Why Mergers and Acquisitions Fail, and What to do About It?
This article was contributed by Dr. Halil Kiymaz, Crummer’s Bank of America Professor of Finance
Mergers and acquisitions (M&As) continue to be a preferred strategy for firms to grow and strengthen their competitive position in the marketplace. Although the number of acquisitions varies each year, growing through acquisitions has been an attractive strategy for large and small firms. Academic studies show that when companies merge or acquire, most of the shareholder value created through a merger is likely to go not to the acquiring firm but the target firm. The acquirer, on average, pays the target a premium of about 10 -35% of the target’s preannouncement market value. Targets benefit most in many acquisitions, while acquirers cannot achieve the desired benefits both in the short and long-run. Recently, Gilead Sciences Inc. announced a $21 billion acquisition of Immunomedics Inc. and its prized breast-cancer drug. Gilead agreed to pay $88 a share in cash for Immunomedics, representing a 108% premium. The target stock price doubled following the announcement while the acquiring firm’s (Gilead Sciences) stock price declined over 5% during the following days. The long-term impact of this acquisition on Gilead, however, remains to be seen.
Here I highlight various interrelated reasons why mergers or acquisitions may not achieve the desired benefits for acquirers. The list is rather long and can include inaccurate valuations, overpayment to target firm, overstating synergies, failures in operational and cultural integration, executive biases, among others. I will limit the discussion to a few of these and offer effective remedies along the way.
Overvaluation and hence overpayment for a target is one of the major reasons why acquisitions fail. Acquirers typically share the expected benefits or synergies from acquisition with a target firm in the form of a premium paid. Overvaluation of target translates into higher premiums paid. Overvaluation of a target may result from overstating expected synergies from an acquisition. Acquirers are typically more vulnerable to this error in cash transactions, as acquirers assume the risk of realizing synergies. Acquirers tend to overvalue their targets more during an economic expansion phase when the market valuations are high. A bull market can increase valuation multiples on recent transactions, and using these multiples with no adjustment may cause overvaluation of a target.
Overconfidence of management for their biased valuation may be avoided by seeking an external validation of figures.
Similarly, inflated expected synergies would increase the valuation of a target. Furthermore, the presence of competition for a few targets in certain industries may rush acquirers’ decisions about the urgency of acquiring a firm and hence causing overpayment to their targets. Overvaluation may also stem from overconfidence of management for their valuation numbers that may be biased. Seeking external validation of valuation analysis may help managers to avoid valuation biases and overoptimistic expectations from an acquisition. Although it is challenging for managers to accept their biases, having a formal decision-making process would help them curve their tendencies.
What are the synergies, and why would acquirers often overestimate them? Most acquirers overvalue the synergies expected from acquisitions. The sources of synergies may include economies of scale and scope, sharing of capabilities and opportunities, and adopting best practices, among others. Synergies typically are classified as revenue or cost synergies. An accurate estimation of both synergies is essential, as a minor variation from these estimates may influence the valuation and the outcome of an acquisition. With higher deal multiples, capturing both cost and revenue synergies are necessary to achieve acquisition objectives. When firms look for synergy potential in deals, they tend to focus on cost synergies as they are more straightforward to estimate than revenue synergies and often pay off quickly. Revenue or growth synergies are more challenging to evaluate and typically take a long time to capture. Achieving revenue synergies depends not only on the competitiveness of the acquirer but also on the growth potential in the industry. What can acquirers do to increase their chances of success? Starting with cost synergies, the following would help acquirers to realize their cost synergies effectively. Although many cost synergies are realized relatively more straightforward, outside industry benchmarks should be used routinely to estimate cost synergy estimates. Also, while most cost synergies are related to cost reduction, there may be cost increases incurred to achieve the projected synergies, and managers should not neglect these increases. Finally, managers should be realistic about how long it will take to realize cost synergies.
Revenue synergies are typically more challenging to estimate and capture as these synergies are not entirely under the control of acquiring firms. Acquisition announcements often note revenue synergies as one of the strategic rationales for acquisitions, such as expanding to new markets both geographically and through new product offerings and accessing target customers. Not realizing revenue synergies has a significant impact on the bottom line and hence on the value of the acquiring firm. Many acquiring firms use assumptions about pricing and market share that may contravene overall market growth and competitive realities. It is difficult for an acquirer to know the changes in pricing strategies of its competitors as they respond to the acquisition.
Revenue synergies are harder to estimate but have a more pronounced impact on valuation compare to cost synergies.
Furthermore, if the market is not growing, then the only way an acquirer can grow would be to take market shares from their competitors. So, relying on typically inflated revenue estimates may reduce the reliability of target valuation and benefits of revenue synergies. Additionally, acquiring firms should also consider negative revenue synergies resulting from the loss of focus on their existing businesses as they spend time on integration and achieving expected synergies. Merging firms may end up losing a fraction of their combined customers. Acquiring firms should consider the sensitivity of their assumptions about pricing and market share and the recovery time of revenue synergies.
Aside from the quantity of sales, post-acquisition pricing strategies may significantly influence realized synergies. Although an acquisition may provide the acquiring firm some control over pricing as it would affect its competitive position, post-merger pricing should not translate in raising prices automatically. Acquiring firms should focus on the value proposition to their customers and price their products and services accordingly. Merged firms can destroy value by failing to align prices with enhanced benefits to their customers.
Finally, to achieve the projected revenue synergies, the acquiring firm should closely examine the cross-selling opportunities to combined customers. Cross-selling refers to selling products and services sold to one set of customers to another group of customers to realize synergies. The success of cross-selling varies among firms, but it is typically challenging to achieve. It would require the right skill set for the sales team, extensive training of employees, and a complementary product and service menu.
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