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Harbert Magazine
Harbert Magazine

How mergers and acquisitions come about — or don’t

Map of Confluence of a River

In the first half of this year, we saw mega-mergers unfold — most prominently AT&T/Warner Media and Discovery in May, in a $43 billion deal. And major acquisitions, notably Amazon’s acquisition of MGM, also in May, for $8.45 billion.

Make way for more supersized M&As.

“There will be no slowing down of big deals across the industry in the months to come,” predicts the AI platform Intellizence, which monitors sales and growth and tracks industry trends and issues. “The outlook is positive with organizations looking to grow and scale business, while private equity firms and SPACs (special purpose acquisition companies) are ready to invest capital.”

What fuels this movement? Lou Bifano, director of entrepreneurship strategy at Harbert, points to some of the reasons acquisition is so alluring.

It could address a strategic need or fill a gap in products and services faster than the company could develop its own solution or gain a time-to-market advantage, Bifano said. And then there’s invaluable access — access to new technologies, adjacent or new market opportunities, to employees, executives and thought leaders with needed skills, to new customers or key patents.

Sometimes, it all comes down to timing — taking advantage of an industry consolidation opportunity or an unexpected opportunity to acquire a company in distress at an extremely attractive price.

Valuation is key

Before joining forces or offering a deal, price discovery — finding the acquisition target’s fair value price — is essential. Valuation estimates create financial models and business cases, prevent overpaying for the acquisition candidate and establishing a fact-based rationale during valuation discussions and negotiations with the acquisition candidate, Bifano said.

He added that this process is also key in preventing emotional decisions — what he calls “deal fever” — from being made during negotiations.

A company looking to acquire a business and calculate that prospective acquisition’s value — the process of price discovery — can’t ignore the current financial, political and social climates. In 2021, five trends are distorting the way markets are pricing prospective acquisitions, according to economist Dambisa Moyo. 

These distortions, particularly during a buoyant stock market, could lead to companies using incorrect valuations to enter M&A transactions they can’t afford. 

First, the current low interest rates mean there are few public peers for business leaders to value their companies against, Moyo writes. Second, a shift toward passive investing — a strategy that maximizes returns by minimizing buying and selling — tips the balance of power to a small group of dominant investors who could be important shareholders and investors on both sides, meaning they could be more willing to accept a lower price on an acquisition than investors who only have shares in the company being sold. 

Third, the rise of ESG — environmental, social and governance — investing is changing the valuation game on a global scale, with potential markdowns for companies that lack strong ESG credentials and decreased clarity in price discovery.

Fourth, a current surge in nationalism, protectionism and other global crosscurrents impact how companies are valued in numerous ways, all coming down to a more balkanized and less transparent valuation process around the globe. 

Finally, the surge in cryptocurrency and other global financial innovations presents another challenge to valuation. When companies put cryptocurrencies on the balance sheet, valuation becomes difficult to calculate. 

The quest for synergy, and  its challenges

While working for a Fortune 500 company largely in the defense industry, Brian Connelly, professor and Luck Eminent Scholar at Harbert, was responsible for finding acquisition targets that could diversify the company, adding more commercial and consumer products to its arsenal.

What he learned: Synergy is crucial. The acquisition of the target firm is worth more after it becomes part of the larger firm than it would be on its own. As the adage goes, the whole is greater than the sum of its parts. As idyllic as that sounds, it isn’t that simple. 

“It is also important to recognize that acquisition motivations are not always as pure as the driven snow,” Connelly said. “For example, keep in mind that CEOs gain prestige and compensation in large part based on the size of their company. Thus, there could be a hidden motivation to grow quickly by acquisition as opposed to the slow route through internal innovation.” 

And there are further complications. Connelly and fellow Harbert professors found through their research that shareholders can easily push managers to acquire firms in which the shareholders also own appreciable shares. That’s because when an acquisition is announced, the price of the target firm can skyrocket. 

He calls this common practice “a hidden, and potentially nefarious, form of antitrust.”

But these clouds overshadow the essential components of seeking a successful merger or acquisition — having complementary assets, low debt, sufficient attention to evaluation and staying innovative over time.

Connelly said the role of company cultures can easily be overlooked. 

At one point, he and the general manager of the defense contracting company traveled to Silicon Valley, ready to make an offer to buy a successful startup there, only to face a stark realization.

“We took one look at the people walking around in flip-flops and the ping-pong table in the conference room and said, ‘This is never going to work,’” Connelly recalled. “People need to realize that acquiring a company means marrying two cultures, and if those cultures are sufficiently far apart it introduces complexities that are hard to overcome.”

Still, it’s common for larger companies to forge ahead regardless. Understanding culture and proactively managing it is critical to a successful integration and requires a comprehensive approach, according to the McKinsey report “Organizational Culture in Mergers: Addressing the Unseen Forces.” While 95% of executives cite cultural fits as a critical component of integration, 25% of those leaders say the primary reason integration efforts fail is a lack of cohesion and alignment.

The approach to managing business culture during a tumultuous transition should be simple: Diagnose how the work gets done, set priorities and hard-wire and support change — and start this process early.

Organizations on the verge of acquiring or merging can glean as much from abysmal failures as they can from soaring victories.

Often, the failure of an M&A emerges from “the overconfidence effect,” which has everything to do with the C-suite, particularly the CEO, Connelly said. 

Former Quaker CEO William Smithburg sparked one such disaster in the 1990s. After an impulsive but extraordinarily successful acquisition of Gatorade, he soon set his sights on the beverage company Snapple for $1.4 billion, fully confident he could turn the brand into a money-maker.

Industry analysts predicted a bleak outcome, since Snapple faced a barrage of challenges. It was outside the mass-market arena, lacked manufacturing and distribution synergies with Gatorade and had poor inventory management. 

The headline that followed soon after: “$1.4 billion mistake costs CEO his job.” 

—Teri Greene