Taking the “A” out of M & A
Today there is very little devastatingly new or original commercial thought. Business is very much driven in current times by the economic downturn and surprisingly, fear. This doesn’t mean that businesses need to stop innovating, they just need to do so in a manner that suits currents times.
This brings me to an area of my activities that has not been in favour for many years, but the reasons for being overlooked have always been a personal mystery. For your benefit, I would like to explore pure Mergers, the forgotten cousin in the Mergers and Acquisition world. My reason for doing so is that its time may have arrived.
Let me explain. A merger is a business combination or amalgamation. It is often friendly and should not require cash to complete, but it does dilute the shareholding levels of the participants. It has very much lost its identity in recent years because there is a saying that “there is no such thing as a merger, just a disguised acquisition”. The view is that there is always a dominant party and it suits their narrative to call the takeover as a merger, to appease the management and staff of the acquired business. There is often merit in this view, but not always.
So why do genuine mergers make sense now? The fact is they always have but the current market conditions force many companies to reappraise their position. Corporate control over an acquired business is less important now when looked at it through the current prism of the market and business survival. The changes have been as follows:-
- The overall economy is some 20% lower than it was before the Coronavirus Pandemic took hold
- Many respected economic think tanks see recovery taking 2-3 years to achieve
- Some markets will never fully recover as economic change dictates fundamental shifts in business
- Brexit may well further hit the economy, if as looks likely, a deal is not concluded
- Corporate cash levels are at their lowest level for many years and will take time to recover
- The lending support from Banks for business is likely to contract and become more challenging
- Redundancies and cost cutting have already weakened many company’s ability to grow
So how does a merger help?
The new legal entity formed is generally bigger. It will probably have a greater, more varied customer/product base, so it should be more resilient to future setbacks and have more opportunities to grow its sales.
Typically, the driving force for a merger has been size and reducing operational costs, therefore improving profits in similar sized businesses. But in defining too narrow a rationale, companies are missing out on a better way forward. So, what are they missing?
To answer this question, we need to go back to basics and take a less egotistical view of business:-
- Business is ultimately about strategy. What is the most efficient and profitable way to provide the right products to your marketplace? Is that how you see your business? Most businesses that I encounter see their business as lifestyle rather than Chess. Strategy is very much an afterthought!
- But in the new constrained markets that we all now find ourselves, what is our new strategy for survival, dare you plan to thrive?
- Are we addressing the key business problems of our sector such as productivity, poor cashflow, lack of skilled labour, market positioning/ corporate differentiation, declining trading margins and refining your product ranges/services?
- If you do not change and evolve, how long can you survive? Will your business be worth anything when we decide to sell it, as part of your personal exit and retirement planning?
- The personal pride you have in calling yourself Managing Director or owning 100% of a challenging business must be offset against the realities of being able to support yourselves and your family over the decades to come. What sounds impressive at a dinner party or with friends can become an increasingly stressful burden to sustain.
When should you be thinking about a merger- what should be the driving force?
There are several reasons but consider the following situations:-
- A weakened company resulting from the economic slowdown will probably struggle to get credit, win larger contracts, attract key staffing, spends too long firefighting its problems and managing its cashflow. If that sound like you, a merger is a sensible consideration.
- If your product range is such that you often lose contracts? You could of course collaborate with another business but that often does not work in the customers eyes, as they want one supplier. What is the key product or service that would unlock new business, could a merger be the best way to deliver this product?
- Many firms are strong in different management areas. Having a capable sales team is only as strong as the technical and operational backup needed to fulfil the contract. Bringing the two together can result in a sum greater than its parts.
- Are you wearing too many hats such as MD, operational and financial? If so, the likelihood is that you are not excelling at any and your customers will know it! Business combinations can make filling the management gaps affordable and improve productivity.
- All companies need to innovate in both new products or services or improving the systems that interface with your customers. There is often a big cost that is better afforded by the larger business to keep the company at the leading edge in its sector. Merging technologies can save years of capital investment and research.
- If a business has older shareholders that are looking for an imminent retirement, a merger might provide the best route to achieve this outcome. Most business sales these days involve an earnout with the sellers winding down their involvement over agreed timescales. This could prove an ideal solution.
