If you had the ’flu, would you run a marathon? Clearly not. The same is true for companies planning to acquire. Any company must start an acquisition programme from firm foundations. Acquisitions consume an enormous amount of management time and other resources. The existing business has to be running well enough to sustain the strain of buying and integrating another one. Acquisitions divert attention from challenges in the core business. For example Compaq was facing intensifying competition in its core PC market when it acquired Digital, which was also facing tough competition in its markets. The combined businesses struggled to integrate and their combined performance was unexciting.

As already noted, acquisitions are a strategic tool. This means that, before buying another company, the acquirer needs a clear strategy in which an acquisition can be shown to add value. For example AT&T decided to enter the IT arena in the early 1990s looking for the expected benefits of the convergence of IT and telephony. It acquired NCR in 1991 for $7.5 bn – a company which it shoehorned into its strategy. The fit was poor and, worse, NCR was not an IT company but a supplier of cash registers that happened to use IT. AT&T divested the company in 1995 making a loss of more than $3.5 bn on the transaction.

Numerous companies pursued flawed strategies at the time of the dotcom boom, mainly because they understood neither the fundamentals of the Net nor, more surprisingly, of their own businesses. Time Warner’s merger with AOL was among the most spectacular. Time Warner was not able to dramatically increase the revenues earned by its content because it also owned an Internet Service Provider (ISP). Having the right strategy means understanding how the acquirer can add value, for example through top line growth or by taking out cost. Figure 1.1 overleaf compares the acquisition strategies applicable to different growth strategies.

<source>Source: AMR International</source>

Figure 1.1. Various growth strategies require acquisitions

If a company has sensibly defined acquisition as a realistic and sensible growth path, the lack of availability of the right acquisition target is a major frustration. But one of the worst reasons to select an acquisition is simply because it happens to be available.

The economics of Mergers and Acquisitions (M&A) are very simple. Unless you have impeccable inside information, you will end up paying at least 30 per cent more than a business is actually worth. To make a success of an acquisition, therefore, you have to be able to add value at least equal to that premium. To do this you must be able to bring something new. Do you really expect to be able to do this with a business which just happens to come up? I remember sitting open-mouthed when the disgruntled financial controller of a very large UK engineering company told me how disillusioned he had become with his bosses because their acquisition strategy consisted of ‘buying companies on the cheap that they think they can turn round, failing and selling them off a couple of years later at a loss’. As the one who had to pick up the financial pieces there was no wonder he was frustrated.

All serial acquirers tend to come unstuck in the end. One example in the 1980s and 1990s was ITT. It created a broad group with interests ranging from hotels to telephone directories to pumps. In reality, the deal-doing frenzy did not create value; the group became unwieldy and then paid the price for its lack of acquisition rationale as management failed to exploit the group’s assets.

In the late 1990s some private equity investors engaged in ‘drive-by investing’: they hardly stopped long enough to see what they were backing. Rentokil promised a 20 per cent annual growth to the city and found itself making bigger and less logical acquisitions. The acquisition of BET in 1996 was the start of its undoing as Rentokil was unable to dramatically improve what BET was doing.

As such a risky business development tool, acquisition can be seen as a last resort. Toyota entered the luxury car market successfully through Lexus. In contrast Ford, which paid a premium for Jaguar, subsequently faced high integration costs and found that its cost per car was much higher. As a company seeks to grow it should not immediately leap to the conclusion that it must acquire to achieve its goal. It must decide whether the natural advantages of acquisition which are speed, scale and bringing specific assets or skills, outweigh the risks.

An acquirer needs a complete understanding of both its own and the target company’s market and how it proposes to use the target to develop. It needs to know what drives the market, what is happening within it, how it will evolve and how the profitability of participants will evolve. A common mistake made by acquirers is to assume that they ‘know’ the market because they already operate in it. If the target business is in an adjacent segment, the acquirer’s assumptions can be positively dangerous. EMAP entered the French publishing market through a joint venture with Bayard Presse and developed subsequently by launching its own titles before finally acquiring a leading publisher, Editions Mondial. The architect of the strategy then went on to open up the US by acquiring Peterson for £932 m. With no local knowledge and too much confidence the deal was a disaster.

Dot.com investors and traditional businesses that acquired new economy start-ups misjudged the market dramatically. People often overestimate the impact of new technologies in the short term, but underestimate it in the long term.

