Planning for a Successful Merger

Mergers and acquisitions (M&As) continue to be a dominant growth strategy for companies worldwide. This is in part due to pressure from key stakeholders vigilant in their pursuit of increased shareholder value. It is therefore timely to identify key planning steps that will assist CEOs and company boards to achieve M&A success. This study used semi-structured interviews to: identify the link between corporate strategic planning and M&A strategy; examine the due diligence process in screening a merger or acquisition; and evaluate previous experience in successful M&As. The study found that there was a clear alignment between corporate and M&A strategic objectives but that each organisation had a different emphasis on individual criterion. Due diligence was also critical to success; its particular value was removing managerial ego and justifying the business case. Finally, there was mixed evidence on the value of experience, with improved results from using a flexible framework of assessment. Jarrod McDonald, BBus.Com (Hons): has been employed at Monash University in the Faculty of Business and Economics as a Tutor and Research Assistant. His research interests include mergers and acquisitions and taxations issues facing investors, in particular share buybacks. He has been published in academic and professional journals. He is now employed in the financial services industry and is an Affiliate of the Securities Institute of Australia. Max Coulthard, M.B.A.: is a Lecturer and Unit Coordinator in International Business, Department of Management at Monash University, Melbourne, Australia. His teaching and research interests include entrepreneurship, international business and franchising. Max has written 17 refereed publications and coauthored three books. He is currently completing his PhD investigating the effect of entrepreneurial orientation on firm performance. Paul A de Lange, PhD: is an Associate Professor in the School of Accounting and Law at RMIT University, Melbourne, Australia. Paul teaches in a variety of Financial Accounting units to both graduate and undergraduate students. His research interests include management, accounting education, financial accounting issues and auditing. He has presented research papers at both national and international conferences and has published over 20 refereed publications. The authors gratefully acknowledge the reviewers and participants of the Global Business and Technology Association, 2005 International Conference, for their constructive comments on earlier versions of this manuscript. We are also thankful to the participants who agreed to be interviewed for this research. Jarrod McDonald, Max Coulthard, and Paul de Lange ©Journal of Global Business and Technology, Volume 1, Number 2, Fall 2005 2 INTRODUCTION Growth continues to dominate the minds of CEOs and their Boards. Mergers and Acquisitions (M&As) has been one of the favoured methods of achieving growth targets and appeasing key stakeholders, vigilant in their goal to increase shareholder value. Given past high failure rates of M&As, it appears timely to identify effective planning practices that enhance the chances of their success. In 2004, worldwide M&A activity increased by over 40% to $1.95 trillion resulting in the highest M&A activity levels since the year 2000 (Thomson, 2005). This growth in activity is interesting to note considering that research has shown that, historically, approximately half of all mergers and acquisitions have proven unsuccessful (See Covin, Kolenko, Sightler & Tudor, 1997; Gadiesh & Ormiston 2002; Gadiesh, Ormiston & Rovit 2003; Kaplan 2002; Stanwick & Stanwick 2001; Weber, Shenkar & Raveh 1996; Schneider 2003). In contrast to previous research, a recent Australian study found that for the first time shareholder value was increased, more than it was reduced as a result of mergers and acquisitions (KPMG, 2003). It was established that 34% of the deals enhanced shareholder value, 32% reduced value and 34% had no effect. This was a significant improvement from the first survey carried out in 1999 where 53% of mergers and acquisitions reduced shareholder value (KPMG, 2003). Given the conflicting research results and in light of the large increase in mergers and acquisitions activity, this approach to organisational growth appears worthy of review. This exploratory research had three main objectives: (i) to identify the link between corporate strategic planning and merger and acquisition strategy; (ii) to examine the due diligence process in screening a merger or acquisition; and (iii) an evaluation of previous experience in the successful completion of M&As. THEORETICAL BACKGROUND Mergers & Acquisitions and Corporate Strategy Alignment This section reviews the literature on the effect of aligning corporate strategy and M&A strategy. Strategic planning has long been emphasised by organisations as an important tool leading to business success (Coulthard, Howell & Clarke, 1996). In a study conducted by Harding and Rovit (2004) the importance of aligning corporate strategy to planning for mergers and acquisitions was examined. They reviewed more than 1,700 mergers and acquisitions and interviewed 250 Chief Executive Officers (CEOs). It was found that less than one in three CEOs interviewed had a clear strategic rationale for the M&A, or understood the contribution the deal would make to their company’s long-term financial future. This study also found that over half of those companies with a clear rationale underpinning their M&A activity came to a post-M&A conclusion that their rationale had been wrong. A number of authors have discussed the different growth strategies available to CEOs (Chanmugan, Shill, Mann, Ficery, Pursche, 2005; Gulati, Freeman, Nolan, Tyson, Lewis & Greifeld, 2004; Lynch & Lind, 2002). Lynch and Lind (2002) describe mergers and acquisitions as being one of the central techniques for organisational growth, whilst Hurtt, Kreuze and Langsam (2000) go further and suggest growth is the primary reason for M&As. Perry and Herd (2004) emphasise the critical role of strategic planning when using M&As to grow an organisation. They suggest that in the 1990s companies shifted the focus for undertaking M&As from a cost saving perspective to using M&As as a strategic vehicle for corporate growth, which the authors regarded as an inherently more difficult challenge. PLANNING FOR A SUCCESSFUL MERGER ©Journal of Global Business and Technology, Volume 1, Number 2, Fall 2005 3 Harari (1997) lists several reasons given by CEOs to justify a merger or acquisition. These include: to obtain synergies, economies of scale, cost savings, increased products and rationalisation of distribution channels. Selden and Colvin (2003) highlight the way companies focus on the potential return on capital. They also suggest that the most common reason companies buy one another is to acquire customers. Selden and Colvin (2003) note the pressure on CEOs to use their excess cash and increase earnings by mergers or acquisitions even if that may not be an appropriate strategy for the company. Albizzatti and Sias (2004) identify that the reasoning for an acquisition needs to be more strategic than simply the use of excess cash. The strategic reasons they identify for acquisitions are: (i) acquire new products, capabilities and skills; (ii) extend their geographical reach; (iii) consolidate within a more mature industry; and (iv) transform the existing industry or create a new industry. Whilst many CEOs appear happy to share the virtues of their latest acquisition it appears few are keen to highlight their failed M&As. Harari (1997) questions why so many M&As fail after CEOs extol their strategic rationale. This author suggests the reason for failure is the lack of vision by short sighted executives, who take the safe route and buy current competitors to gain market share. Harari recommends that instead companies should boldly redefine themselves and their market place. Balmer and Dinnie (1999) identify a number of reasons for the failure of M&As. They found that there was an over-emphasis on short term financial and legal issues, at the neglect of the strategic direction of the company. This neglect included failure to clarify leadership issues, and a general lack of communication with key stakeholders during the merger or acquisition process. Some studies have focused on identifying the specific reasons for the failure of mergers or acquisitions. For example Gadiesh and Ormiston (2002) list five major causes of merger failure: • Poor strategic rationale. • Mismatch of cultures. • Difficulties in communicating and leading the organisation. • Poor integration planning and execution. • Paying too much for the target company. Of these five causes of merger failure Gadiesh and Ormiston (2002) believe that having a clear strategic rationale for the merger is the most important problem to overcome, as this rationale will guide both pre and post merger behaviour. They emphasise that this issue alone may result in the other four causes of merger failure occurring. Lynch and Lind (2002) list other reasons for merger failure such as: slow post merger integration, culture clashes and lack of appropriate risk management strategies. Given the importance of aligning strategic planning policy to M&A strategy it is crucial to identify and utilise an effective tool to ensure there is alignment between an organisations strategic plan and M&A plan. This tool is generally referred to as the due diligence process. Due Diligence: Screening of Potential Merger or Acquisition Targets Due diligence is a generally accepted method in undertaking an assessment of potential M&A targets. Sinickas (2004) defines due diligence as ‘...where each party tries to learn all it can about the other party to eliminate misunderstanding and ensure the price is appropriate’. Angwin (2001) identifies due diligence as critical in the M&A process. This author points out that effective due diligence should be a comprehensive analysis of the target company’s entire business, not just an analysis of their cash flow and financial stability as has traditionally been the case. Perry and Herd (2004) note that as the complexity of mergers and acquisitions has increased, the scope and effectiveness of due diligence are now key issues. This view is supported by Jensen (1982) who notes that the majority of acquisitions in the 1960s came from referrals through investment and commercial bankers, whereas in the 1970s a more proactive screening process was utilised to identify candidates. Jensen Jarrod McDonald, Max Coulthard, and Paul de Lange ©Journal of Global Business and Technology, Volume 1, Number 2, Fall 2005 4 suggests that potential candidates have become well exposed to many potential suitors and it can be difficult to determine if they are the best candidates available for M&As. To overcome the danger of entering a bidding war amongst suitors, Carey (2000) advises that a potential buyer of a company needs to set clear criteria when considering a potential merger or acquisition. Jensen (1982) states that it is essential to test the business case by examining operational and management strengths and weaknesses. Carey (2000) also recommends that this examination should include full financial information, candour about the company’s operating performance and problems, its corporate culture plus an honest