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Assignment II

Mergers Acquisitions & Corporate
Restructuring

‘Why do Mergers fail?’

Submitted to:
Dr. Beena Dias
Professor
AIMIT
Submitted by:
Mr. Nithin Pradeep Saldanha
Reg. No. 0816093
IInd MBA ‘B’ Batch
AIMIT

Date of Submission: 2nd November, 2009.
Why do mergers fail?
Globalisation is the challenge, and for big business mergers are the solution. However, all
too often the multi-billion dollar deals turn sour. The battle of three French banks over who
should merge with whom is the latest example, and the managers making the deals might pause to
ask if the end result will be worth it. The six-month battle involving BNP, Paribas and Societe
Generale has been fought via advertising and in courtrooms, two costly arenas. Investors
scrutinising the minutiae of the legal battles should worry if such a merger will create shareholder
value. Chances are it won't. Whatever the logic or likely success of the French bank merger,
analysts agree that many mergers are hit or miss. Commerzbank research -some of it anecdotal -
says that more than half of mergers ultimately fail to create value.
Merger gains may have a short shelf life, Commerzbank said, with the merger only
temporarily offsetting an inevitable decline. "Some research does show that companies don't
deliver on all the promises they make," Stephen Barrett, head of mergers & acquisitions at
KPMG, said, but he added that "many do create shareholder value". The problem, he said, was
that little empirical evidence existed as to the success of merger and acquisition activity.
With the recently announced mergers involving Procter & Gamble and Gillette, and SBC
and AT&T, it's time to ask one of the most common questions about mergers: What does it take
for a company to be successful, post merger? After all, many mergers ultimately don't add value
to companies, and even end up causing serious damage. "Studies indicate that several companies
fail to show positive results when it comes to mergers," says Wharton accounting professor
Robert Holthausen, who teaches courses on M&A strategy. Noting that there have been
"hundreds of studies" conducted on the long-term results of mergers, Holthausen says that
researchers estimate the range for failure is between 50% and 80%.
Management professor Martin Sikora, editor of Mergers & Acquisitions: The Dealmaker's
Journal, agrees. "Companies merge and end up doing business on a larger scale, with increased
economic power," Sikora says. "But the important questions are whether or not they gained
competitive advantage or increased market power. And that will be reflected in the stock price.
"The truth is," he adds, "mistakes happen. The accepted data say that most mergers and
acquisitions don't work out."
Merger Failure Rates:

The burning question remains-why do so many mergers fail to live up to stockholder
expectations? In the short term, many seemingly successful acquisitions look good, but
disappointing productivity levels are often masked by one-time cost savings, asset disposals, or
astute tax maneuvers that inflate balance-sheet figures during the first few years. Merger gains are
notoriously difficult to assess. There are problems in selecting appropriate indices to make any
assessment, as well as difficulties in deciding on a suitable measurement period. Typically, the
criteria selected by analysts are:

• profit-to-earning ratios;

• stock-price fluctuations;

• managerial assessments.

Irrespective of the evaluation method selected, the evidence on M&A performance is
consistent in suggesting that a high proportion of M&As are financially unsuccessful. US sources
place merger failure rates as high as 80%, with evidence indicating that around half of mergers
fail to meet financial expectations. A much-cited McKinsey study presents evidence that most
organizations would have received a better return on their investment if they had merely banked
their money instead of buying another company. Consequently, many commentators have
concluded that the true beneficiaries from M&A activity are those who sell their shares when
deals are announced, and the marriage brokers—the bankers, lawyers, and accountants—who
arrange, advise, and execute the deals.

"What Went Wrong?"

According to Steve Tobak is managing partner of Invisor Consulting LLC, the kinds of
problems companies face with mergers range from poor strategic moves, such as overpayment, to
unanticipated events, such as a particular technology becoming obsolete. "You would hope these
companies have done their due diligence, although that isn't always the case," he says. Aside from
those extremes, however, many analysts view clashing corporate cultures as one of the most
significant obstacles to post-merger integration. In fact, a cottage industry of sorts has emerged to
help companies navigate the rough terrain of integration -- and especially to help them overcome
the internal inertia that comes with facing change.

"It's like changing a wheel on a bus," says Cari Windt from Access GE, which offers GE
best practices to clients who are undergoing M&A transitions. "You can't skip a beat for your
customer." Windt says the earlier a company attempts to plan, the better. Often times, however,
companies don't plan as thoroughly as they should: "It's unusual that companies work on
developing quality solutions for the acceptance side of mergers."

