Here’s the thing about big corporate mergers: in the long run, they’re rarely successful. And yet they keep happening.
In fact, the corporate world is witnessing a wave of merger and acquisition mania. US pharmaceutical firm Pfizer has pitched a £63 billion dollar bid for its UK rival AstraZeneca. The French energy and rail firm Alstom has been offered €12.35 billion for its energy division. The concrete industry has seen a £39 billion merger between Holcim and Lafarge.
The sheer size and amount of deal-making was last seen during the mergers and acquisition (M&A) boom of early 2007, just before the financial crisis began to hit. This has prompted varying reactions. A recent Financial Times piece makes the case that this time, things are different. Past waves of M&A were paid for by companies borrowing money in order to buy take-over targets for cash. Firms may have grown, but they also loaded themselves with debts they would struggle to pay off. In contrast, much of the current wave is financed through a mixture of cash and stocks, which means the buying company shouldn’t be shouldered with massive debts.
In the past, M&As have often involved firms in one industry making acquisitions in an altogether different sector. The result were companies which were a hodge-podge of unrelated and poorly integrated divisions. At one point in the 1980s, US conglomerate ITT operated in the insurance, telecommunications, hotels and manufacturing sectors. However the recent M&A wave involves companies acquiring or merging with others in the same industry. In theory, firms should be able to use the merger to strengthen what they are already good at doing.
But many remain sceptical. While CEOs might get a handsome bonus and shareholders receive an appealing bump in share price, there are losers too. Studies repeatedly find that 70% to 90% of mergers fail. Mergers need to be paid for by cost cutting, which often makes job losses inevitable. Customers, local communities and national governments can lose out from M&As. The Pfizer deal, for instance, could mean AstraZeneca’s innovative cancer drugs get lost in development, and never make it to market.
Sometimes the whole economy loses. Consider the M&As behind recent bank failures: Co-op overreached by taking over Britannia; RBS bought subsidiaries around the world; Halifax and Bank of Scotland became HBOS, which fell victim to the financial crisis; HBOS was bailed out by Lloyds which then in turn ran into difficulties.
But the most surprising downside is that the very people who are supposed to be the main winners – the shareholders – actually end up losing out. A review of more than 130 studies found that, while on balance M&As created some value for the company selling the assets as well as shareholders, they made no difference to the value of the acquiring company. In other words, acquiring companies often go through painful and expensive processes for absolutely no pay-off.
So why do senior executives seem so attached to M&A? Perhaps the most obvious reason is that while long-term benefits are highly uncertain, short-term share price benefits can be significant. Even the announcement drives up share prices, sometimes to unwarranted levels. AstraZeneca shares rise with every positive buy-out news story, and analysts now believe they could fall 21% if Pfizer pulled out of the deal.
This can richly reward activist shareholders and hedge funds who typically buy and hold shares to take advantage of such fluctuations. Gaining control of a company, pushing up its price and then selling it on is a lucrative business to be in. Just ask Carl Icahn.
However, for those shareholders who are in it for the medium or longer term, the value is very uncertain. And these are the exact owners companies need – patient shareholders willing to sacrifice making a quick buck for an investment in long-term growth.
Of course, there is another group who make handsome profits from M&As: the so called “market intermediaries”, including investment bankers, lawyers, consultants, coaches, branding and design agencies, and so on. The core business of many of these advisers is to identify, promote and execute mergers or acquisitions. They don’t see mergers as a means to deliver better results for a given company; for such intermediaries, the deal is an end in itself.
And such deals are expensive, even beyond the basic price tag of the acquisition. It’s not easy to pull together financing, to integrate the new business and successfully rebrand, or to deal with staff conflicts and legal problems such as anti-trust cases. Firms need help, and lawyers and bankers don’t come cheap. They have a clear incentive to convince companies M&As are a good idea, even when the case might be shaky.
But clearly it is not just the fault of the management advice industry. Senior executives themselves are often willing accomplices. Increasingly they have their incentives directly linked to short-term share price increases, growing the companies’ revenues or market-share. This search for short-term rewards is backed up by CEOs who over-value their own abilities. One study found that CEOs who are over-confident tended to do more mergers and acquisitions, but with poor long-term results.
The real value created by M&As is work for well-paid intermediaries, speculative gains for short-term activist investors and bonuses for senior executives. The costs often end up being carried by downsized employees, abandoned local communities and national governments who can loose their industrial base.
This is not to say all M&As are simply mechanisms for small groups of elite professionals, investors and managers to further line their pockets. There are indeed occasions where mergers can make a great deal of sense. Successes include the merger of Disney and Pixar, or Exxon and Mobil. But companies need to approach them soberly and recognise that if they actually want to make a merger work, the odds are stacked against them.