WHY DO MERGERS LOOK BETTER ON PAPER THAN IN REALITY

Suppose a company acquires another company to form a single company in order to boost its profits, gain more customers, and expand its business. In this case, one company has a well-known brand, and the other has superior technology. It appears to be a reasonable move since both companies have something the other one needs, and so it should work.

This is typically how mergers and acquisitions appear before they take place. A merger involves two companies combining to form a single business, while an acquisition occurs when one company takes over another. But quite different things can happen once the deal has been completed. Staff may resign, expenses may go up, and the anticipated rise in profits might never materialise. So what goes wrong? 

The promise of a merger

There are a number of reasons why companies choose to merge. These can include a desire to enter a new market, cutting costs, obtaining technology or in order to face less competition. The fundamental concept is that two companies acting together can achieve more than they can individually. For instance, a company that has a well-developed distribution network could buy a business which produces a new product with good prospects. The product will then be able to reach a larger number of customers, and both companies have the opportunity to gain benefits.

The value gained from bringing two businesses together is referred to as synergy. The difficulty, however, lies in the fact that while these benefits are often easy to predict, they are difficult to achieve.

The problem of paying too much

Before purchasing a company, the buyer attempts to arrive at an estimate of its value, taking into account the company's earnings, its potential for future growth, and the advantages that the merger might offer.

The problem is that these estimates are based on what people expect to occur in the future; if those expectations are excessively optimistic, the buyer could end up paying more than the business is really worth. It can make the situation worse. If more than one company wishes to take over a business, they might continue to raise their bids in order to win the deal, and while being excited about completing the acquisition, the buyer may fail to consider whether the price is really reasonable.

The deal might still not be profitable enough to warrant the amount that was paid even if the company in question continues to perform well. It is one thing to buy a successful business and quite another to buy it at the right price.

When the expected benefits do not show up

A company which is planning to carry out a merger might anticipate cutting costs by combining its offices, by getting rid of duplicate departments or by negotiating more favourable terms with its suppliers. It might also expect to increase its profits by selling its products to the other company's customers.

These plans do not always turn out as intended. Merging two businesses can be costly and their systems might not be compatible. Customers could be unconcerned about the new products, and the savings might not appear for years.

There is also the issue of the employees. They may lose confidence in their positions as a result of the merger, particularly in the case where the two companies have similar departments. Such uncertainty can have an effect on morale and productivity. It is ironic that firms at times end up spending a large amount of money in an attempt to obtain the cost savings which had originally led them to decide on merging.

Two companies, two different cultures

A merger involves more than simply combining money, buildings, and technology; it also means bringing together people who are used to working in entirely different ways. In one company, employees are allowed to make quick decisions, whereas in the other several approvals are required. In one, the focus is on individual performance, while in the other greater emphasis is placed on teamwork.

At the time of the merger, these differences might appear to be insignificant, but they can become a source of annoyance when employees have to work side by side. Managers could disagree about the way things should be done, and employees might find it difficult to get used to the new expectations. It is a situation that cannot be easily dealt with by financial projections; two firms might appear to be a perfect financial match yet still have difficulty working together.

Leadership changes and losing the right people

There may also be disagreements as to who should take charge of the new company, since senior executives from both sides might wish to keep their current positions or could have different views on the company's future. Whenever there are frequent changes in leadership, employees often fail to be clear about the future course of the business, and as a result, some of them choose to leave.

This is especially harmful when employees who have gained valuable knowledge, skills, and contacts, which were the reasons that initially made the company being acquired so attractive, decide to leave. A firm might have to spend a great deal of money to buy a business, only for some of its most valuable people to leave afterwards.

Does the advice always come from people with the same interests?

Investment bankers assist companies in working out the value of businesses, in negotiating deals and in handling the acquisition process. Their advice may be useful, but there is one point that is worth taking into account.

In a large number of transactions, advisers receive fees once a deal has been completed, the amount of the fee sometimes being related to the size of the deal. There thus arises a possible conflict of interest since finishing the deal may bring a financial advantage to the adviser, even if the buyer would be better off thinking about it again.

It doesn't follow that investment bankers intentionally promote bad deals, but companies ought not to place their complete trust in the people who are assisting them with completing a transaction. They should question the assumptions, check the figures, and consider whether the acquisition is truly worth the price.

It can in some cases be the more sensible business decision to decide not to proceed.

Case study: AOL and Time Warner

The AOL and Time Warner merger is a useful example of how a deal which seems promising can go wrong.

AOL was a big internet company, whereas Time Warner had a number of well-established media businesses, including CNN and Warner Bros.; the merger was announced in January 2000 and was finished in 2001, the aim being to combine AOL's internet reach with the media content of Time Warner.

At the time, it looked like a sensible idea. The internet was growing rapidly, and it seemed that combining online services with existing media businesses would provide considerable opportunities.But the dot-com bubble eventually burst; it was a period in the late 1990s when excitement about the internet led investors to put large amounts of money into internet-based companies, often expecting rapid growth. This actually led to internet companies being overvalued, and their share prices fell sharply; the same impact was on technology companies, such as AOL. AOL's valuation had benefited from this excitement. When the bubble burst, investor confidence in internet companies declined, and AOL's market value came under pressure. At the same time, combining AOL's internet business with Time Warner's traditional media operations proved more difficult than expected. The companies struggled to achieve the benefits they had promised, while differences in management and business culture added to the problems.In 2002, AOL Time Warner suffered nearly $100 billion in non-cash write-downs concerning goodwill and other intangible assets. To put it simply, the company was forced to admit that certain parts of the business were worth much less than had been expected earlier. This was an accounting loss, not a cash outlay of $100 billion that year.

It showed that a merger between two large companies can go wrong whenever the expectations are too high, and the actual difficulties of combining businesses are not properly estimated.

What are we able to learn from this?

Mergers can aid companies in growing, gaining access to new markets, and becoming more competitive. The issue isn't the concept of merging, but rather the assumption that combining two businesses will automatically result in them being stronger.

The price ought to be reasonable, the expected benefits should be realistic, and the people taking part must be capable of working together; at the same time, companies should consider the possible problems as well as concentrating only on the advantages. A merger may appear to have been a success at the time it is announced, with bold plans and impressive financial forecasts. However, the true outcome is only realised once the companies have started working together.

In the end, the easy part is signing the agreement, while getting it to work is the important thing.

By Udit Chaturvedi