Is It Possible to Predict Success?

Still, despite planning and good communication, things can go awry. According to
Analysts, one-third of mergers create shareholder value, whereas one-third destroys value, and
another third don't meet expectations. For shareholders, these deals can be "a crap shoot,"
however, that being in the successful one-third can add tremendous value.

Aside from solid preparation for a deal, then, how can presence in that top third are predicted?

"Companies that acquire with frequency and make it a major core competency tend to do well and
perform better than their peers". In fact, he adds, more companies regard M&A as essential for
growing value. He cites the recent history of M&A activity as evidence: As M&A activity has
cycled over the past decade, the downturns have tended to be less extreme than years before. In
other words, even when there's a lull in activity, there are more companies engaging in mergers
than there were before during slow periods. In fact, according to press reports, last year's U.S.
M&A volume ($886 billion) was almost double the volume of 2001 ($466.5 billion). It's more of
an established structure. "More companies are equipped to do it, and it's more an integrated part
of doing business."

Integration is really about mobilizing chang. The key question is, what is the change
dynamic of the companies involved -- how quickly do they adapt? Although companies may
seem similar on the surface and therefore a perfect match, they are often vastly different in terms
of change orientation, leadership style, organization systems, and methods of dealing with
conflict, she notes. In addition to the ordinary due diligence of getting to know the acquired
company and industry thoroughly, speed is essential in these transactions -- especially with regard
to anything that will impact employees, including layoffs, benefits changes, location, etc.
"Difficult decisions need to be addressed early on so that they are not lingering and hit later."

One of the most important aspects of the process, according to analysts, is a strong
commitment to change on the part of management. First, there needs to be consistent
communication regarding the process; ideally, there should be a "rhythm" of communications for
employees, which might take the form of regular email updates, newsletters, and general visibility
on the leadership level. Secondly, management needs to assign resources to complete the
transition successfully. Acquiring companies should consider assigning an "integration leader" to
help oversee the process. This is a ‘multi-directional ambassador" with leadership skills,
"aggressive project management’ capabilities, and ‘exceptional people skills.’ ‘Listening is key.’

Some Reasons for Failure of Mergers and Acquisitions:

A definite answer as to why mergers fail to generate value for acquiring shareholders
cannot be provided because mergers fail for a host of reasons. Some of the important reasons for
failures of mergers are discussed below:

Excessive premium:

In a competitive bidding situation, a company may tend to pay more. Often highest bidder
is one who overestimates value out of ignorance. Though he emerges as the winner, he happens to
be in a way the unfortunate winner. This is called winners curse hypothesis. When the acquirer
fails to achieve the synergies required compensating the price, the M&As fails. More you pay for
a company, the harder you will have to work to make it worthwhile for your shareholders. When
the price paid is too much, how well the deal may be executed, the deal may not create value.

Size Issues:
A mismatch in the size between acquirer and target has been found to lead to poor
acquisition performance. Many acquisitions fail either because of 'acquisition indigestion' through
buying too big targets or failed to give the smaller acquisitions the time and attention it required.

Lack of research:

Acquisition requires gathering a lot of data and information and analyzing it. It requires
extensive research. A carelessly carried out research about the acquisition causes the destruction
of acquirer's wealth.

Diversification:

Very few firms have the ability to successfully manage the diversified businesses.
Unrelated diversification has been associated with lower financial performance, lower capital
productivity and a higher degree of variance in performance for a variety of reasons including a
lack of industry or geographic knowledge, a lack of focus as well as perceived inability to gain
meaningful synergies. Unrelated acquisitions, which may appear to be very promising, may turn
out to be big disappointment in reality.

Previous Acquisition Experience:

While previous acquisition experience is not necessarily a requirement for future
acquisition success, many unsuccessful acquirers usually have little previous acquisition
experience. Previous experience will help the acquirers to learn from the previous acquisition
mistakes and help them to make successful acquisitions in future. It may also help them by taking
advice in order to maximize chances of acquisition success. Those serial acquirers, who possess
the in house skills necessary to promote acquisition success as well trained and competent
implementation team, are more likely to make successful acquisitions.

Unwieldy and Inefficient:
Conglomerate mergers proliferated in 1960s and 1970. Many conglomerates proved
unwieldy and inefficient and were wound up in 1980s and 1990s. The unmanageable
conglomerates contributed to the rise of various types of divestitures in the 1980s and 1990s.

