It may seem rather simplistic, even glib, but the phrase “Buy Smart” separates the good dealmakers from the bad. Smart M&A executives replicate certain tactics and behaviors in deal after deal, following four key principles that help them avoid buyer’s remorse. Buyer’s remorse never stands a chance.
The corporate community’s love affair with mergers and acquisitions shows no signs of abating. In fact, according to Thomson Financial, merger activity reached $3.8 trillion in 2006, making it the most active year for mergers in history. What’s more, today’s deals – involving giants like Nokia and Siemens, AT&T and BellSouth, E.ON and Endesa, and Wachovia and Golden West Financial – are bigger than ever.
Smart dealmaking is at the heart of many great, successful companies. Bain & Co.’s research shows that companies with a strong history of doing deals earn higher returns for shareholders than those that do few deals or none at all. Think GE, Cisco, Johnson & Johnson, Washington Mutual and Fiserv, which have flourished. Of course, not every M&A has a positive outcome: only about 30% of big deals create meaningful value for shareholders, and 50% of deals actually destroy value. Nevertheless, companies are often forced to proceed with deals as a way of satisfying investors’ expectations for higher sales and earnings that can’t be met through organic growth alone.
So, what separates the successful and unsuccessful dealmakers? In Bain & Co.’s research, which involved analyzing the M&A activity of more than 1,700 companies over 15 years, surveying 250 M&A executives and interviewing a score of top acquirers, Bain & Co. observed that successful companies employ specific tactics and behaviours that dramatically improve their odds of achieving positive results. They execute a series of small, low-risk deals rather than attempting to pull off complex megamergers. In this way, they sharpen their skills at acquiring and integrating companies, gradually scaling up to larger deals and institutionalizing a success formula. Smart dealmakers also focus on the critical decisions that make or break a deal, so they don’t have to waste time on excessive number-crunching or inch-by-inch integration. They follow four key imperatives:
- Targeting deals according to a sound investment thesis;
- Determining which deals to close by asking and answering the big questions;
- Prioritizing which aspects of the businesses to integrate and which to leave independent; and
- Developing contingency plans for when deals inevitably go off track.
Let’s examine each of these imperatives in detail.
Choosing the right targets
Successful acquirers begin with a sound investment thesis, a clear statement that explains why and how an acquisition will make the current business stronger. Bain & Co.’s experience repeatedly underscores the value of doing deals that bolster a company’s core business, as opposed to moving into distantly related businesses. Deals that grow a company’s scale, by adding similar products or customers – such as British Petroleum’s acquisition of Amoco – have a higher probability of success. Deals that expand a company’s scope, by adding new customers, products, markets or channels – like Newell’s acquisition of Rubbermaid – often disappoint.
One of the keys to creating a strong investment thesis is to understand the basis of competition in your business. Most companies compete primarily on cost position, brand power, consumer loyalty, real asset advantage or government regulation. The best acquirers know their core strengths and target deals that enhance them.
The stock market is good at detecting deals with a poor investment thesis. If an acquirer’s stock drops more than 10% relative to its industry peers just after the announcement of a deal, the odds are 75% that the share price will still be down one to two years later.
Deciding which deals to close
Too often, due diligence becomes a “check the box” exercise, but the reams of data that are collected fail to tell executives what they need to know to decide whether to consummate the deal. The best dealmakers zero in on the “big” questions, the ones whose answers will demonstrate whether the investment thesis will pan out. What’s critical in due diligence isn’t how much you know; rather, it’s determining what you don’t know and should know, and then nailing down that information.
Corporate buyers can learn a great deal from private equity firms like KKR, Bain Capital and Texas Pacific Group. These firms don’t assume they know the business they’re buying. They take a critical outsider’s view of a company and its market, and don’t take its future prospects for granted. They answer the big questions by building a proprietary view of the target from the ground up, getting the information they need first-hand from customers, suppliers and competitors. They then test what they’ve learned against predetermined “walk-away” criteria. If any of those tests leads to irreconcilable doubt, the next step is obvious: they walk away from the deal.
Integrating where it matters
Many companies take a holistic view of integration. The truth is, there are only a few integration activities that really make or break a deal. Top acquirers focus on getting those activities absolutely right.