assessment of management talent. Carey suggests this can be achieved by building relationships with target companies. The literature suggests that due diligence process is essential for M&A success. However, the scope and complexity of due diligence has increased as businesses continue their international expansion. Therefore it is important that past M&A experience be explored to identify whether an organisation can learn from past mistakes and improve its M&A performance. Learning from past Merger and Acquisition experience Hayward (2002) states that while people undertaking mergers and acquisitions have a great opportunity to learn from their experience, they seldom do. This author found that firms who have small losses in prior acquisitions are stimulated to learn from their performance and outperform on subsequent acquisitions. On the other hand, firms that have had great success or great failure find it difficult to learn from that experience. Rovit and Lemire (2003) established that frequent buyers, regardless of economic cycles, were 1.7 times more successful than those firms who were not as frequent, (i.e. between 1 4 deals). They suggest consistent purchasing will increase the chances of success, as is being prepared to walk away from deals that are considered too risky. By contrast, Hayward (2002) finds that acquisition experience is not enough to generate superior acquisition performance; however, firms are more successful when they acquire companies that are in a moderately similar business. This author also finds that acquirers, who make acquisitions one after another in quick succession, do not outperform companies that acquire infrequently. According to Hayward (2002) the best results come from those organisations who take a modest break in their acquisition process to allow the lessons learnt from acquisitions to be processed, i.e. a break long enough for management to consolidate key lessons, but not so long that those lessons are forgotten. Guest et al. (2004) suggest that having a successful first merger is a predictor of declining performance in subsequent acquisitions. This is in contrast to Hayward (2002), who found that acquirers who have an unsuccessful first merger learn from their mistakes and improve their subsequent performance. Even though these acquirers do learn from their mistakes, they never quite catch up with the organisations successful in their first acquisition. Guest et al. (2004) concluded that if your first merger does not succeed, it is not worthwhile pursuing future mergers. Overall, the body of literature on the usefulness of prior experience in undertaking M&As has shown mixed results. This study focuses on three key planning requirements necessary to achieve M&A success: aligning corporate strategy; due diligence; and learning from past M&As. This does not diminish the importance of other factors such as post M&A integration; however these are outside the scope of this study. PLANNING FOR A SUCCESSFUL MERGER ©Journal of Global Business and Technology, Volume 1, Number 2, Fall 2005 5 RESEARCH DESIGN AND METHODOLOGY A qualitative research approach was adopted in this study. The benefit of qualitative research is its ability to allow the investigator to gain depth and detail (Patton, 1990), and to address the ‘how and why’ questions (Yin, 2003). Researchers suggest a qualitative approach may yield important insights into the phenomena of mergers and acquisitions (Pablo, 1994; Cartwright & Cooper, 1990). This methodological design is particularly useful in expanding our understanding and knowledge of mergers and acquisitions in terms of strategic planning and the issues surrounding the due diligence process. Datta (1991) supports the utilisation of a qualitative approach in the study of mergers and acquisitions on the grounds that previous studies in this area provided limited insight as to the reason around half of these transactions have failed. This exploratory study used semi-structured interviews to collect data. Punch, (1998) suggests this method allows an in-depth study of a variety of common topics, while providing the flexibility of moving from the more general to specific. The use of common topics in all interviews provided a level of consistency and allowed an evaluation of data to be conducted between interviewees. The interviews were undertaken with experienced senior managers and CEOs of Australian listed companies and Australian based United States of America subsidiaries. The participants had a diverse range of experience, competence and skills. They operated in different industries and in companies of varying size and revenues (See Table 1). The major topics covered in all interviews were: (i) the relationship between corporate strategy and M&A strategy; (ii) the criteria organisations use to screen M&A targets; (iii) identification of the key planning requirements to achieve M&A success; and (iv) whether M&A experience improves performance. Table 1: Description Of Participants Interviewed Organis ation Organisation Description Partici pant Position Listing Status A A multi national beverage company. A Manager – group strategies Australian Stock Exchange(ASX) listed B A leading global information technology company B President/CEO – Asia Pacific NASDAQ listed C Global consulting firm, consulting across all industries with a focus on results. C Senior Manager Global Partnership D A leading manufacturing company operating in Australia, New Zealand, Asia and the US. D Senior Business Analyst ASX listed E A transport and logistics provider. E Chief Financial Officer ASX Listed F A diversified manufacturing and service company F General Manager of an Australian Division New York Stock Exchange listed