Poor Cultural Fits:

Cultural fit between an acquirer and a target is one of the most neglected areas of analysis
prior to the closing of a deal. However, cultural due diligence is every bit as important as careful
financial analysis. Without it, the chances are great that M&As will quickly amount to
misunderstanding, confusion and conflict. Cultural due diligence involve steps like determining
the importance of culture, assessing the culture of both target and acquirer. It is useful to know
the target management behavior with respect to dimensions such as centralized versus
decentralized decision making, speed in decision making, time horizon for decisions, level of
team work, management of conflict, risk orientation, openness to change, etc. It is necessary to
assess the cultural fit between the acquirer and target based on cultural profile. Potential sources
of clash must be managed. It is necessary to identify the impact of cultural gap, and develop and
execute strategies to use the information in the cultural profile to assess the impact that the
differences have.

Poor Organization Fit:

Organizational fit is described as "the match between administrative practices, cultural
practices and personnel characteristics of the target and acquirer. It influences the ease with which
two organizations can be integrated during implementation. Mismatch of organation fit leads to
failure of mergers.

Faulty evaluation:

At times acquirers do not carry out the detailed diligence of the target company. They
make a wrong assessment of the benefits from the acquisition and land up paying a higher price.

Poorly Managed Integration:
Integration of the companies requires a high quality management. Integration is very often
poorly managed with little planning and design. As a result implementation fails. The key
variable for success is managing the company better after the acquisition than it was managed
before. Even good deals fail if they are poorly managed after the merger.

Ego Clash:

Ego clash between the top management and subsequently lack of coordination may lead to
collapse of company after merger. The problem is more prominent in cases of mergers between
equals.

Incompatibility of Partners:

Alliance between two strong companies is a safer bet than between two weak partners.
Frequently many strong companies actually seek small partners in order to gain control while
weak companies look for stronger companies to bail them out. But experience shows that the
weak link becomes a drag and causes friction between partners. A strong company taking over a
sick company in the hope of rehabilitation may itself end up in liquidation.

Failure of Top Management to Follow-Up:

After signing the M&A agreement the top management should not sit back and let things
happen. First 100 days after the takeover determine the speed with which the process of tackling
the problems can be achieved. Top management follow-up is essential to go with a clear road map
of actions to be taken and set the pace for implementing once the control is assumed.

Lack of Proper Communication:

Lack of proper communication after the announcement of M&As will create lot of
uncertainties. Apart from getting down to business quickly companies have to necessarily talk to
employees and constantly. Regardless of how well executives communicate during a merger or an
acquisition, uncertainty will never be completely eliminated. Failure to manage communication
results in inaccurate perceptions, lost trust in management, morale and productivity problems,
safety problems, poor customer service, and defection of key people and customers. It may lead
to the loss of the support of key stakeholders at a time when that support is needed the most.

Inadequate Attention to People Issues:

Not giving sufficient attention to people issues during due diligence process may prove
costly later on. While lot of focus is placed on the financial and customer capital aspects, not
enough attention is given to aspects of human capital and cultural audit. Well conducted HR due
diligence can provide very accurate estimates and can be very critical to strategy formulation and
implementation.

Expecting Results too quickly:

Immediate results can never be expected except those recorded in red ink. Whirlpool ran
up a loss $100 million in its Philips white goods purchase. R.P.Goenk's takeovers of Gramaphone
Company and Manu Chhabria's takeover of Gordon Woodroffe and Dunlops fall under this
category.

Biggest Merger and Acquisition Disasters:

If a merger goes well, the new company should appreciate in value as investors anticipate
synergies to be actualized, creating cost savings and/or increased revenue for the new entity.
However, time and again, executives face major stumbling blocks after the deal is consummated.
Cultural clashes and turf wars can prevent post-integration plans from being properly executed.
Different systems and processes, dilution of a company's brand, overestimation of synergies and
lack of understanding of the target firm's business can all occur, destroying shareholder value and
decreasing the company's stock price after the transaction.

