Spotting Deals that Destroy Value: Buyers saddled with sour acquisitions should start paying attention to the telltale signs that their m&a programs are leading to value destruction.

Acquisition overreach invariably catches up with the indulgent buyer. The company’s stock price gets savaged and the management is cursed with the dreaded stigma of value destruction. Investors are exacting revenge because the performance has stumbled or results have lagged lavish promises that premium values would explode from a highly touted m&a program. Once the market meltdown starts, the company’s troubles are in an advanced stage. It may never be able to work its way out of the operational problems brought on by acquisition indigestion, and at the very least it could suffer a severe loss in investor confidence that keeps the shares perennially depressed. However, experts on m&a strategy and implementation maintain that the serious acquirer doesn’t have to let things get that out of hand. There are, they say, telltale signs that alert management should be looking for to determine if its acquisition program is on track and delivering – in quantifiable and measuring terms – the results needed to create real value. A major reason that acquisition programs go sour, the experts say, is that even managements making the right buys tend to forget about their new properties, allowing them to fly blind once the deals are done and the businesses seem to be well integrated into existing operations. Executives, they say, often are diverted from the metrics by either the next deal or some new initiative that consumes time and energy. Except for value destruction, acquisition excess doesn’t have a single theme. It may afflict the company that does one bad deal as well as the acquisition-hungry buyer that piles up a string of transactions that aren’t seamlessly knit into a cohesive whole. It can be the so-called “acquisition machine” that can’t thrive without another acquisition because of accounting gimmickries or the realization that it can’t maintain high growth on an organic basis. Or it can be the frequent acquirer that has good strategic intentions but finds itself muscle-bound when it tries to make its asset mix work. Regardless of the format, m&a has been taking another critical pounding during the recent eruption of corporate scandals triggered by suspect accounting, unorthodox finance, and executive self-aggrandizement. Indeed some of the corporate lightning rods such as Tyco International Ltd. and WorldCom Inc. got into trouble via the acquisition route. Yet knee-jerk anti-acquisitionists, especially from academe, haven’t lost any time piling on m&a, even if had but a cameo role in a corporate downfall. Perhaps the attacks shouldn’t be surprising. Critics have been handed an arsenal of ammunition by the almost endless reports by professional services firms and academics classifying most acquisitions – up to two-thirds by some counts – as failures because they haven’t created, and in many cases destroyed, shareholder value. In any event, experts say, the scandals and the evidence provide a wake-up call for companies, even the best-run organizations, to review their entire development processes to make sure they are getting the best out of what acquisitions can offer. That doesn’t relieve them of responsibility for starting right – crafting reasonable objectives, selecting good targets, paying optimal prices, and integrating to achieve realistic synergies. But it also requires a post-deal monitoring system that tracks performance and signals if a single acquisition or a string of them are getting out of bounds. Mark Sirower, m&a leader at Boston Consulting Group, says a principal flaw in failed acquisitions is that the economics – returns, margins, and other contributors to value – get detached from strategies and goals. Postacquisition vigilance involves making sure that the connection remains in place and that the acquisition is meeting carefully set goals. “When you have stopped worrying about how you are integrating and building the businesses, that’s one sign of overreaching,” he says. “Secondly, you’ve overreached when you provide huge incentives for people to go out and look for acquisitions.” Overly generous incentives could be symptomatic of the star-struck company that loves to do the deal but has trouble with the integration grunt work. Its dealmakers tend to become motivated mostly by their own rewards for landing the transaction, rather than whether the target meets the company’s needs and enhances its competitive edge. When the individual’s payoff rules, Sirower says, strategies and economics are detached. Jeffrey Schmidt of Towers Perrin says that many acquirers pass the “failsafe point” because they fail to “look at the economic calculus on every deal.” “They should be asking whether this deal is producing the kind of returns that were expected or were sold to shareholders when the company went forward with it,” he asserts. Frequent acquirers that ignore the metrics tend to fall into the trap of having to do cascading acquisitions to keep alive their romance with Wall Street. “If