There are hundreds of anxious investment bankers fearing a predicted market downturn. Fear not, bankers, mergers and acquisitions are likely to continue regardless of a bear market – at least in Europe. The eurozone should see continued amalgamation even after US markets have cooled.
But the reasons for buying may change. Whereas the past decade has seen companies combine primarily for market share with the added bonus of economies of scale, companies will increasingly acquire for cost reduction with market share becoming a secondary objective.
While this difference sounds pedantic, the impact can be significant.
Market share acquisitions are based around building future marketing muscle, but cost-cutting acquisitions in a downturn can have a frenetic ‘get the costs out at any price’ mind-set.
Even in good times acquisition success rates are poor. Recent studies found success rates have not improved during the last decade. So what added risks are present if there is an economic downturn? There are primarily three: finding the right partner, the health of the parties and the implementation process itself.
A time-consuming and often frustrating exercise for an astute acquirer is ascertaining which potential partners are suitable and available. It is not uncommon for an acquirer to take months or years to secure appropriate acquisitions especially in specialised markets.
A downturn could cause companies to react and enter into wholly unsuitable alliances hard-pressed by poor performance or inadequate cash flow. Important steps in the march towards merger can get forgotten. Anxious buyers or sellers do not negotiate for the best price – they deal at almost any price.
They also tend not to walk away from a deal with silly prices – they are just too desperate hoping getting it done will save them. This is not a stable mindset for entering into a long-term relationship. Defensive acquisitions are not an easy story to sell to stakeholders.
A downturn could bring opportunities but in most cases buyers will need to react quickly. Any reduction of key pre-acquisition activities, such as due diligence, should be discouraged especially when it plays a role in ascertaining the health of the seller and target during a downturn.
The finances of the seller and target company can have a fundamental impact on the acquisition’s success. In a downturn, target companies may suffer under-investment, costing the seller too much to put right.
A classic symptom is an inordinately high return on capital employed compared to industry standards and should be spotted during due diligence.
These targets would require intensive investment and should be factored into the purchase price. During a downturn and if there is doubt of the target’s economic condition, due diligence is critical.
Implementation is the acquisition’s most critical stage. AT Kearney’s recent study on acquisitions found the greatest risk of failure was during implementation (51%). During a downturn, risks are greater as shareholders want returns even faster. Cost reduction acquisitions are difficult as they are about removing costs, the bulk of which are human. It is critical to get the ‘human side’ right but this takes time and careful communication.
When you are trying to move quickly, time is the one luxury unavailable, so ‘human issues’ get ignored and there is a failure to consult and communicate with employees. Managers often fail to take outside counsel to keep costs down and they often fail to secure investment they had agreed. What can happen is a domino effect. Once implementation begins to go wrong, it is nearly impossible to put right.
The downturn should present organisations with opportunities. A KPMG study found six pre-deal activities were associated with acquisition success: pre-acquisition planning, synergy papers, holistic due diligence, communication with employees, selecting senior management early and addressing cultural differences. This is good advice at any time. During a downturn, it is vital.
You need to do as much pre-deal as possible, gathering information and planning.You must know your strengths and weaknesses, and where you ‘fit’.
Who are your key employees and what will it take to secure them? Consider costs associated with buying, including the implementation (redundancies and IT harmonisation) and ensure you can afford it.
But don’t forget the biggest acquisition cost: management time. If management is stretched trying to salvage an ailing business, an acquisition will compound the problem and bring the business quicker to its knees.
– Nancy Hubbard is a director of Hubbard & Associates and associate fellow at Templeton College University of Oxford
Nancy Hubbard’s book ‘Acquisition: Strategy and Implementation’ (Palgrave) is available to readers at a price of #20 (RRP #25.99). To order your copy contact Nathan Gaw on 01256 302708 or at email@example.com.
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