It is also important to work out why the business is really for sale. The seller may have spotted a problem looming in the market. This is particularly true of entrepreneurs who are good at sensing when a business has reached its full potential. In the early 1980s, Reynolds Rings, a UK subsidiary of the British engineering company TI Group, bought King Fifth Wheel (KFW) in the USA. Reynolds made engine rings, the structural outer casing of jet engines. It used a process which is best described as sophisticated blacksmithing. This comprised of heating a long slab of exotic steel, bending it into a ring and flash-butt welding the join between the two ends. The fabricated ring then spent several months in a sub-contract machine shop having all the holes, wells and channels machined into it from which would hang the engine’s subsystems and fuel lines. Reynolds biggest customer was the UK jet engine manufacturer Rolls Royce. KFW made exactly the same product in exactly the same way. Its biggest customer was the number two US jet engine maker Pratt and Whitney.

On paper this was a marriage made in heaven. Buying KFW would give Reynolds access to the lucrative US market on a scale which would give it an R&D advantage over its rivals in the US and Europe. It did the deal without any market due diligence. After the deal was done TI insisted (rather late in the day) that Reynolds come up with a development plan. A colleague was dispatched to research the American market. His first stop was a meeting with the R&D director at Pratt and Whitney. He soon made it clear why KFW and indeed the other four other rings makers in the US were for sale. There was a new technology coming along which allowed most of the machining to be done pre-forming, which was considerably cheaper and quicker.

Understanding the market is one thing, understanding the target’s business model is another. As an acquirer, do you really understand why this business you are going to buy makes money? Different companies in the same market make money in different ways and for different reasons. In air travel, BA focuses on service, Ryanair on price; in computing, Dell focuses on delivery, Compaq on quality. Club Med makes money from its packages, resort hotels make money from the extras. These are the obvious examples, differences between businesses are often more subtle.

Acquirers need to challenge their initial assumptions and make time to understand how the target operates; this means understanding how it generates its revenues and where the best margins lie. This analysis should also show where it could be losing out. The financial information on the business will provide the initial pointers, but an acquirer needs to understand far more. What are the processes, people and other resources that allow the company to achieve what it does? Gaining this understanding is essential because otherwise the acquirer can unwittingly make changes which damage the performance of the business. Without a comprehensive assessment of how, and how far, the target will be integrated into the new joint operation the acquirer can work out where the operational and business development gains are to be achieved.

In the engine rings example above, one of the chief reasons KFW did so much business with Pratt and Whitney was the personal relationship between KFW’s president and an important vice-president at Pratt. The last thing that needed to happen post acquisition was for him to be fired or moved.

At an early stage of the process an acquirer needs to justify – in detail – the synergies it hopes to achieve. Logically it should never be otherwise, but often is. It is all too tempting to adjust some of the up-sides of an acquisition when modelling its future performance to get a desired number in the total box of your spreadsheet. The market for companies is highly competitive. Synergies justify the price you will have to pay, so how can you go into price negotiations without having worked out where they are going to come from and when and how you are going to release them?

The acquirer must base its synergy estimates on evidence, benchmarks and directly relevant experience, not just assumptions. Cost reduction synergies are the safest: they are typically relatively easy to quantify and deliver and the finance director will believe your sums. The danger is that you make changes which damage the business because you did not understand the business model. For example Wells Fargo, the US bank, acquired First Interstate Bank for its high-net-worth customers. Its attempt to achieve cost reduction synergies (through branch closures and a reduction in service levels) destroyed any hope of achieving the predicted business development gains, because it could not serve First Interstate’s wealthy customers in the manner they expected.

Sales growth synergies are much harder to quantify and achieve. Sales forces do not always work well together; customers do not fall over themselves to buy more products from the company which just bought their supplier. Many of the sales synergies which are modelled in acquisition cases are illusory. However, perhaps they deserve more attention because there is a large body of evidence that suggests that cost reductions are short-lived while sales gains are critical to successful acquisitions.^[1]

A key purpose of due diligence is to identify the big problem areas and the black holes. Ferranti, the well-respected British defence giant would not have bankrupted itself by buying ISC, another electronics company had it conducted commercial due diligence (CDD) and spoken to a few (non-existent) customers instead of just relying on the seller’s word, management opinion and a re-hashed audit. British & Commonwealth hit the rocks over the Atlantic computers leasing liabilities, which proper project management of due diligence would have picked up. Cendant shot itself in the foot by skimping on financial due diligence in its acquisition of HFS and Comp-U-Card ‘CUC’.

