s List is up 24%, against 6% for the NASDAQ 100 and 13% for the S&P. The least of the ‘distributed knowledge’ companies outperformed the gains of both the NASDAQ and the S&P taken together!

TTM Stock performance for distributed-knowledge stocks v. NASDAQ

Historically, outside of free markets (such as stock markets) such systems could never be built on mass participation because there was no infrastructure to support it. But, as one MarketWatch journalist recently put it, “If the Internet has demonstrated anything, it may be to show how easily people’s opinions can be disseminated and how powerfully they can matter.” These ‘distributed knowledge’ companies are all new, and they are demonstrating the immense value that can be realized by collating distributed knowledge in a given market, and presenting it to the most interested parties.

Strategy goes Social

Corporate strategy, along with finance, is probably the most important area of competence expected and demanded of executives today. The more senior one is within an organization, the closer one is to dictating that organization’s strategy. Many of the best minds coming out of business schools are attracted to the strategy consulting industry, and CEOs and Boards of Directors spend $Bs every year hiring these bright minds through the services of McKinsey, Bain, BCG and others. Strategy remains the exclusive preserve of a corporation and industry’s elite.

But things are changing. In The Lords of Strategy (HBR 2010, p.321), Walter Kiechel describes the new wave of strategy development as ‘adaptive strategy’, meaning iterative learning of strategy fed from the periphery of the company back to HQ. Strategy at its best has become bottoms-up, and the best strategists are now those who build the skills and environment required to build a strategy by engaging with others and learning from them rather than by dictating it from on high. According to a 2011 HBR article by BCG partners, this form of ‘adaptability is the new competitive advantage’. Competitive advantage is no longer about speed, or change, it’s about the speed at which you can change. It is about being adaptive. This is not dissimilar to what has happened in the news journalism industry; journalists used to pride themselves on the thoroughness of their research and the depth of their contacts. Today, a lot of the research is done for journalists by the crowd, but journalists still distinguish themselves by their ability to collate that information effectively, and present it coherently. The same goes for strategists: the next wave of strategy is no longer driven by Porter’s 7Cs or some other framework determined by the c-suite in its occupants’ infinite wisdom. Rather, the organization that can identify and filter strategic insight from its many constituents, and amalgamate that into a coherent, actionable strategy, and do so continually, will have a considerable competitive advantage. In other words, the company with an adaptive strategy will win out.

Social Strategy goes Mainstream

McKinsey stated in a recent report (McKinsey Global Institute’s July 2012 report ‘The Social Economy’) that “the secret to good idea generation is to involve many internal and external stakeholders in the process – to leverage the ‘wisdom of the crowd’. By tapping into a broad range of inputs, you can begin to see deeper threads of ideas emerging – which can then be woven together into possible solution options.” We can pause to recognize how remarkable it is to hear this advice from McKinsey. In the past, the only ‘secret to good idea generation’ you could hear coming from McKinsey was… McKinsey. But even that venerable idea generator is bound to recognize the reality that it is well nigh impossible to think outside the box when you’re standing inside it. McKinsey is standing inside the box, right next to the executive who ultimately makes the proposed strategy into company policy. McKinsey does us a great service by recognizing that the next great idea for a company cannot come from within the box, but only from without.

Successful Growth through M&A at National Oilwell Varco

At Merjerz we’ve been writing about M&A – with recent articles on Seeking Alpha on focusing on Dell and Cisco, and how their M&A isn’t quite cutting it, and conversely an analysis on Avis-Zipcar and how that deal looks. In this short article we’re going to look at a company that seems to be doing M&A just right.

National Oilwell Varco (NOV) has had an amazing run since the stock fell off a cliff in the 2008 crisis. In the last four years its stock has returned 180%, 2.5x S&P’s return over the same period, and ahead of its competitors:

NOV’s success is clearly attributable to many factors, including good timing in the oil industry product cycle, the Deepwater Horizon disaster and what that means for drillers, and various regulatory and industry shifts. But NOV’s own M&A strategy is by all appearances a major part of NOV’s performance and success story.

