What the Stock Market Wants to Know About a Merger: Acquirers may be able to avoid a post announcement pounding of their stocks by pinpointing where value will be created. (Honing Supp)

The stock market does not always agree with the strategy and putative value behind megamergers, according to studies done by the Strategic M&A Practice of PricewaterhouseCoopers. In the majority of cases, in fact, we see a drop in the acquirer’s shareholder value when a merger is announced. This drop in value, in turn, leaves companies and management teams vulnerable to criticism by shareholders and even boards of directors. In our research on the impact of mergers on shareholder value, we have taken a hard look at the numbers and interviewed the CEOs and CFOs who drive those deals. Our findings offer lessons on how companies can gauge the wisdom of their strategy as reflected by the creation – or dilution – of stockholder value, both in the immediate wake of a merger announcement and in the longer term. We focused on transactions of more than $500 million completed during the period of 1994 to 1997, tracking the acquirer returns around the announcement date, and again one year later. This approach measured both the market’s initial reaction to a deal and its subsequent assessment of the transaction, once integration was underway. We allocated the deals to various portfolios, depending on their immediate and long-term return performance. Overall, we found that: * Only 22% of acquirer stocks outperformed the markets both at announcement and a year later; those deals fall into the value-creating category. * Another 17% initially lagged the market but had turned positive by the end of the year. * The remaining deals – almost 61% of our sample – were value-destroying, having failed to win the market’s confidence a year after the announcement. This statistic includes the 18% of deals that were positive initially but ended behind the market and the 42% that were negative in both periods. The illustration below shows the dramatic imbalance between deals that destroyed value and those that added value: Why do the majority of deals fail to deliver value? The reasons stem from weaknesses in some of the key factors that drive value: strategic objectives, price, and integration. It is worth reflecting on what value creation means in the context of an acquisition. The most common definitions related to expectations are increased cash flow and economic profit above and beyond what is already forecast to be paid to the target’s shareholders. These economic profits, in turn, should translate into stronger stock prices. We define these terms as follows: * Expectations – Forecasts must be established and supported by a credible plan to achieve them. * Economic profits above and beyond – Management teams cannot merely improve operations. They must reach a new, synergistic level that reflects, at the very least, the premium that the company paid for the acqui-sition. Combined, the concepts of expectations and economic profits point toward what shareholders want, and how your company can deliver what shareholders want. The sections below discuss the tactics of value creation and delivery in greater detail. The Cornerstones of Value Shareholders’ expectations require a rapid and effective transition from buying to running the merged business. The work leading up to the deal itself merely begins the process. Identifying and nurturing the benefits, capturing momentum, and integrating the organization are critical and continuing necessities. Making value enhancement the centerpiece of deal analysis and implementation steers the entire process in the right direction. But what can CEOs and CFOs do to nurture continued success? Our research points to three critical factors: * Value drivers – Know your enterprise’s strengths and priorities, what you must achieve from the merger, and how you plan to accomplish it. * Integration focus – Keep your eye on the ball, so to speak, on the overall strategy that delivers value. * Stakeholder communications – Identify the most influential audiences and tell them your story eloquently and often. Know Yourself First Fifty-five percent of the companies that receive positive reactions to merger announcements keep and build on this momentum for a year after the transaction is announced. These companies convince analysts and investors that they can deliver on strategy, price, and integration – and then do so. On the other hand, 71% of companies that cannot provide convincing arguments up front fail to do so a year later. Stated another way, if your vision and story don’t hang together from the outset, the forecast isn’t promising. A key lesson, often overlooked in the frenetic deal process, is that both the acquirer’s and the target’s strengths and weaknesses are important to the deal’s success. We expect to hear what value that the target will provide. But what does the acquirer bring to the table and can it articulate its position? What benefits emerge as the two enterprises join forces? Understanding the value inherent in both businesses, separately and together, clarifies the acquisition strategy and also provides a road map to assess candidates and the synergies they bring. This knowledge driver not only strategy but also the appropriate prices and integration processes. It is seldom noted that a target’s potential price does and should vary, depending on the bidder’s analysis. Every deal offers different degrees of benefit, depending on the amount of business overlap and opportunities for synergy. The right price depends on the merged companies’ unique and complementary synergies. As an acquirer, you must know the point at which price exceeds reasonably attainable benefits. Detailed self-assessment will help you know when to walk away. This kind of candid cost-benefit analysis sets the backdrop for a succinct and credible message to the marketplace. As one CFO noted regarding a successful deal, “We knew exactly what we wanted to do before we acquired them.” It is equally important for a target to understand the merger’s underlying strategic rationale. We have seen many deals fail because the acquirer and target did not communicate effectively. Both have to see the reasons behind the deal. The target’s staff needs to understand these because they must help deliver many of the promises that drive value at deal announcement. If the acquirer does not demonstrate the merger’s value to the target, the deal may well falter. Tell Your Story A poor initial reaction need not doom the deal’s success. In our study, we found that 17% of the companies that ended the one-year period ahead of the market did so despite a weak initial response. How did they achieve their turnarounds? By demonstrating early on that their deals made sense. One CFO noted that the absence of a track record created market skepticism about whether his company’s deal would actually succeed. However, attitudes changed when the company achieved its goals during the integration process. While every deal needs to be clearly explained to the market, communication becomes even more critical when the acquirer has a lackluster m&a record or is new to m&a activity. Keep in mind that companies with strong acquisition records are not immune to negative market reactions. Such companies need to provide evidence that each new deal will be a winner – just like its predecessors. Says one CEO, “The market…gets frustrated when it can’t get the detail behind overall numbers.” The assumption of course is that if you don’t provide the detail, you can’t provide the detail – and your ability to perform usually will be discounted. Investors, in general, do not act on faith. Past performance is one good indicator, but each deal has unique factors and benefits that require fresh explanation. The market’s cynicism can be stated simply: “What have you done for me lately? Why should I believe you?” Speak the Language of Investors To be a successful player in today’s m&a market, you need to articulate your moves in terms that investors understand – that is, how they can profit from your deal. Value enhancement, after all, is the language of investors. They want to know how a deal affects your value or cash flow creation opportunities and how you intend to achieve the results that propel any share price movement. Our analysis and interviews with m&a executives suggest these final lessons: Zero In on Value – Emphasize where and how the merger will create value within your existing business. Early Concentration on Synergies – Focus your early action plan on how you will identify and exploit the deal’s synergies. This forms the heart of a more detailed integration plan as you move forward. Let It All Hang Out – Give the market detailed information that addresses the major drivers of value. Otherwise, investors will be wary and stock prices will suffer. Finally, don’t forget all of your other key stakeholders whose interests should be aligned with those of your shareholders. Your communication strategy needs to ensure that media, industry and trade observers, customers, business partners, and employees understand what you’re trying to accomplish, why, and how it affects them. Their support can bolster market reaction and even counter analysts’ skepticism. And their input can help you identify any early urgent concerns or possible impediments to your success. Forewarned in forearmed. The benefits of such planning go beyond influencing stock price. They are essential business exercises that help your company define and execute strategy. In today’s volatile markets, no single approach guarantees rising shareholder value. The ideas we’ve developed, however, should help you move your company forward and, ultimately, deliver benefits for your shareholders. Reprinted from the May 2001 issue of Mergers & Acquisitions Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com