Managing Director & Senior Partner
Research, including that done by The Boston Consulting Group, repeatedly shows that acquisitions more often than not destroy value. (See Riding the Next Wave in M&A: Where Are the Opportunities to Create Value?, BCG report, June 2011.) Yet companies continue to acquire, each secure in the belief, apparently, that it can buck the trend.
When we asked corporate leaders why their acquisitions do fail or do not deliver the expected value, the most often-cited reasons fell into three categories: poor deal preparation and execution (including target selection and strategic fit); inadequate PMI; and bad market timing. (See Exhibit 1.)
These results and our own experience working with many clients on acquisition strategy and execution point to three considerations that acquirers must keep front and center if they are to create value: cast a wide net, but prepare to seize opportunity; effective PMI is imperative; and timing and communication matter.
Acquiring companies are selective—as they should be. Our research shows that the average acquirer reviews roughly 20 candidates before closing a deal, eliminating high percentages of potential targets at each stage of the review process before finally making a binding offer. There is good reason. The two reasons for failed acquisitions most cited by respondents to our 2015 Corporate Leaders M&A Survey were unclear strategic fit and lower than expected synergies. Acquirers ought to be able to surface both of these issues with a disciplined review and selection process. On the basis of our experience with corporate acquirers, we recommend that the following five principles guide the target selection process:
One word of caution, however. The process should not be so rigid—or so rigidly adhered to—that it actually hinders the buyer from moving quickly and opportunistically when an attractive prospect presents itself. A surprising finding of our research is that extensive selection does not by itself guarantee success—or vice versa. Companies that consider and reject relatively few candidates—an elimination rate of 20 percent or less—have a better success record than those that cast a very wide net before narrowing the field. (See Exhibit 2.)
The four reasons most cited by corporate leaders for failed acquisitions involve what happens after a deal closes: integration, complexity, cultural fit, and low synergies. As we have written before, many companies struggle to integrate fully after the deal. Synergy targets that were so enticing in the run-up to the deal melt away under the realities of meshing two often very different organizations in a short time. (See Enabling PMI: Building Capabilities for Effective Integration, BCG Focus, July 2012.)
This should not be surprising. For the vast majority of companies, acquisitions are infrequent events. In a typical year, three-quarters or more of the deals executed involve acquirers that have made one acquisition or no acquisitions in the previous five years. At the same time, PMI is one of the most difficult challenges that senior executives face. It is a complex undertaking, often involving multiple simultaneous changes in a company’s business processes, organization structure, and management personnel. Bringing together two organizations, each with its own culture, norms, and behaviors—while protecting day-to-day cash flow—is a corporate mission unlike most others.
Adding to the challenge is the need for speed. Investors typically expect to see cost synergies delivered rapidly—within 12 to 36 months of a deal being signed. They know that the longer PMI takes, the less likely that synergies will be achieved and the more probable that problems will emerge.
And while most executives believe that they are quite aware of how to integrate properly, and they stand ready to devote the necessary resources to making sure PMI gets the attention it requires, they often find that they either overestimated their preparedness or underestimated the challenges. In most organizations PMI is not a core skill. It requires considerably different talents and capabilities than conventional line management, and every situation is different. The approach a company takes to a particular integration depends substantially on the strategic rationale for the merger and the circumstances of the two companies involved.
Capital markets understand this phenomenon all too well, and if they are skeptical of promised synergies, they are equally quick to punish inexperienced acquirers that do not deliver. Deals done by “one-timers” (companies that make only one acquisition in a five-year period) generate an average relative total shareholder return (RTSR) of only 2 percent in the first year after the announcement date, and only 43 percent of such deals generate a positive shareholder return. Because so many deals involve one-time acquirers, they drag down the overall averages—the typical deal generates an RTSR of only 4 percent, and only 47 percent of all deals perform above this mark. (See Exhibit 3.)
By contrast, more experienced acquirers, which include active buyers (two to five deals in a five-year period) and portfolio builders (more than five deals in five years), receive much better capital-market treatment. They generate average one-year RTSRs of 6 percent and 8 percent, respectively, and more than half of all deals involving these acquirers (51 percent for active buyers and 56 percent for portfolio builders) generate positive returns for their shareholders.
The data show why—in M&A, practice makes perfect (or close enough). Strategic acquirers that make regular acquisitions enhance value for their shareholders. They do this over multiple reference periods—5, 10, and 25 years. Active buyers and portfolio builders achieve annual TSR rates substantially higher than those achieved by one-timers—and also much higher in all instances than companies pursuing only organic growth. (See Exhibit 4.)
It should be noted that capital markets are not adverse to one-time acquisitions—quite the opposite, in fact. Investors actually reward one-timers with a higher initial cumulative abnormal return (CAR) than they give portfolio builders—perhaps because they give the company credit for seizing an attractive “once-in-a-lifetime” opportunity. (CAR assesses a deal’s impact by measuring the total abnormal change in market value over a seven-day window centered on the transaction announcement date.1) But inexperienced buyers are likely to underestimate the complexity that comes with an acquisition and the difficulty of integrating two organizations, so they often fail to reap the promised synergies. Initial high hopes are frequently followed by low returns. Experienced buyers, by comparison, tend to overcome initial capital market skepticism by executing a sound PMI plan well and delivering improved performance over time. (See Exhibit 5.)