In their recent analyst report, Argus noted that NOV management “views M&A as a full-time activity”, and CFO Clay Williams recently confirmed that the company will continue to find and close “attractive acquisitions.” Indeed, 2012 was a very busy year for NOV’s M&A team. Though we outsiders don’t yet know exactly how many companies they bought or for how much, we do know the company has bought many targets, including big ones such as CE Franklin for $225m, Wilson for $800m, and Robbins & Myers for $2.5B – NOV’s biggest acquisitions since it acquired Grant Prideco for $7.2B in 2007. Here’s a quick look at the volume of NOV’s M&A moves (2012 details are still incomplete):

Basically, NOV has drawn synergies from its previous M&A moves by standardizing the fragmented oil rig industry (as noted by the Motley Fool). It acquired Spirit in 2009 and Ambar in 2010, both in drilling fluids. It acquired Welch in 2008 for its temperature control business, and Grant Prideco for its drill pipe products; it acquired Rolligon in 2006 adding more pressure pumping capabilities and coiled tubing products; in 2005 it bought into the machining services market when it acquired Turner, expert in thread repair, adding also Hendershot and Mid-South, both also in machining services. National Oilwell Varco has effectively used its acquisitions to become a one-stop-shop for drill pipe customers, and is now doing the same in the FPSO market (Floating, Production, Storage, Offloading), based on its acquisitions of APL in 2010, and NKT Flexibles in 2012.

In addition, NOV has also used its acquisitions to gain positions in new geographical markets, with many non-US targets acquired. The company, by its own admission (2012 10K), has “made strategic acquisitions… to expand our product offering and our global manufacturing capabilities, including adding additional operations in the United States, Canada, Norway, the United Kingdom, Brazil, China, Belarus, India, Turkey, the Netherlands, Singapore, and South Korea.” South Korea-sourced revenue grew tenfold as a result of the 2009 Hochang acquisition.

NOV is using its acquisitions to improve its revenue mix too. The company has three main revenue lines: Rig Technology, Petroleum Services & Supplies, and Distribution & Transmission. Its acquisitions have helped NOV balance out its revenue mix:

We will keep digging for insight on how NOV manages its M&A processes, how it consistently grows and strengthens its revenue bases through M&A, and how it maintains the culture and spirit across such massive acquisitions and disruptions.

Culture-shock in M&A

M&A has traditionally been a part of the core Finance syllabus in bschools, but in recent years has become increasingly anthropocentric in several ways. More and more attention is being given to how employees are treated through the M&A process, how culture affects M&A deal terms and structure, and post-merger integration (here’s a good book on that) and several bschools now offer courses like ‘HR in M&A’ which typically includes also culture issues. So clearly culture and communications – the human aspect of M&A – is coming increasingly into focus and we should expect companies to do a better job on this front as time goes on.

Let’s dig a little deeper. Obviously, culture exists at many levels. Two main groups of cultural issues worth considering in the M&A context are (i) societal culture; (ii) corporate culture. Let’s look at each very briefly.

Societal culture includes many sub-cultures, and both need to be considered in an M&A context. For example, if an American company acquires an Israeli company, as often happens, there are many cultural lessons each side will need to learn, and fast, in order for the companies and teams to work effectively. At the general cultural level, there are differences in power-distance, in how straightforward or diplomatically one speaks, in work-life boundaries, the significance of various days, holidays etc. There are also important sub-culture subtleties such as political, religious and ethnic sub-cultures that affect how people in the acquiree, for example, will react to the American acquirers. See this note on how one Israeli acquirer (TEVA), has done a good job on recognizing and addressing societal cultural differences.

Corporate cultures are an additional layer of complexity that needs consideration. Some companies are engineering drive; others sales driven. Some are explorative, encouraging entrepreneurial ventures, celebrating effort and innovation; others are purely results driven, discourage creativity and punish failure. Some are strongly hierarchical, others are pretty flat. Some have consensus driven decisions; others are more authoritative. This also applies to more mundane aspects of work: some fly you business class, others coach; some expect you to travel for weeks at a time, others don’t; some require you to clock in and work from the office, others encourage you to work wherever you’re most productive, and so on.