As stated, there are numerous reasons, like the ones above where a business merger makes a great deal of sense, as well as the more obvious ones. Merger with a southern company that is not represented in the north where a national presence is important; securing key production materials to secure supply i.e. sand for a cement manufacturer or improving supply competitiveness; using a larger scale to reduce key material costs such as professional indemnity insurance or IT components if they are a key industry cost for your business, for example.
How about some real-world examples?
America Online and Time Warner
The largest merger in history took place in 2000 when America Online (AOL) merged with Time Warner Inc. (TWX) in a deal worth a staggering $360 billion. At the time, AOL was the largest Internet provider in the U.S. Riding high on its success and the massive market share that it had across American households, AOL decided to merge with Time Warner, the mass media and entertainment conglomerate. The vision was that the new entity, AOL Time Warner, would become a dominant force in the news, publishing, music, entertainment, cable, and Internet industries. After the merger, AOL became the largest technology company in America. However, the joint phase lasted less than a decade. The deal was very much ahead of its time and a good strategic fit but failed to navigate the dotcom bubble burst. Timing is one of the key considerations.
Dow Chemical and DuPont
Announced in 2015 and completed in 2017, the $130 billion mega-merger of equals was executed to create highly focused businesses in agriculture, material science, and specialty products. The merger was expected to deliver around $3 billion in cost synergies and another $1 billion in expected upside from growth synergies from the merged entities. The combined company is operating as a holding company under the name DowDuPont Inc. (DWDP) and is listed on NYSE. The combined business has gone on to deliver fantastic shareholder growth and become an industrial powerhouse in its sectors.
J. Heinz and Kraft Foods
The $100 billion merger of H. J. Heinz Co. and The Kraft Foods Group was aimed to create a U.S. food giant and the fifth-largest food and drink company in the world. The deal was announced in 2015 and created a newly merged entity with the name The Kraft Heinz Company. It brought leading household food brands, like Philadelphia, Capri Sun, and Heinz Ketchup and HP sauce, under one roof. The revenues of the newly merged entity at the time were pegged at around $28 billion. Even at the global scale, this merger proves that size and marketing reach are often needed to capitalise on leading brands potential.
So why do mergers not feature more often in the corporate world?
This question has often perplexed me to be honest. As an economist and believer in free trade/ liberalisation of economies, my corporate finance experience has shed some light on this dilemma. Let me explore some of the problems and pitfalls that I have encountered:-
- Mergers need high level strategic thinking on both sides, which is often lacking in the monthly business cycle process. The requirement is that both parties have a clear vision of where they are currently and have clear objectives that they can share. Lack of planning, insight and research can derail the merger.
- Differing management styles and business approaches can sometimes get in the way. It is unlikely that both parties will be run the same and some compromise and open mindedness will be a basic requirement.
- If the rationale for the merger makes sense, market conditions can and should be set to one side. It should not influence the decision. Nonetheless, if one party is having a bad year, they may want to delay the merger for fear of losing value in the transaction. This is often a mistake and there are ways around the issue, but it can scupper the outcome.
- Management is key to any transaction. If you do not bring along the key senior managers with you through incentives and tie ins, personal security can sometimes override the greater good that can be achieved. Both managements need to commit to work as a team to drive the outcome.
- Often the two parties are driven by reducing competition in the hope that price increases can be pushed through as a result of their merger. If this is the driver, it can often flounder because it is not customer driven. Customers must believe that they benefit from the merger rather than be exploited by it, otherwise they move their trade elsewhere. The PR must be authentic and plausible to both management and customers alike.
The economic climate, to my mind, should make the merger a much more powerful tool in the armoury of commercial growth and expansion. The fact that it should not require funding and will allow growth at a time when the general market is well down in many sectors should make it a much more common tool for business. But it does require a change in corporate mindset. Management egos must be set to one side and business strategy should be the main driver of such activity. These two main stumbling blocks are easily remedied with better corporate and strategic support. Companies should seek the help they need! Experience is the key when business amalgamations are in play.
Not all companies will survive the current downturn, but mergers should play their part in bringing together the stronger and weaker partners as part of the commercial realignment that is required. The smarter businesses are not only recognising this fact but starting to look around and put the professional support they require to make it happen.
Article was written by Philip Waxman, an experienced business growth consultant with a focus on business growth planning, business funding, mergers and acquisitions and exit strategy. Philip is an ICAEW qualified accountant. Message Philip today to talk about your best business strategy options to withstand the recession in the coming economic climate. Call 0330 223 5030 or email on [email protected]