The urge to merge

Finance directors have been burning the candle at both ends to work on potential deals since last year, as buoyant stock markets, supported by growing company profits, have triggered a spate of mergers and acquisitions.

The proposed takeover of the London Stock Exchange is far from the only large deal in town. There are plenty of other significant M&As around, including Aviva’s hefty billion-pound proposed acquisition of the RAC, and global mining company BHP Billiton’s £3.8bn bid for Aussie mining stock WMC.

When the deal is right, and the integration is smoothly delivered, all parties stand to gain. Investors get comfort from having their money in a larger, more robust company, while staff and management enjoy the buzz of working for an organisation that is clearly successful and has the potential for further growth.

But what does it mean for the finance director, other than a string of late nights in the office? Working on big deals can be exciting, test your skills and knowledge, and are great for the CV. In the City, the dealmaker is king, and working on a large deal can be a quick way for an FD to earn his or her stripes.

There is, of course, always a flipside to the coin. There are always potential problems when companies come together for the first time. In fact, no less than half of all mergers or major acquisitions fail outright, sadly.

Failures are most likely when companies move into markets in which they have little or no direct experience. Even when they have experience of running a similar service in the UK, company forays abroad are exposed to the greatest risk. When Scottish Power bought US generator PacifiCorp, it experienced a raft of unexpected problems with one of its power stations in Utah.

More recently, Morrisons’ drawn-out battle to acquire rival supermarket Safeway promised much. It was supposedly an excellent fit, with Safeway stores mostly in the southeast and Morrisons dominating in the north, meaning not too many jobs would have to go. Again, the difference between on-paper potential and reality were reflected in a recent large profits warning to investors and the resignation of finance director Martin Ackroyd.

Ackroyd’s departure, widely called for in the City following Morrisons’ unexpected extra £40m provision for integration, highlights all too clearly how it’s often the FD who bears the brunt for a failure. If the numbers fail to add up, and profits undershoot or costs are higher than expected, rightly or wrongly, it’s the FD that usually ends up carrying the can.

In truth, FDs are more expendable than chief executives, and deemed easier to replace. What both the Morrisons and Scottish Power examples illustrate is that completing a successful merger or acquisition is easier said than done. Even when the deals are deemed ‘successful’ – that is, the new corporate entity hasn’t failed – the shareholder can often get little obvious joy out of the transaction.

Merging with or acquiring a company is fraught with risk. To avoid having an embarrassment on their hands, FDs and their team oversee the crucial due diligence process that evaluates the risk of M&As and determines whether they should go ahead.

With huge sums at stake, as well as corporate reputation, it is unsurprising that due diligence has to be a painstaking process. Due diligence tests the assumptions on which the merger or acquisition is predicated, and should reveal the weak spots. During due diligence, the independence of the advising accountant is integral.

After weeks of due diligence for a major merger or acquisition, the accountant presents a report to the FD summarising the findings. This report will assess both the quality and quantity of the financial and management information supplied by the company being acquired.

The accountant will have looked at the markets, management team and industry trends, all with a dispassionate eye on potential financial risks. For example, proposed regulation or legislation might affect the combined business going forward; it’s the accountant’s job to find this out and brief the FD on the financial effects.

However, there are many factors other than financial ones that can cause an M&A to fail. The cost to management efficiency is one of them. Even a small deal is going to be time consuming and stressful for senior managers, particularly the FD, who will be spending hours poring over the numbers.

With managers engaged in interminable all-party meetings with advisers, they may not notice recent moves by a competitor, or a serious new problem with one of their own divisions.

It is therefore imperative that companies take into consideration several key issues before embarking on mergers or acquisitions.

First, investors want companies that look to M&As for rapid growth to be able to prove that they will be truly earnings enhancing. In short, the company isn’t just bigger, it is also more profitable. Once the merger or acquisition has been agreed, the implementation team must introduce changes swiftly, including radical surgery where any cost is duplicated.

Investors like companies that have a proven record of setting objectives and achieving them. Companies that most please investors set tough targets and exceed them.

The merged business must avoid aggressively cutting back on staff numbers. Many City companies found this to their cost during a wave of mergers in the powerhouse 1980s. They cut too deeply, only to find that the continued explosive growth in the market meant they soon had to recruit again. As anyone who is involved in personnel knows, recruiting staff is time-consuming and costly.

While it’s great to cut overheads, FDs should be wary of flattering the bottom line by taking out other costs essential to expansion. The future growth of the business should be predicated on enhanced sales or productivity, not on reduced costs.

With large M&As grabbing the headlines once again, it is important to remember the mistakes of the past. The most successful deals will be the ones that recognise the potential pitfalls and take action to avoid them. And the most successful companies will be the ones with FDs who can do just this.

Justin Lewis is chief executive of Corporate Synergy Plc

Related reading

PwC office 2