The right level of integration varies with the type of deal. A holistic approach may be valid in deals involving companies with similar products or customers, where extensive integration is required. In these cases, companies first need to home in on the activities that will deliver the largest cost savings or revenue gains. Deals that expand the scope of a company’s existing business call for more selective integration, in specific areas where the operations overlap. In all cases, it’s critical to move quickly to capture the key sources of value the deal presents. Companies also need to make sure that the merger doesn’t distract the workforce; the majority of employees must stay focused on running the base business.
Getting deals back on track
No deal goes exactly as planned. Assumptions are proven wrong. People quit. Competitors take advantage of disruptions. Customers get upset. What sets world-class acquirers apart? They expect to hit a few potholes. They install early-warning systems to detect problems and they tackle them as soon as they emerge. They make a distinction between the inevitable glitches and those that signal something far more serious.
Here, the need for unsentimental discipline reaches its peak: acquirers must let go of the past, admit errors and take tough, decisive action to put their deals back on track. Many bad deals have turned into disastrous deals simply because managers failed to dissolve them soon enough.
Doing it right: Kellogg’s big win
What does strong discipline look like in practice? Kellogg Co.’s acquisition of Keebler Cos. provides an illustration.
At the dawn of the 1990s, Kellogg was one of the most successful brands in business history. Products like Kellogg’s Corn Flakes were staples of the family breakfast table. The company was growing and very profitable, with top-tier operating margins and a leading share of the ready-to-eat cereal category.
But, by the middle of the decade, Kellogg’s business was getting soggy. General Mills Co., No. 2 in the cereal category, had taken the lead in market share, while Post cereals, at No. 3, had initiated a price war. At the same time, retailers began to step up their offerings of store-brand products, calling on companies like Ralston Foods to supply them at cut-rate prices. And consumers were increasingly turning their backs on cereal – that once-ubiquitous bowl of Corn Flakes at breakfast was deemed unnecessary in time-constrained families. Kellogg’s stock dropped by almost 20% in the late 1990s in an otherwise booming market.
When Carlos Gutierrez, a long-time Kellogg executive (and now the U.S. Secretary of Commerce), was named CEO in 1999, he sketched out three priorities: make traditional products more appealing; look beyond ready-to-eat breakfast cereals for the engine of future growth; and change the company’s culture so that everyone understood the importance of executing plans more quickly.
Gutierrez saw some encouraging signs. People liked to snack on cereal-based products during the day, and Kellogg offered such products as Nutri-Grain Bars and Rice Krispies Treats. Between 1996 and 2001, the hand-held breakfastbar category grew 8% annually even as demand for ready-to-eat cereals declined. But making a big push into the snack market raised a fundamental problem: Kellogg lacked access to a direct distribution channel – the best way to deliver snacks – and Gutierrez knew it would be difficult and costly to build one from scratch. He would have to buy one.
Enter Keebler, the country’s No. 2 cookie and cracker maker, which had a well-tuned direct-store-delivery (DSD) system. Rather than ship products to retailers’ warehouses, Keebler employees drove trucks to stores every day and stocked fresh snacks directly onto the shelves. The system allowed the company to generate high product turnover and exert great control over merchandising – an important advantage over most competitors, whose products had to travel through the retailers’ logistics systems.
Kellogg saw gold in Keebler’s DSD system, and its pursuit of the company is a textbook case of dealmaking discipline at each of the four crucial decision points:
Picking the targets. Kellogg’s investment thesis was clear, focused and compelling: buying Keebler would add one to two points of top-line growth and give Kellogg a direct distribution channel that it could rapidly fill with an expanded snack-food product line. Some analysts said the deal would likely dilute earnings per share to $1.30 from $1.75 in the first year after closing and that the merged company would add $4.6 billion in debt. But the stock market actually applauded the deal. From the time the merger was announced to a year after it was completed, Kellogg’s stock rose 26%, outperforming its peers by 11%.
Evaluating the deal. Kellogg focused its due diligence on the few variables that would drive payoffs. Could Kellogg seamlessly move its snack products into the Keebler distribution system? Due diligence suggested this was plausible. Could Kellogg achieve cost savings large enough to help offset the cost of the acquisition? Due diligence cautiously determined that the deal could deliver $170 million in cost synergies by year three. This justified the $42 a share paid for Keebler. In fact, Kellogg beat the synergy estimates by a wide margin, making the deal even more valuable than projected.