My anecdotal impression is that in an M&A context people are much more forgiving of differences in societal culture, and more strongly demotivated by difference in corporate culture. It seems that whatever can be put down to societal culture is shrugged off somewhat fatalistically as ‘well, that’s just how it’s done over there’. By contrast, company culture is a challenge to the other company’s modus operandi. When one company imposes its culture on another, it is effectively saying ‘out culture is better than yours’, and that gets acquirees uncomfortable.

So what can be done about the cultural challenge?

Firstly, there is the ‘observer effect’; just recognizing that there is a challenge should already go some way to meeting it. A recent study shows that cross-border M&A between companies in very different cultures actually outperform other deals (R Chakrabarti, S Gupta-Mukherjee & N Jayaraman ‘Mars–Venus marriages: Culture and cross-border M&A’, Journal of International Business Studies, 2009). The authors suggest it’s possibly because extra attention is paid to the cultural issues. In other words, in those cases the cultural challenge is obvious, and therefore it is given attention. Societal culture differences are much harder to ignore than differences in corporate culture, but both need to be recognized (and there are ways to measure and plot culture, e.g. http://geert-hofstede.com/). Beyond mere observation, there are now tools in place that ostensibly address the cultural challenge directly (and consultants now peddle advice on cultural aspects of M&A as a service they can provide; incidentally, that paper mixes between HR disruption in M&A, and cultural issues, but we can leave that for another time).

Second, there is now a considerable body of research that supporting the ‘hubris hypothesis’ – the notion that executives’ over-confidence largely drives M&A, underestimating the risk and overestimating the value the acquirer can extract (if you’ve read Nobel laureate Daniel Kahneman’s Thinking, Fast and Slow, he mentions this research there). Executives overestimate their ability to build successful companies. They’re also motivated to Empire-build, and M&A offers the perfect opportunity for a corporate version of cultural imperialism. Acquirers, by the nature of things, have the upper hand. They are purportedly the bigger, stronger, and the more successful of the two parties. Post-acquisition they will generally impose their rules, their budget, their board, their IT…. and their culture. There is an emerging trend of bottoms-up strategy building (see McKinsey’s article on this), and Merjerz (www.merjerz.com) is one of the M&A thought leaders leading this shift in M&A. As employees in the trenches, as well as customers and shareholders have more say in strategy generally and M&A specifically, executive hubris has less influence on M&A. As a result, cultural considerations become material to the M&A process, and not just something to be done away with post-merger.

Finally, with globalization cross-border M&A is increasing as a proportion of M&A transactions. American trained executives, engineers etc have always been ambassadors for American culture, and are bridge builders in transactions between American and foreign companies. Same goes for other countries. Unfortunately, American and British immigration policies are actually reducing in relative and absolute terms the enrollment of foreigners in their universities and this will have a result that these cultures have fewer ambassadors in foreign countries. But other countries, such as Australia and Canada are picking up the slack. This cultural cross fertilization prepares people, companies and societies for cultural mash ups and change.

In summary, awareness is growing, tools (including of course Merjerz) and metrics are being built, and there are long-term trends that are moving us towards better results from M&A of companies with different cultures.

Sharing a Dream, Driving a Reality

Avis (NASDAQ:CAR) recently announced its acquisition of Zipcar (NASDAQ:ZIP) for $490m, at a 49% premium to ZIP’s previous close, and at a discount of over 50% to ZIP’s initial public valuation.

On the one hand, this is a great success for venture-backed ZIP. It has made a great return for its investors, and is to be integrated into an industry stalwart, Avis. ZIP more or less created a market and a new business model, and paved the way for other sharing companies such as AirBNB. On the other hand, the agreed price is less than half the IPO value of $1.2B –  Greylock, Benchmark and Case have paid a hefty price for holding on – and though it has lost about $55m since 2007, ZIP never turned a profit, and has about as much debt as cash today. In other words, the model never actually worked. ZIP could not create a viable stand-alone business; it failed as a public company. Presumably ZIP realized this and agreed to become a bolt-on to Avis, which is why they sold low. Some dramatize this as ‘The Death of Entrepreneurship’ (nonsense!), but this sale does appear to at least b a recognition of the limitations of Zipcar’s entrepreneurial model; they built a great $500m service that fits nicely within Avis, not a great $1B standalone company.