New York Central and Pennsylvania Railroad:
In 1968, the New York Central and Pennsylvania railroads merged to form Penn Central,
which became the sixth largest corporation in America. But just two years later, the company
shocked Wall Street by filing for bankruptcy protection, making it the largest corporate
bankruptcy in American history at the time. The railroads, which were bitter industry rivals, both
traced their roots back to the early- to mid-nineteenth century. Management pushed for a merger
in a somewhat desperate attempt to adjust to disadvantageous trends in the industry. Railroads
operating outside of the northeastern U.S. generally enjoyed stable business from long-distance
shipments of commodities, but the densely-populated Northeast, with its concentration of heavy
industries and various waterway shipping points, created a more diverse and dynamic revenue
stream. Local railroads catered to daily commuters, longer-distance passengers, express freight
service and bulk freight service. These offerings provided transportation at shorter distances and
resulted in less predictable, higher-risk cash flow for the Northeast-based railroads.
Short-distance transportation also involved more personnel hours (thus incurring higher
labor costs), and strict government regulation restricted railroad companies' ability to adjust rates
charged to shippers and passengers, making cost-cutting seemingly the only way to positively
impact the bottom line. Furthermore, an increasing number of consumers and businesses began to
favor newly constructed wide-lane highways.
The Penn Central case presents a classic case of post-merger cost-cutting as "the only way
out" in a constrained industry, but this was not the only factor contributing to Penn Central's
demise. Other problems included poor foresight and long-term planning on behalf of both
companies' management and boards, overly optimistic expectations for positive changes after the
combination, culture clash, territorialism and poor execution of plans to integrate the companies'
differing processes and systems.

Quaker Oats Company and Snapple Beverage Company:
Quaker Oats successfully managed the widely popular Gatorade drink and thought it
could do the same with Snapple. In 1994, despite warnings from Wall Street that the company
was paying $1 billion too much, the company acquired Snapple for a purchase price of $1.7
billion. In addition to overpaying, management broke a fundamental law in mergers and
acquisitions: make sure you know how to run the company and bring specific value-added skills
sets and expertise to the operation. In just 27 months, Quaker Oats sold Snapple to a holding
company for a mere $300 million, or a loss of $1.6 million for each day that the company owned
Snapple. By the time the divestiture took place, Snapple had revenues of approximately $500
million, down from $700 million at the time that the acquisition took place.
Quaker Oats' management thought it could leverage its relationships with supermarkets
and large retailers; however, about half of Snapple's sales came from smaller channels, such as
convenience stores, gas stations and related independent distributors. The acquiring management
also fumbled on Snapple's advertising campaign, and the differing cultures translated into a
disastrous marketing campaign for Snapple that was championed by managers not attuned to its
branding sensitivities. Snapple's previously popular advertisements became diluted with
inappropriate marketing signals to customers.
Oddly, there is a positive aspect to this flopped deal (as in most flopped deals): the
acquirer was able to offset its capital gains elsewhere with losses generated from the bad
transaction. In this case, Quaker Oats was able to recoup $250 million in capital gains taxes it
paid on prior deals thanks to losses from the Snapple deal. This still left a huge chunk of
destroyed equity value, however.

Sprint and Nextel Communications:
In August 2005, Sprint acquired a majority stake in Nextel Communications in a $35
billion stock purchase. The two combined to become the third largest telecommunications
provider, behind AT&T and Verizon. Prior to the merger, Sprint catered to the traditional
consumer market, providing long-distance and local phone connections and wireless offerings.
Nextel had a strong following from businesses, infrastructure employees and the transportation
and logistics markets, primarily due to the press-and-talk features of its phones. By gaining access
to each other's customer bases, both companies hoped to grow by cross-selling their product and
service offerings.

Soon after the merger, multitudes of Nextel executives and mid-level managers left the
company, citing cultural differences and incompatibility. Sprint was bureaucratic; Nextel was
more entrepreneurial. Nextel was attuned to customer concerns; Sprint had a horrendous
reputation in customer service, experiencing the highest churn rate in the industry. In such a
commoditized business, the company did not deliver on this critical success factor and lost market
share. Further, a macroeconomic downturn led customers to expect more from their dollars.
Cultural concerns exacerbated integration problems between the various business functions.
Nextel employees often had to seek approval from Sprint's higher-ups in implementing corrective
actions, and the lack of trust and rapport meant many such measures were not approved or
executed properly. Early in the merger, the two companies maintained separate headquarters,
making coordination more difficult between executives at both camps.

Sprint Nextel's managers and employees diverted attention and resources toward attempts
at making the combination work at a time of operational and competitive challenges.
Technological dynamics of the wireless and Internet connections required smooth integration
between the two businesses and excellent execution amid fast change. Nextel was simply too big
and too different for a successful combination with Sprint.

Sprint saw stiff competitive pressures from AT&T (which acquired Cingular), Verizon
and Apple's popular iPhone. With the decline of cash from operations and with high capital-
expenditure requirements, the company undertook cost-cutting measures and laid off employees.
In 2008, the company wrote off an astonishing $30 billion in one-time charges due to impairment
to goodwill, and its stock was given a junk status rating. With a $35 billion price tag, the merger
clearly did not pay off.