But due diligence is not just about finding problems. As we will see in Chapter 5 (Investigating the target) it should also be used to identify and quantify the potential synergies and feed in to the integration actions needed to unlock them. The quality of due diligence has improved dramatically over the past 20 years as acquirers have sought to avoid the mistakes of others but it is still, wrongly, seen as the boring bit of deal-doing.

There is no such thing as a right price for an acquisition; a company is worth what the buyer is prepared to pay. This is shown by the William Low example^[2]. By launching a counter bid for the Scottish retailer William Low, Sainsbury forced Tesco to react and to pay £93 m (60 per cent) more than the price originally agreed by both sides. In the end Tesco paid William Low’s shareholders what it thought the business was worth which was far above the shareholders’ initially accepted valuation.

Corporate finance advisers now ensure that most companies are sold at auction, with a range of competing bidders. Buyers must set a walk-away price based on a realistic valuation. Experienced acquirers will testify that having walked away on price, the same deal often comes back a few years later.

Significant amounts of value can be won and lost in negotiation. Anyone who has been on a negotiating course is well aware from the practical examples of the discrepancy between what the sellers are prepared to accept and what buyers are prepared to pay. An acquirer needs to have the right negotiating team which has done its homework, excellent communication within the team and a clear negotiation strategy. Do not jet in the other board member for the photo opportunity at the final signing ceremony unless the details are all tied down. Otherwise the other side will hold you to ransom whilst your increasingly impatient colleagues ask what is going on.

An acquisition process is rarely straightforward. Each deal has its own twists and complications. The level of time and resources required can be a shock to those unfamiliar with acquisitions. Before embarking on an acquisition, the acquirer needs to ensure that all the necessary internal and external processes and relationships are in place. If internal approvals are not in place, the process can become so bogged down that a rival buyer slips in to woo a frustrated target.

You also need controls. Whilst an acquisition requires a champion to push it through and for it to succeed, it is essential for balancing controls to be in place. If they are not, deal fever can take over and an acquisition, however poor, can become unstoppable.

Frustrations and problems with the process are not all self-inflicted. Target companies and their advisers can also hamper the process. For example, follow-up information beyond that supplied in the Information Memorandum may not be readily available, or they may have imposed an unrealistic timetable on the sale. Poorly-briefed sellers can lose their cool over run-of-the-mill terms with which they are unfamiliar. Preparation must, therefore, include agreeing your process with the other side.

A recurring theme throughout this book is that an acquirer cannot afford to arrive in the car park of its new business and start planning integration on the way to reception. This cannot be repeated often enough: if a buyer has not worked out what the synergy benefits are and how to obtain them well before taking control, it should not be doing the deal at all. Integration planning is a central part of the valuation. Valuation requires a clear view of the profit stream and, to state the obvious, this depends on the cost base and the sales line. The acquirer needs to be clear about any changes it will make to the cost base and the impact of its influence on sales and margins. When acquisitions go wrong, it often turns out that in the heat of trying to get the deal done, integration was left till the last minute, or even ignored. For example, in 1994, a cash-hungry BAe sold Rover to BMW for £800 m after problems with its regional jet business. BMW acquired Rover because it was struggling to develop its own off-road four-wheel drive vehicle and was attracted by the strong Land Rover brand. Unfortunately it also acquired Rover’s cars business, for which BMW had no clear integration plan. It never managed to get to grips with Rover’s Longbridge ‘volume’ car business and eventually sold it in 2000 to a management team at an estimated loss of €4.1 bn.

Acquirers need a pre-prepared communication plan which reflects the objectives of the deal and the circumstances of the acquired business. There is nothing like a takeover to generate stress, insecurity and ill-founded rumours, messages are all too easily misinterpreted and rumours spread. For example, a department meeting is called in the canteen. There are 30 chairs but 45 people, allowing some to leap to the conclusion that there will be 15 redundancies. Clear, rapid and consistent communication is essential. The sellers may be happy, but management, staff, customers, suppliers and other stakeholders did not ask for this change and they are all expecting the worst.

Not only do key messages have to be repeated over and over, but also they need to be reinforced by concrete actions. When communicating just after an acquisition, two of the golden rules are no hype and no empty promises.

