Strategic Mergers Pay, Darden Dean Says

September 28, 2005
Robert Bruner is Dean and Charles C. Abbott Professor of Business Administration at the Darden School of Business.

Contrary to popular belief, company mergers and acquisitions do pay over time for shareholders, as long as the merging businesses avoid a "perfect storm" of factors that can lead to financial disaster, said Darden Dean Robert Bruner at an Alumni Business Advisory Council session Sept. 23. The Council meets each fall for a substantive program on recent developments in private industry, public policy, and business law. Bruner, former Assistant Attorney General for Antitrust R. Hewitt Pate '87, and several alumni panelists focused on the benefits and drawbacks of mergers and acquisitions during the day-long conference.

"I'm one of the few people to say M&A pays," said Bruner, whose talk focused on his recent book, "Deals from Hell: M&A Lessons that Rise Above the Ashes." Previous books and scholarship suggested that companies lose when they try to merge or acquire another business, Bruner noted, but these were "not terribly well-grounded in evidence."

"I determined that I would write a book based on live cases, actual cases," he said. In the course of his research he looked at more than 2,500 mergers and acquisitions and explored in detail why 12 deals bombed.

There have been many waves of M&A historically, Bruner said, starting with the large surge of trust formations in 1890s, when 1,900 firms were absorbed into 90 trusts. "Virtually all M&A waves are economically disruptive to the industries in which the waves hit hardest." The high tide of antipathy toward mergers reached its peak in 1979, when Sen. Ted Kennedy proposed a bill that would have banned mergers of firms larger than $350 million (on both the buyer and seller side). "The effect on M&A would have been dramatic" had it passed, Bruner said. "With the Reagan administration in the 1980s, the attitude toward mergers and acquisitions changed." The latest M&A wave, in the late 1990s, was driven by technology advancements and deregulation.

"There's a wide sense [in the public mind] that M&A is wasteful, that it does not pay," he said. Studies have reported that only 20 percent of mergers succeed. "Language like this is widespread, but does it hold up?"

Thanks in part to new works by journalists and inside executives "spilling beans," there is a rich resource of information about M&As. Data shows that sellers typically earn 10 to 30 percent in stock market returns, and "all of the economic evidence suggests the buyers earn at least the cost of capital [invested] and in fact many buyers earn more.

"Our general conclusion across all these studies would be that M&A pays," he said, with 45 percent of studies finding that buyers earn a significant positive return. "M&A is not a wasteful activity," he added, "but it's also not an activity to bet your career on."

In his study, Bruner compared how companies who merged or made acquisitions fared with peer companies who didn't. "If viewed alone, you often find performance deteriorating after a deal." But when compared to a pool of peer firms, they usually perform as well as or better than their benchmark pool. If companies had chosen not to act on deals, many would have been worse off. Bruner noted that America Online CEO Steve Case has said that AOL shares were vastly overvalued and to preserve shareholders' wealth, he needed to buy hard assets — available through the purchase of Time Warner. Although the merged company's stock has plummeted since its peak, "compared to other Internet companies, Case's strategy did better."

Bruner said mergers or acquisitions are more likely to have better value if the deal is motivated by strategy rather than by glamour or momentum. "One of the strongest indicators of success is the degree of focus," he said. "Is the buyer acquiring into a business it knows?"

Buyers are also more likely to succeed if they are stronger than the target company. The best buyers "really know what they're bringing to the deal."

Cooler market conditions also favor buyers. One of the lessons of the 1990s is that if more than one company is bidding to take over a business, the resulting auctions are "killers to buyers," he said. "My advice to buyers is if you're facing an auction, drop out."

Buyers tend to overpay in hot markets where auctions are common, creating an environment for big deals and big failures, he added. Another warning sign of a hot market is when talk of paradigm shifts — such as the entry of the Internet changing lives — populates business conversations. "Often we see in a hot market the entry of inexperienced players."

Some have wondered whether big deals should be banned, as Kennedy proposed, but the research suggests otherwise, Bruner said. "It's really the hot market that becomes the workshop for failure."

Bruner pointed to the merger of the Pennsylvania and New York Central railroads in 1968 as a "deal from hell." Both companies were struggling with competition from trucking, the highway system, and air freight, and chose to join forces as one of the last deals to consolidate railroads. Both firms had neglected training and cut back on staff and spending before the merger. Then a severe winter during 1969-70 ran off business. The two CEOs had labored to form a post-merger integration plan, then threw the plan out. There was no integration of computer systems, no standardization of manuals and processes, and as a result of all of these factors, the firm declared bankruptcy in mid-1970.

"Pay attention to the fact that large failures result from what I call the perfect storm," Bruner said. In the cases he examined, the businesses being merged were complex. "The complexity means one important thing — that it's tough for the CEO to understand." CEO over-optimism and deal-frenzy also frequently leads to bad deals. Other "perfect storm" factors include a lack of firewalls or safety buffers and poor management before and after a merger.

"We need to be storm spotters and we need to focus on ways to prevent the disastrous action," Bruner said. Aircraft carriers and hospital emergency rooms have an ideal business approach, he said, because they are preoccupied with failure, focus on operation to solve potential problems, and are willing to decentralize decision-making "to encourage people at the point of trouble to take decisive action."

When asked about investment bankers' contribution to the problem of bad deals because of their desire for profit from M&As, Bruner noted that the best companies internalize what investment bankers do. He suggested GE was an icon for having the analytic capability of an investment bank and a deep set of corporate standards. He also pointed to Cisco Systems for smart deal-making; Cisco buys smaller companies who have good ideas instead of devoting large resources to its own research and development department. "That makes a great deal of sense in my view," he said.

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