Sunday, January 15, 2006

Most mergers fail

Numerous studies suggest that most mergers destroy shareholder wealth. For example, a Chicago Tribune/A.T. Kearney study of 50 mergers between January 1999 and September 1999 found that 69% of the surviving companies lagged their industry average in shareholder returns in the two years after the deal closed. About 70% of surviving companies underperformed their peers five years after the deals closed according to Kidd Stewart (2001).

But not all mergers are bad for shareholders. While the average big merger does not do much for shareholders, there are big performance differences across industries. This is the conclusion of my firm’s analysis of 30 big mergers concluded between 1998 and 2001. These 30 mergers averaged $39 billion and the stock prices of the average acquirer lost 6% between the date of the merger announcement and March 29, 2002 as compared to an 11% loss on the S&P 500.While the average acquirer’s stock among these 30 performed 5% better than the S&P 500 from the date of the announced merger there are wide differences across industries. For example, financial services, energy, and consumer products mergers performed very well while telecom, media, and tech (TMT) mergers were shareholder value destroyers.

This is important because mergers are among the most significant strategic decisions that a company will make. Mergers can involve enormous capital commitments and can alter in fundamental ways a company’s strategy. As the studies above suggest, the risk of failed mergers is high and the cost of such failures can be enormous.

Three examples illustrate the risks of poorly considered and executed mergers. WorldCom, which announced its acquisition of MCI for $37B in October 1998, underperformed the S&P 500 by -90% from the date of this announcement – before ultimately filing for bankruptcy; JDS Uniphase, which announced its acquisition of SDL for $41.1B in January 2000, underperformed the S&P 500 by -76% from the date of this announcement; and VeriSign, which announced its acquisition of Network Solutions for $21B in March 2000, underperformed the S&P 500 by -71% from the date of this announcement.

In November 2005, my firm completed a study of successful diversification in the payment services industry – companies that process credit card and other financial transactions -- which offers general lessons for corporate acquirers. Our study of 10 diversification businesses created by eight payment services providers (PSPs) found that the PSPs added an average of $559 million to their 2004 sales and $103 million to their 2004 operating income through 20 acquisitions costing an average of $429 million. How did these PSPs succeed? Their approach to M&A takes seriously the basic blocking and tackling of diversification strategy. Specifically, the PSPs in our study apply the following management discipline:
  • Pinpoint large, rapidly-growing, profitable markets;
  • Focus only on such markets where the acquirer’s core capabilities – such as operational excellence, marketing, technology-based innovation – will give the acquirer a competitive advantage in the new market;
  • Negotiate a reasonably priced deal with a company that offers a beachhead into this new market; and
  • Grow market share by integrating the acquired company with care while ‘pouring in’ the acquirer’s core capabilities.


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