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James Montier

James Montier

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  WorldGlobal Strategy 
19 November 2008
Mind
Matters
 
Failure is an option: an investor
s guide to M&A 
James Montier
(44) 20 7762 5872 james.montier@sgcib.com
IMPORTANT: PLEASE READDISCLOSURES AND DISCLAIMERSBEGINNING ON PAGE 12
www.sgresearch.socgen.com
Perhaps the most egregious evidence of corporate management delusion can be found in therealm of M&A. A quite outstanding 93% of managers think the M&A
they do
adds value, butobjective measures show only around 30% of deals actually add value. So scepticism shouldbe the default option for investors when it comes to M&A deals. However, several factors limitthe degree of value destruction investors may face. The ‘perfect’ deal from an investor’sperspective is a cheap private firm with good governance as a target, with an acquirermotivated by increasing focus and cost-cutting synergies, financed by cash at a time of lowM&A activity.
 
The mismatch between corporate managers
view of their M&A success and theobjective measure is truly mind-blowing. Some 93% of managers think their M&A addsvalue, whereas the data shows that less than one in three deals actually do. Either corporatemanagers simply don
t conduct post-deal analysis, or they ignore the results. Witness thedelusional statement of DaimlerChrysler
s CEO concerning the disastrous deal, that themerger was
an absolutely perfect strategy
.
 
The two most common rationales for M&A deals are to
take advantage of synergies
andto
diversify
. Unfortunately both of these motives can be a source of major problems forcorporates. A survey by KPMG found that only 30% of firms conducted a robust analysis ofthe expected synergies! Investors should then be especially wary of deals based on
revenue synergies
, as apparently nearly 70% of mergers fail to achieve the expected levelof revenue synergies.
 
The dream deal from an investor
s perspective is a cheap firm with good governance as atarget, with an acquirer motivated by increasing focus and cost-cutting synergies. Themanagers of the firm would be paid based on operational performance. The deal would becash financed and occur at a time of generally cheap markets and low M&A activity levels.
 
In contrast the deal from hell would involve an expensive public firm with poorgovernance as the target. The acquirer would be motivated by empire buildingdiversification, effectively addicted to repeated M&A. The rationale would be based on a
pipedream
of revenue synergies. Such a deal would be financed purely via stock, and themanagers would receive a completion bonus. This deal would also occur when the marketwas generally expensive and the M&A was the flavour of the month.
 
Mind Matters
19 November 20082
Failure is an option: M&A from the investor’sperspective
Delusions of management
 According to the latest biannual KPMG survey of global M&A 
1
, a truly staggering 93% ofcorporate managers think that their M&A adds value. This must surely be the most damningevidence of the over-optimism and over-confidence on the part of corporate managers that Ihave ever come across.The chart below shows the contrast between an objective measure of M&A performance
itcontrasts the percentage of firms who conducted M&A deals that managed to outperformindustry peers in the stock market during the two years following the deal against managers
 subjective belief regarding the percentage of deals that added value.Strangely enough, the managers
beliefs are always massively above the objective measures.For instance, in the latest survey KPMG show that while 93% of managers think their M&A work added value, fewer than 30% of deals actually did so.
Objective or subjective: % of M&A that is successful
010203040506070809010019992001200320062008% of M&A that add value (objective)% of managers who think their M&A added value
 
Source: KPMG, SG Equity Research
This chart also provides evidence of another behavioural trait that I often refer to which is ourvery limited ability to learn from mistakes. You might have been forgiven for thinking that overthe course of the last decade or so, managers might perhaps have come to realise that M&A should be treated with extreme caution. However, nothing could be further from the truth. Infact, corporate delusions with regard to the value of M&A only seem to have increased!This shows that corporate managers simply just don
t conduct any thorough post dealperformance analysis, or that if they do, they simply ignore the outcome! A prototypicalexample of this failure to objectively measure the post deal performance is provided byDaimlerChrysler. The merger failed on any operational definition. It destroyed value roughly
1
 
15
th
October 2008
 
 
Mind Matters
19 November 20083
equal to the total purchase price of Chrysler. Yet even after acknowledging these appallingconsequences, the CEO Jurgen Schrempp continued to defend the merger as
an absolutelyperfect strategy
.Similar evidence of such delusional thinking was found by Bruner
2
. He surveyed 50 businessexecutives and found that they thought that only 37% of deals created value for the buyers,but that 58% believed their own deals created value. Similarly, they thought that only 21% ofall deals achieved their strategic goals, but that 51% of their own deals did in fact deliver ontheir strategic goals.
Others’ M&A vs own M&A
010203040506070Added ValueAchieved strategic goalsIn generalOwn
 
Source: Bruner (2004) SG Equity Research
The bad news for managers and investors alike is that study after study finds that theacquiring firms tend to underperform the market in the long-run. For instance, a new study byBen-David and Roulstone
3
shows that the acquiring firms underperform by -13% in their firstyear (after adjusting for the market, size and style) and -25% over the three years post deal.
Performance of M&A (abnormal returns, %)
-30-25-20-15-10-50Over one yearOver three years
 
Source: Ben_David and Roulstone, , SG Equity Research
2
 
Bruner (2004) Applied Mergers and Acquisitions
 
3
 
Ben-David and Roulstone (2008) Why do small stock acquirers underperform in the long-term?
 

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