is Weimar-Republic hyperinflated. However, the use of equity may also signal a deal's importance if the acquirer is demonstrating to the target a willingness to use a tender that both believe has significant potential to appreciate.
When Berkshire Hathaway uses it stock, the company signals that it views the acquisition as having special value. As Warren Buffett quipped at a shareholders meeting about issuing stock in a transaction: “Charlie [Munger] and I like using stock about as much as preparing for a colonoscopy.”
Perhaps here's the key takeaway regarding M&A financial performance for acquirers. Average returns across all companies may not be all that exciting. But the real issue is, how does a company outperform these averages? How does a company move into the top quartile of performers? How does a company build a core strategic advantage via M&A? Throughout this book, we'll explore what we can learn about these questions from Google.
Reasons for M&A Failure
In other to provide context for understanding M&A success, let's highlight three major reasons for M&A failure. Not surprisingly, these reasons closely connect to the broad areas of M&A activity discussed earlier.
Flawed Strategy
The strategic rationale for an acquisition must be soundly based on a company's core competencies. Growth opportunities should be centered in areas where a firm has some distinctive advantage, not on areas of overt weakness. The chances that M&A will solve a company's problems have about the same likelihood of success as a marriage resolving the difficulties of two troubled people.
Consider an example. If a product or service is unable to obtain distribution by clearly providing value, acquiring distribution is unlikely to be the solution.22 In 1987, during the early days of personal computing, Atari was struggling to convince retailers to sell its PCs. In an attempt to solve the problem, Jack Tramiel, then chairman of Atari, bought the Federated Group chain of consumer electronics stores for $67.3 million. Tramiel reasoned that the network of 65 Federated stores in California, Arizona, Texas, and Kansas would successfully move his computers.
Other retailers were reluctant to carry Atari's machines, given that customers viewed Atari as a video-game manufacturer and not a serious PC provider. But using its newly obtained captive distribution, Atari graced its computer line with prime shelf space at Federated. And yet, Atari and Federated soon faltered. As the adage goes, you won't improve buoyancy by strapping together two leaky canoes.
For a corporate business development effort to succeed, it must be connected to a company's core competency and not try to solve a company's fundamental flaw.
Attempting to move too early into a market can be another source of seriously flawed strategy. When AOL and Time Warner attempted to create the world's first global digital media company, the vision was splendid. The timing was not. Although numerous explanations can be given for what is considered by many to be the worst business combination ever, one prominent reason is a flawed timing strategy. After all, in 2000 broadband capacity was still in its infancy in the United States.
Overpayment
Just as numerous factors can lead to flawed M&A strategy, overpayment can spring from many sources. Overestimating synergy is one of most common overpayment drivers.
Recall that the origin of the word synergy in M&A activity arises from Fred Weston's encounter with Irish coffee on a restaurant drink menu. So perhaps it's not surprising that corporate executives may appear somewhat inebriated in asserting the amount of synergy (particularly revenue synergy) that will arise from transactions. It's no wonder that Wall Street believes and values cost synergies much more than revenue synergies as vehicles for wealth creation. Cost synergies are viewed to be much more in control of an acquirer. Revenue synergies can be quite fanciful.
Nevertheless, a company can build a reputation for knowing how to generate revenue synergies. Indeed, very few Google deals can be described as driven by cost-reduction synergies. Google's ability to use M&A for semi-organic growth derives from continuous organizational learning relating to how to create revenue synergy that blends existing with newly acquired resources.
Associated with overestimating synergy is a phenomenon known as the winner's curse.23 Simply stated, the winner's curse implies that in an auction the winner tends to overpay.
Consider the experiment I've run numerous times in an executive program at UCLA. It's called the pitcher experiment. Put a collection of currency into a water pitcher, with dollar bills, some fives, some tens, and perhaps a twenty-dollar bill visible. Then ask the participants to bid on the contents. The winning bidder will pay the amount bid and will receive, in turn, the contents of the pitcher. Only once in the many times I've run this experiment has the winning bidder benefited. All other bidders fell trap to the winner's curse, paying more for the contents of the pitcher than the value obtained.
Certainly, the winner's curse is one reason when Warren Buffett described his acquisition criteria this way in Berkshire Hathaway's annual report: “We don't participate in auctions.”
Integration Pace and Style
As previously mentioned, the sooner enhanced cash flows from deal cost or revenue synergies are realized, the larger will be their present value. For some deals, this is absolutely appropriate. Furthermore, rapid integration can provide organizational clarity and minimize the uncertainty felt by company stakeholders, from employee to customer. However, for other deals, rapid absorption of the target into the mother ship will be the catalyst for the departure or suboptimal performance of key human assets acquired in the transaction.
Given the need for tight controls, especially in its defense contacting businesses, as a practice Honeywell Aerospace quickly and efficiently absorbed the people, assets, and systems of the companies it acquired into the corporate parent. But when it discovered a superb center of excellence somewhat hidden in one of its acquisitions, Honeywell realized that it would be a mistake to dismantle the creative talent and distinctive technology the unit possessed. Rightly so, the company not only preserved the unit, but worked hard to nurture and spread its capabilities throughout the entire company.
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