serial acquirers are doing deals, none of which is achieving their expectations, they have a fundamental problem and the only way to obscure that problem is to keep doing deals,” Schmidt says. “They focus the analysts and the market on revenue growth or earnings or they just consolidate the financials, rather than look at the inherent economics of the deal from a value standpoint.” Persistent vigilance is critical, Schmidt says, because acquirers frequently don’t take full account of the initial purchase price premium and the transaction costs in the initial deal, which must be worked off before value emerges. Schmidt also warns that the calculus will get tougher because the new acquisition accounting rules require tighter identification and valuation of intangible assets as part of the purchase price. It’s new territory, he says, because “there isn’t a lot of methodology or experience or expertise in making those kinds of judgments.” “The frequent acquirer may buy high-quality companies but after the premium and the transaction costs, they set the bar so high,” Schmidt notes. “Even though the targets are high quality, they don’t get any lift of synergy from being combined with a serial acquirer. So you have just taken a high-quality company and loaded it down with costs it can’t possibly shoulder.” Frequent restructuring charges are alarm bells to Jeff Smith, a partner at Accenture Ltd. that the acquisition isn’t going according to the desired plan. Restructuring costs previously weren’t much noticed, Smith says, having been “stuck in below the line” by acquirers who touted such results as EBIT-DA in unveiling pro forma results of the combined company. “I think when you see restructuring charges occurring every quarter, instead of just once, because we didn’t know what we were doing in the first place, that to me constitutes a red flag, not just a yellow flag,” he says. “They have overreached or aren’t competently executing against the plan they told everyone – including themselves – that they would achieve when they were making the acquisition and doing the postmerger integration work.” Smith notes, for example, that restructuring charges often spring from the information technology operation, and that the company was “clobbered” because the m&a team never spoke with the IT unit and never understood the stakes before they “finalized the business model economics.” A complete plan which runs from conceiving the idea to the post-deal monitoring should include every aspect of the process, including culture and personnel changes and rationalization of assets in specific terms, among other elements. “The question is whether there is a clear understanding and accountability within the acquisition and postmerger integration plan as to the milestones, so we know that somebody is actually managing it like a project,” Smith states. “Is there a clear roadmap from the day we signed the deal to the day all the signs are switched and all the colors of the payroll checks are changed?” Operating systems specialists David Klebba and Michael Matte of KPMG Consulting say that a lack of focus on these systems often is an Achilles’ heel in many deals. Line people outside of the systems area, they say, tend to treat systems as a working tool rather than a real weapon for business stimulus. This leads to a shortchanging of the systems people in financial terms and the systems’ loss of effectiveness in being a contributor to making corporate combinations work. A good systems integration, Matte says, should be “well planned so that it not only considers the customer, the systems, and the data but also the cultural fit of the organizations and their alignment.” Klebba says that the companies tend to “convert silo to silo without realizing that they can be converting customers. I think it’s a blind spot.” In the view of Michael Wathen, a transaction services partner at PricewaterhouseCoopers, acquirers frequently get off on the wrong foot by overweighting up-front analysis on the value of the deal while downplaying the risk factors. A result is that the value bias gets imbedded in the process, continuing well after the deal is done, and masks whether the business is or is not performing for its new owner. The often calculable value side, says Wathen, is “the fun side, that is, what’s it worth, what are we buying it for, how can we structure it to get a better deal, what’s it going to look like on our financial statements. The grittier mind-challenging risk side, he adds, includes things like “Can we get it done? How will we manage it? What are the unique risks attendant in that business, such as integration risks? How well are we set up as an organization to manage this property? Do we have the right people to assess this?” “The value part is the fun part – sexy and exciting,” he says. “The risk part is the boring, disciplined processes. It’s three yards and a cloud of dust off right tackle 35 times. You can get a touchdown, but it’s not airing it out and throwing the bomb.” John Klee, also a PricewaterhouseCoopers transaction services partner, calls the risk evaluation “just plain hard work” that a