So ZIP has saved itself by selling to Avis. The question then is: has Avis done something smart here? Time will tell. Let’s look at the pros and cons. On the pro side, Zipcar and Avis appear to mesh very naturally. Avis rents cars by the day and week; Zipcar rents cars by the day and hour. Avis will, post-acquisition, be able to offer a full range of car rental services, and will have access to Zip’s loyal customers and fleet. According to Reuters, the CAR-ZIP deal “is expected to produce $50 million to $70 million in annual synergies through lowering fleet costs, increasing utilization across the two companies, and increased incremental revenues…”. Apparently, Avis’ expertise in fleet financing can make Zipcar a whole lot more efficient and Avis-Zipcar can better meet Zipcar’s demand than it could on its own. Well, if Avis can hit those synergy numbers, then this will have been an outstanding acquisition without a doubt.

However, those numbers do seem a little fanciful. If Glassdoor reviews are anything to go by, Zipcar’s culture is still pretty innovative, entrepreneurial and exciting. Avis is a big, stodgy corporation by comparison. Zipcar’s talent is currently in Cambridge, MA, but Avis’ is in NJ. Avis is a rental company; Zipcar is a sharing company. That difference reflects a whole other set of values that the companies probably don’t share. Zipcar’s homepage still touts the company as “the world’s largest car sharing and car club service. It is an alternative to traditional car rental…” Yes, an alternative to Avis. As others have pointed out, the young, cool, green, demographic of Zipcar users may stay with Avis as they mature into middle-class Americans and Europeans, but for now at least, Avis and Zipcar have two very different user-base demographics. All these militate strongly against a deal like this one creating massive synergies of over $50m per annum. Just look at these two images – the Prius Zipcar in green grass, versus ‘We Try Harder’. These two emotions and cultures are farther apart than MA and NJ. Still, the market didn’t punish Avis shares, which – unless it shows New Year excitement and general enthusiasm for a fun looking deal – indicates that the crowd considers this deal has a fair chance.

Good luck to the Avis and Zipcar teams, we hope they can pull this off, and particular congratulations to the Zipcar investors who can take their winnings and, say, buy a car.

Fortune 500 List driving M&A!

This blog is not really a deep dive into one aspect of M&A, but a quick highlight of three areas that may be of interest:

M&A and Fortune 500 List: New research by Costanza Meneghetti and Ryan Williams shows that companies who haven’t yet made the Fortune 500 list but are close, will actually increase their M&A activity in order to grow and join the Fortune 500 list.  What’s more, this is despite the fact that such M&A is more value decreasing that other M&A: “Using a sample of all U.S. public firms from 1991-2008, we find evidence that firms closer to the final spot on the Fortune 500 list are significantly more likely to make M&A bids. This result is robust to the inclusion of CEO incentive compensation on a subsample of Execucomp firms. Further, we find evidence that cumulative abnormal returns associated with bid announcements are lower when the bidder is close to the 500th position on the Fortune 500 list, suggesting that these activities are perceived as value decreasing (Jensen and Meckling, 1976).”

In plain English, companies engage in M&A in order to make the Fortune 500 list, though that M&A performs worse than usual. Given all that we know (some of which has been discussed in this blog before) about executive bias and M&A, this cannot really be a surprise. What is remarkable is that their finding is controlled for CEO pay increase. In other words, CEOs do this not (or not only) to increase their salaries but also for non-pecuniary benefits of joining the Fortune 500.

M&A Superstars: Many corporations tie their strategy, and specifically their M&A, to the personality of a single person. At Citrix, for example, Mike Critinziano seems very much to be the life and soul of CTRX’s 40 deals in recent years. Perhaps the most interesting detail in a Bloomberg on Cristinziano, is that he works from home in Raleigh NC, not in Citrix HQ at Fort Lauderdale, Florida. Perhaps this elevates him above the ‘groupthink’ that infects most M&A teams.

