Wednesday, November 11, 2009

"What were they thinking" department

With my undergraduate strategy classes, we just got through talking about mergers and acquisitions. This year, as in previous years, I made three points:

  1. Due to egos and compensation, CEOs bias towards creating bigger but not necessarily better companies.
  2. Adding revenues without increasing profitability does not improve a company’s strategic position.
  3. When you are doing a major acquisition, there are two types of companies available: expensive good companies and lousy cheap ones.
I also point out that 99% of “mergers” are actually acquisitions, with a clear dominant partner. (NB: HP-Compaq).

In this morning’s Merc, Chris O’Brien writes about tech companies that are both unwinding acquisitions gone bad while continuing to make other acquisitions. As O’Brien notes, this is not a particularly good time in the economic cycle to get a good price for divestitures (although presumably new acquisitions will be relatively cheap).

A number of these acquisitions were ill-conceived from Day One. Some are dumber than others, as when eBay spent billions to buy Skype but some lawyer (or biz dev guy) forgot to get rights to Skype’s technology.

O’Brien summarizes some of the broader trends of deals gone bad:
Bryan McLaughlin, a partner with PricewaterhouseCoopers' Transaction Services, … said that in the third quarter, which ended in September, about 40 percent of the acquisition deals involved some kind of divestiture, up from 25 percent for the same period one year ago. That is, companies weren't buying smaller, stand-alone outfits; they were buying essentially the castoffs of other companies.

And a recent survey by Pricewaterhouse found that 69 percent of the 215 companies polled expected divestiture activity to either stay the same or increase over the next year.

Many of these divestitures are the fruit of ill-considered acquisitions made over the past few years. This failure rate should come as a surprise to no one in the board room or executive cubicle. A few years ago, McKinsey & Co. published a study indicating that 70 percent of mergers failed to generate the expected returns. Hope, however, seems to spring eternal in boardrooms as companies keep making deals.
Small companies continue to get acquired as an exit strategy, and often these are a cheap way to gain access to talent and technologies. The problems seem to be around the big chest-thumping acquisitions that make headlines for a company and its CEO.

Interestingly, once a company overpays for an acquisition, there’s not much of a reason to divest it unless you can find some greater fool who’s also going to overpay. So the specter of firms divesting their acquisitions suggests they either bought a bad company, or at least the claimed synergy used to justify the acquisition never materialized.

Update 1:30pm: After I posted this article (and after the bell), HP announced it’s spending $2.7b to acquire commodity networking company 3Com, at a 39% premium to its closing price and more than 2x trailing revenues.

1 comment:

Caroline S said...

what do you think about culture? I think one of the things CEOs and others overlook when deciding which companies to acquire is cultural fit. Clashes of culture can destroy the value of the acquisition or limit the acquisitor's capacity of capitalizing on the value of the acquired company. A certain Linkabit/Ma-Com example comes to mind ;-)