Acquisition integration requires clear, strong leadership. There should be a single boss. This way there is a single point of reference, a single point of responsibility and a single point of decision making. Corus, the merger between British Steel and Hoogovens was never a great success because there were two bosses. Similarly, the Travellers/Citicorp integration was a disaster as the two leaders set about job-sharing. Worse, the next level of top jobs in the organisation were similarly shared. Jobs should be allocated on the basis of merit and ability; this is not the time for patronage and consensus.

Two other golden rules of acquisition integration are do it big and do it quick. Speed and decisiveness are critical. Change is expected and uncertainty builds until it is made. There will be tough decisions and there will be mistakes, but it is better to get the essential changes implemented than it is to dither and fuel uncertainty. HP and Compaq got this right: the top 1,500 job postings were announced on day one of the acquisition.

As the integration process unfolds, the acquirer rarely finds that he has over-estimated the scale of the task. It takes experienced, senior resource, a detailed plan and contingencies for those larger than expected costs or drains on management. Credit Agricole only reaped half of the €574 m in initial savings it once expected from the first year of its merger with Crédit Lyonnais. Ford and BMW faced larger-than-expected integration tasks on acquiring Jaguar and Rover. Ten years after Marks and Spencer acquired Brooks Brothers a press campaign was finally launched trumpeting the success of the acquisition. Acquisition integration rarely proceeds more smoothly than originally anticipated. Research by AMR International^[3] shows that the ideal target size is 5–10 per cent of the acquirer because at this size, the acquirer should have sufficient resources to manage integration.

Set against the needs for clarity of leadership and communication, and for rapid and effective action, comes the question of whether the acquirer has really understood whether its proposed changes will actually enhance the business. A ‘one size fits all’ or ‘there is no alternative’ approach to acquisition can spell disaster. For example, BAT failed to manage its non-tobacco subsidiaries effectively and exited from them. Equally the UK utilities all dabbled in the acquisition of non-regulated businesses after privatisation and mostly found that they were unable to achieve change which added value.

Effective integration requires people to work together. When cultures clash or the acquirer embarks on ‘winner’s syndrome’, problems follow. Companies in the same market can have very different cultures. Look at British Airways and Virgin – and then add Ryanair to the mix. In this example cultural differences have grown out of different business models. National differences are also a rich source of cultural divergence.

One of the persisting problems with acquisitions is that they are still the province of lawyers and accountants. Lawyers and accountants deal with hard issues like contracts and balance sheets but getting the soft issues right – culture and management – will give the biggest chances of successful integration and therefore the biggest chance of a successful acquisition.

Acquirers need to understand cultures and manage accordingly. Two businesses with hugely divergent cultures cannot just be slammed together. For example, Sony and Matsushita have never come to grips with the freewheeling managers of the Californian film studios they acquired in the early 1990s.

Customers pay the bills but are all too often relegated to second place as acquirers fall into the trap of focusing on internal reorganisation. They forget that customers do not necessarily leap for joy when they hear their supplier has been taken over. Equally they are not waiting for the acquirer to come and explain that its additional wonder product is the answer to their needs. Instead their thoughts turn to price rises, or worse. Then, just at that point, the representative of a rival firm makes an appointment to see them.

Almost every pharmaceutical merger in the 1990s resulted in a reduced market share for the combined businesses. Marks & Spencer considered it could do no wrong, but found that ignoring customers after the Littlewoods acquisition was a contributor to declining sales and market share.

The acquirer must put customers at the heart of an acquisition. The integration plan therefore needs to cater for customers in detail. This means worrying about how they will be served and who will communicate with them. Even if they will continue to be served in the same way, customers may well be sceptical about any benefits which the change in ownership will bring them. If their point of contact changes, or if their terms and conditions are altered, they will immediately be on their guard and more open to the approaches of alternative suppliers.

When acquiring, the focus of management attention naturally turns to the acquired business. Whilst all this is going on, the core business is expected to perform as usual. This can only happen if the acquirer has prepared a clear plan for how it will run its own business while it diverts resources to buying and integrating other businesses.

Airfix, the once dominant UK plastic model kit maker, destroyed its highly profitable core business by focusing entirely on acquisition. The management left behind to run the core business was strongly production focused and failed to innovate. Competitors met the needs of dissatisfied customers and stole its markets. Managers who go off and spend time in other – more exciting – areas need to ensure that their jobs in the core business are still carried out.