The influence on one M&A wizard on the strategy and methodology, and ultimately on the success or otherwise of  a company’s M&A, needs further reflection and some data. David Lawee, head of Google’s extremely active M&A group, has just left that role for another CorpDev role within Google. Ned Hooper, head of Cisco’s very active M&A group left Cisco altogether earlier this year. Merjerz posted an article on Cisco M&A at SeekingAlpha, available here, in which we argued that Cisco’s M&A is by all appearances failing to create value. To what extent does having a strong personality lead M&A in a company bring others in line with his (could be her) thinking, eliminating a plurality of opinions and perspectives? Needs further investigation.

2012 M&A by the numbers: Numbers for 3Q have been available for a while. According to Thomson-Reuters / NVCA 3Q2012 Venture-backed M&A was down on volume and slightly up on value. VMWare-Nicira, Facebook-Instagram, and Microsoft-Yammer all closed in Q3. The average announced deal size was higher year to date 2012 than in recent years, reaching $194M.  However, beyond the Venture-backed market, the situation is worse. According to Allen & Overy, in “Q3, the volume of deals fell 41% to just 394, compared with the same quarter last year, while the value of transactions dropped 35% to just $354B. We have not had a quarter as bad as this since the second quarter of 2009 when the financial crisis was at its very peak and total deals numbered 387.” So VC-backed companies are exiting OK, bolstered by a few big deals, but M&A generally is down. It’ll be interesting to see how 2012 as a whole plays out, and then we can have some fun comparing that with the predictions that industry soothsayers made at the beginning of the year.

Happy Holidays to all Merjerz mavericks!

The Time-Cost of M&A (or: why Revenues drop post-M&A)

One of the great hidden costs of M&A is in the lost productivity that results from the M&A – pre and post closing. There are pretty hefty drains both to the quantity and to the quality of work in the acquired company, and this generally translates into lost revenues. We hint at a couple of ways to reducing this wastage too. Here goes:

Suppose a target has 100 employees. They probably spend an average of about 2 hours a day speculating on and discussing the acquisition, integration, the day-after etc. Most deals take about 6 months to go from first contact to a signed agreement, then a few months to close, then around 18-24 months to integrate. So the team is spending 1-2 hours a day for two years just wondering, talking, speculating about their future. That’s 250 days (per year), x 2 years x 100 employees x 1.5 hours = 75,000 lost hours. (Inspired by Galpin & Herndon, ‘The Complete Guide to Mergers and Acquisitions’, Wiley 2007, p.63). That’s about 30 work years!

That’s just lost productivity in quantity. Let’s consider quality… If someone knows there’s a 30% chance that they’ll be terminated, let’s just assume for argument’s sake that that correlates with a drop in quality or productivity. Their work will be 30% less ‘present’, less effective. So if a 100 employee company is acquired, and 20 of those people will be terminated in the next year – probably that can be translated into a 20% productivity drop for all 100 people. (Of course, if some know they’re in that 20%, their productivity drop will be much higher; others who know they’re secure will have a small drop; let’s stay with our assumptions for now). That’s a further 20% on top of the lost hours. In other words, assuming a 10-hour workday, we’ve lost 15% to the quantitative factor, and a further 20% of the remaining 85% – or 17% of the total human resource of the company – to the qualitative factor. That’s a net loss of 32% productivity, 15% for lost hours and 17% from lost quality. 32 percent! Some acquirers try hard to win this back with bonuses and other schemes, but that is truly a massive loss, and one that is next to impossible to win back.

For that reason “Cost-reduction synergies are more common and easier to achieve because they generally translate into layoffs of overlapping employees and elimination of redundant resources… Revenue-enhancement synergies, however, are much harder to predict and achieve.” (Berk & DeMarzo, ‘Corporate Finance’ 2007 p.877).  Not only are revenue increases extremely difficult to achieve, M&A is actually typically associated with a drastic fall in productivity – a fall in both qualitative and quantitative terms and in the examples above – that generally results in a fall in revenue. This seems to be one of the main explanation as to why revenues in M&A situations typically underperform the market. Here’s how the McKinsey Quarterly puts it (McKinsey Quarterly 2001, 4 ‘Why Mergers Fail’): “Revenue deserves more attention in mergers… Too many companies lose their revenue momentum as they concentrate on cost synergies or fail to focus on postmerger growth in a systematic manner.” We can go further and say that failure to focus on HR, on people, their productivity, their interests and their state of mind, will be destructive to revenues.