One reason is that frequent acquirers are much more likely to have the necessary commitment, experience, and ongoing incentives to overcome the hurdles inherent in PMI. Most companies address their lack of experience by reallocating resources and building or hiring temporary capability to handle integrations on an ad hoc basis. But building these capabilities can be time consuming and difficult. Those companies whose strategies lead to more frequent acquisitions often choose to build more of this capability on a permanent basis in-house. They have trained people, designed processes and templates, and set up structures, moving beyond the common ad hoc approach. They have consolidated and spread the specialized PMI knowledge held by some people to the wider organization.
As is often the case, there is a catch to acquiring one’s way to growth. A dollar bought has to work harder than a dollar earned. Since financial markets recognize that many companies do not do acquisitions well, they are skeptical of all deal-doers, even those that have demonstrated substantial proficiency. This should not come as a surprise considering that acquired growth comes often at the expense of diluted margins, and many acquisitions subsequently fail entirely. As a result, investors require acquisitive companies to achieve higher growth rates than their nonacquisitive counterparts in order to reach the same TSR. (See Exhibit 6.)
Companies can’t control macroeconomic trends and market conditions, but our analysis shows that there are definite circumstances under which acquisitions have a better chance of generating higher shareholder returns than others. (See Exhibit 7.) The ideal circumstance is a combination of low economic growth and low market volatility. Research shows that more than half of acquisitions made under these conditions (which are precisely the circumstances in which respondents to our 2014 Investor Survey indicated a high degree of receptivity to M&A) are successful and that they generate an average one-year RTSR of 7.4 percent (better than the relevant industry index). By contrast, almost two-thirds of acquisitions made in times of high growth (which often also means higher inflation) and high volatility fail to generate a positive TSR. Acquisitions that are made under mixed circumstances have slightly less than a 50 percent chance for success.
Capital markets hate surprises, which is one reason why good managements communicate regularly with their investors. Shareholders are more likely to react favorably to a deal announcement if they have been made aware that such a move is a possibility and the strategic thinking behind it.
PMI actually begins the moment a deal is announced, when management communicates the rationale for the transaction and quantifies the synergies that shareholders can expect. BCG research has shown that shareholders welcome details about the logic underlying a transaction and reward communicative acquirers with higher-than-expected valuations during the period after merger announcements. The valuations of acquirers that quantify synergies as part of merger announcements are roughly 5 percent higher, on average, than those of acquirers that make no such disclosure. Further, the valuation of the combined companies is approximately 6 percent higher than it is for comparable companies that don’t disclose synergies. The value-creating potential of such announcements is especially high in transparent markets that are well covered by equity analysts. In such cases, sellers and their shareholders tend to have a clear idea of the potential synergies they are relinquishing by selling. (See Enabling PMI: Building Capabilities for Effective Integration, BCG Focus, July 2012.)
All the communication in the world, however, cannot preserve the value of a combined company that fails to deliver against the synergy expectations it creates. BCG has identified a set of best practices for setting synergy expectations at the time a deal is announced and for tracking progress against synergy targets. Among these best practices are the following:
As varied as these practices are, they are rooted in a single imperative: be straightforward, candid, and as accurate as possible. Setting expectations too low risks making the seller’s investors feel sandbagged when the company overdelivers against them; but setting them unrealistically high risks harming the company’s long-term credibility in the marketplace. Investors will welcome and reward overdelivery against credible expectations, of course, but the long-term cost of unrealistic promises far outweighs whatever short-term gains those promises may produce.
For plenty of companies, especially those in mature industries or those sitting on big reserves of cash, the temptation to jump into the M&A ring is currently rising. (See “The 2015 M&A Report: Increasing Returns with M&A,” BCG article, October 2015.) Attractive targets are few, and daily announcements of new deals raise the specter of M&A musical chairs—no company wants to be the one left standing, without its desired merger partner, when the music stops.
But—and this is often a billion-dollar “but”—the data also show that most companies are not prepared to acquire their way to growth. Even if they choose well and negotiate effectively, they don’t have the in-house experience or capabilities to integrate the combined operations in such a way that achieves the potential synergies—maximizing top-line growth, bringing that growth to the bottom line, and driving increasing TSR. M&A and PMI must be approached in a systematic, rigorous manner, just like any other management process. Counting on luck is hardly an effective strategy.
This is not to say that companies should forgo acquisitions—far from it. Despite conventional wisdom about destroying value, the data demonstrate that M&A can be a highly effective route to growth and to increasing shareholder returns. (See “Should Companies Buy Growth?,” BCG article, October 2015.) But companies other than serial acquirers need to recognize their short-comings and prepare themselves for a different kind of corporate challenge than the ones they are used to. This advice is not new. Confucius observed around the fifth century BC, “Success depends upon previous preparation, and without such preparation there is sure to be failure.” Or, as the Roman philosopher Seneca put it a few centuries later, “Luck is a matter of preparation meeting opportunity.”