HUMAN RESOURCE: KEY FACTOR

It is reported that one of the main reasons for failure of a merger or acquisition is based on
Human Resources neglect. People issues have been the most sensitive but often ignored issues in
a merger and acquisition. When a decision is taken to merge or acquire, a company analyses the
feasibility on the business, financial and legal fronts, but fails to recognize the importance
attached to the human resources of the organizations involved. Companies which have failed to
recognize the importance of human resources in their organizations and their role in the success
of integration have failed to reach success. While it is true that some of these failures can be
largely attributed to financial and market factors, many studies are pointing to the neglect of
human resources issues as the main reason for M&A failures. PricewaterhouseCoopers global
study concluded that lack of attention to people and related organizational aspects contribute
significantly to disappointing post-merger results. Organizations must realize that people have the
capability to make or break the successful union of the two organizations involved.

Cartwright and Cooper (2000) acknowledged that the leading roles of modern human
resources functions are to be actively engaged in the organization and perform as a business
partner and advisor on business-related issues. Employees do not participate enough in the
integration process of a merger. If a merger is to reach its full success potential, they need to be
informed and involved more actively throughout all the stages of the merger process.

Human resource professionals are key in pre-merger discussions and the strategic
planning phase of mergers and acquisitions early as to allow them assess to the corporate cultures
of the two organizations (Anderson, 1999). Being involved in the pre-merger stage allows HR to
identify areas of divergence which could hinder the integration process. They can play a vital role
in addressing any communication issues, employees concerns, compensation policies, skill sets,
downsizing issues and company goals that need to be assessed.

Making It Happen

Making a good organizational marriage currently seems to be a matter of chance and luck.
This needs to change so that there is a greater awareness of the people issues involved, and
consequently a more informed integration strategy. Some basic guidelines for more effective
management include:

• extension of the due diligence process to incorporate issues of cultural fit;
• greater involvement of human resource professionals;
• the conducting of culture audits before the introduction of change management initiatives;
• increased communication and involvement of employees at all levels in the integration
process;
• the introduction of mechanisms to monitor employee stress levels;
• fair and objective reselection processes and role allocation;
• providing management with the skills and training to sensitively handle M&A issues such
as insecurity and job loss;
• creating a superordinate goal which will unify work efforts.

Conclusion:

When contemplating a deal, managers at both companies should list all the barriers to
realizing enhanced shareholder value after the transaction is completed.
• Cultural clashes between the two entities often mean that employees do not execute post-
integration plans.
• As redundant functions often result in layoffs, scared employees will act to protect their
own jobs, as opposed to helping their employers "realize synergies".
• Additionally, differences in systems and processes can make the business combination
difficult and often painful right after the merger.

Managers at both entities need to communicate properly and champion the post-
integration milestones step by step. They also need to be attuned to the target company's branding
and customer base. The new company risks losing its customers if management is perceived as
aloof and impervious to customer needs.

Finally, executives of the acquiring company should avoid paying too much for the target
company. Investment bankers (who work on commission) and internal deal champions, both
having worked on a contemplated transaction for months, will often push for a deal "just to get
things done." While their efforts should be recognized, it does not do justice to the acquiring
group's investors if the deal ultimately does not make sense and/or management pays an excessive
acquisition price beyond the expected benefits of the transaction.

Bibliography:

Journals:

• Ashok Banerjee, “Managing Risk in Mergers and Acquisitions”, The Journal of
accounting and Finance, October-March 2008, Page 64-69.
• Mergers, Acquisitions and Wealth Creation in Indian Context, S Pannerselvam and B
Rajesh Kumar, Indian Institute of Management Bangalore - Management Review, India
• Rajesh Kumar, B., "Effect of RPL-RIL Merger on shareholder's wealth and Corporate
Performance", ICFAI J. of Applied Finance, Vol 10, No. 9, September 2004.
• “Mergers and Managers Don’t Mix. Will Corporate Marriage Mania Ever Get Better?”,
The Executive Issue, Issue 2, 2005
• Wayne R. Pinnell, “People and Purpose: Tips for a Successful Merger or Acquisition”,
Advisor, November 29, 2001
• Agrawal, Anup, Jeffrey F. Jaffe, and Gershon N. Mandelker, 1992, The post-merger
performance of acquiring firms: a re-examination of an anomaly, Journal of Finance 47:
1605-1621

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• http://www.mid-day.com/lifestyle/2009/sep/030909-Nine-Reasons-Failed-Mergers-IT-
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