What can be done about it?

Well, the most obvious thing to do is accelerate the process. If closing can happen quicker, though employees will spend many hours per week chatting, scheming, talking about the deal, they’ll do so for fewer weeks. Same goes for integration. The more you know about the challenges facing your deal, the quicker it can go. That, of course, is where Merjerz comes in – floating to the surface the tricky issues, integration challenges, revenue and cost synergies. Armed with that information, one can build a successful deal quickly. Integration is also simpler and easier when you know what you’re integrating for, and when it’s properly planned.

Other fixes to the time-cost of M&A include effective real-time communication to employees – which avoids rumor mills and endless corridor chats on what is and isn’t, could and couldn’t be. (See at length: ‘The Human Side of M&A’ by Dennis Carey and Dayton Ogden).

The distraction to employees is just a part of the story; partners, suppliers, customers etc can all suffer similar undermining of their relationships with the company, each compounding the cost from the lost productivity of employees. We’ll leave discussion of those to another time, but note that the lost productivity is often barely considered, under-estimated, and almost always is not adequately understood. As we’ve shown briefly, there are ways to mitigate these losses and Merjerz provides a refreshing new approach to avoiding these revenue disasters.

Premortem of Acquisitions

Daniel Kahneman won the Nobel Prize for Economics in 2002, and is one of the most influential thinkers of this generation. In his recent book Thinking, Fast and Slow, this giant of behavioral economics addresses the world of M&A. Kahneman discusses optimism and overconfidence in business leaders, and how this effects companies and markets. Kahneman quotes a study by economists Malmendier and Tate that shows that optimistic CEOs – measured by the amount of stock they personally owned in the company – took excessive risks; for example, they were more likely to overpay for acquisitions, and to “undertake value-destroying mergers” (p.258).

Kahneman writes that “beliefs in one’s superiority have significant consequences. Leaders of large businesses sometimes make huge bets in expensive mergers and acquisitions, acting on the mistaken belief that they can manage the assets of another company better than its current owners do. The stock market commonly responds by downgrading the value of the acquiring firm, because experience has shown that efforts to integrate large firms fail more often than they succeed. The misguided acquisitions have been explained by a “hubris hypothesis”: the executives of the acquiring firm are simply less competent than they think they are.” (Daniel Kahnman, Thinking, Fast and Slow, 2011, p.258).

How can this common leadership fault be addressed? Part of the problem is that when senior management, especially a CEO, is excited by an M&A deal, it’s a rare and brave soul who stand up and say “this deal sucks”. Groupthink is very, very powerful. It’s what stopped people from preventing failures from Titanic and Pearl Harbor, to the Challenger and Deepwater Horizon. In the world of business, people rarely die from a failed M&A deal (happily, or business would be dangerous), but optimism and groupthink behave in just the same way. At organizations from the CIA and NASA, to Lehman and AIG, professionals are making faulty risk assessments and no one, not even the people whose job it is to do so, looks them in the eye and says ‘this is bad’.

For the world of M&A Kahneman says Gary Klein has the best solution, though it is only a partial remedy: conduct a premortem. When considering an acquisition, pretend now that the deal closed and you’re a year in the future, and the deal was a complete disaster. Now, write a brief history of this disastrous deal. A premortem allows – in fact requires – every member of the team to voice their doubts, to identify pitfalls, and this enables the acquirer to take at least some of the necessary steps to avoid the pitfalls they’ve anticipated.

Merjerz is doing something similar – instead of just requiring a few executives to suspend reality for a minute and find ways to tell their boss that she’s doing a stupid deal, Merjerz enables people who have no qualms or restrictions, no social barriers, to voice their opinions. This is the best way (we know of) to fight hubris, optimism and over-confidence in M&A.