lot of acquiring companies eschew. “Not everybody does it, even the committed companies, because it is hard stuff,” he says. But Klee sees a welcome change developing. “The real focus now is to look at how we really do deals, not when it’s too late to do anything about it, but to look at them on a proactive basis to make sure we are doing what we set out to do.” “I can’t tell you how many times in the last two to three weeks that I have visited clients and they’ve asked for tools to measure whether they were on track. Everyone is looking for the golden screw that they can turn and say everything is right with the world. I tell them it isn’t that easy. It’s going back to why you did the deal to begin with, having the clarity to set out the value proposition, and having the transparency to make certain that the people who need to buy into it at an appropriate level are buying in. And these are things that have to be executed on a risk-oriented basis,” says Klee. Although there is no exact science or guideline, A.T. Kearney vice president Tim MacDonald says that good monitoring includes a check on the right corporate development mix, although that can vary by company. While a growth mixture of 60% organic to 40% from acquisitions may be good for some companies, a different blend may be appropriate for others depending on their markets, technology, customer demands, and other familiar elements of fixing strategies. The pockets of big trouble are the companies that use acquisitions almost exclusively to power growth. “A lot has been proven by the great companies that really do have the right mixture of organic and acquisition-related growth,” he says. “If you are relying almost exclusively on growing your company through acquisitions, our studies show that over time you are destroying shareholder value. If your company’s mission is to keep acquiring companies, you are in trouble,” MacDonald states. Internal techniques may be “less exciting,” MacDonald says, “but developing new products, treating customers effectively, and building the right supply chain and the right manufacturing capability are the right things to do.” “You can tell you’re not getting ahead with the acquisition if you are starting to do things that don’t fit with that sort of vision,” he says. “From our perspective, that will tell you if you are getting out of line.” Overall, MacDonald says, that requires “a diagnostic,” which measures where the acquisitions were supposed to fit into the strategic rationale, whether that initial game plan was correct, and why the acquisitions have or haven’t been successful. While acquisitions can achieve a lot of goals for a company, they can’t “make a bad company better,” is the reminder from D. Malcolm Wright, a transaction services partner at KPMG International. But even if the intent is to improve the company by adding specific skills, technologies, and other attributes, acquirers can get ahead of themselves by adding more companies than they can integrate and strapping themselves financially. That can cloud the postmerger diagnosis. “Everything gets so jumbled up so quickly that it’s very hard to find out if I have increased my run rate of earnings or masked a real decline just by adding more earnings through acquisitions,” he says. One troubling sign is a run-up in corporate debt that can’t be pruned if earnings drop. “People should pay more attention to the ability of a company to service the debt load,” he says. “There should be a cash throw-off to pay the debt. Some companies are highly sensitive to the economy and tend to stumble quicker than others while still other companies have a long cash-to-cash cycle,” he adds. For the serial or frequent acquirer, there is peril in rushing into the next deal before the ink is dry on previous transactions. “I would argue that you’re doing too many deals when you are closing deals so quickly that in three to six months you say, I’ve bought a lot of things but I don’t really know what I’ve bought. I can’t figure out what I’ve bought.’ You’ve got a pile of unintegrated acquisitions behind you. That would be a troubling sign,” Wright remarks. Ultimately, the monitoring should determine whether projected synergies – a combination of increased revenues and reduced costs – are being booked. But that begins with realistic targets, says Mercer Management Consulting’s Mike Lovdal, who claims that too many synergy projections lend themselves to pie-in-the-sky thinking. Lovdal says that corporate directors and senior managements have gotten the message from the scandals. “The directors are saying you can no longer bring in a deal all wrapped up and we’ll automatically approve it,” Lovdal reports. “They want a much more accurate count. They want to know what’s in the pipeline and they want to know the rationales for deals you are thinking about. They want to know whether you have done the right kind of due diligence so that nobody gets surprised about accounting policy or ethical standards. They also want to know about the plan for integrating the company, if you buy it. And the really savvy people are focusing on revenue-driven synergies.”