Focusing integration. Kellogg did not get bogged down in a massive integration effort in the immediate wake of the deal. Diligently following its investment thesis, it focused on getting its snack products into Keebler’s system as quickly as possible. Gutierrez and his team realized that, in many respects, this was a reverse merger – Kellogg was moving its snack business into Keebler’s operation, not the other way around. Keebler had the proven expertise in snacks and direct distribution, so Kellogg put strong Keebler managers in charge of expanding the snack business. David Vermylen, then the president of Keebler, committed to staying on board for three years to oversee much of the integration effort.
Correcting mistakes. Despite the decision to give Keebler executives control over the snack business, cultural conflicts soon emerged. Keebler was entrepreneurial and cost-focused, with a history of growing through acquisitions; Kellogg was none of those things. When Keebler CEO Sam Reed (who had been an icon to employees) departed within a year, it set off an exodus of talent – including David Vermylen, with a year and a half still left on his contract. This became a critical issue, directly affecting Kellogg’s investment thesis.
Kellogg had to scramble to keep the deal on track. Remaining focused on getting the benefits of DSD, Gutierrez put John Bryant, then the respected CFO of Kellogg USA (and now president of Kellogg International), in charge of the integration. Bryant’s top priority was to ensure that Kellogg’s snacks would move through Keebler’s DSD system on schedule. Once the key strategic imperative was fulfilled, Kellogg could address the broader integration issues, particularly the culture clash. An effort was launched to create a new set of corporate values, and a work exchange program was set up so that Kellogg and Keebler managers could share skills and perspectives.
When discipline fails: Newell’s big mistake
Another merger in the consumer products industry – Newell Co.’s 1999 acquisition of Rubbermaid Inc. – reveals the high cost of weak discipline.
When Newell approached Rubbermaid about a merger, it looked like a deal from heaven. Rubbermaid was very profitable and growing quickly. It was a blue-chip firm with a long history of innovation and a reputation as a smart brand marketer.
Newell was a veteran buyer. For three decades, it had aggressively built shareholder value by acquiring businesses such as Sharpie pens, Levelor blinds and Calphalon cookware. Because both Newell and Rubbermaid sold household products through essentially the same channels, Newell stood to reap considerable cost savings by combining operations. At the same time, it expected to enjoy the benefits of Rubbermaid’s high-margin branded products – low-tech plastic items that ranged from laundry baskets to toys – while strengthening a number of weak links in its supply chain management.
Rubbermaid’s executives were receptive as long as the deal could be done quickly, so Newell rushed to complete the $5.8-billion megamerger.
But the deal from heaven turned out to be the “merger from hell,” as Business Week dubbed it. Newell shareholders lost 50% of their value in the two years after the closing, and Rubbermaid shareholders lost 35%. In 2002, Newell wrote off $500 million in goodwill. “We paid too much,” said former chairman and CEO Daniel Ferguson, after the fact.
The failure can be traced to errors at each of the key decision points:
Flawed target selection. Newell knew its growth strategy required a big acquisition because its prospects for organic growth were limited. With Rubbermaid, Newell thought it was building its presence in household products as well as gaining a strong brand – just what it needed to go head-to-head with buyers at big discount chains like Wal-Mart and Target. But at a deeper level, the deal did not fit. While Rubbermaid and Newell were both selling household basics to the same customers, the two companies had fundamentally different bases of competition. Rubbermaid competed on innovation and brand, while Newell emphasized low-cost production. Their production processes and costs were different, as were their value propositions. They were actually in very different businesses, and Rubbermaid’s strategy wasn’t going to work for the markets that Newell was relying on.
Cursory deal assessment. Although Newell had made many modest acquisitions, Rubbermaid was an entirely different proposition. Neither minnow nor fish, Rubbermaid was a whale – 10 times the size of the largest acquisition Newell had ever attempted. Rubbermaid had also worked hard, within legal bounds, to make its business look a lot prettier than it really was.
By agreeing to complete such a huge deal after only three weeks of due diligence, Newell doomed itself to a cursory examination of Rubbermaid. Beneath Rubbermaid’s well-polished exterior, there was a raft of problems, from extensive price discounting for wholesalers to poor customer service to weak management. Newell never had a clear sense of how much Rubbermaid was really worth. “We should have paid $31 a share but we paid $38,” says Ferguson.
Over-integration. Newell took an undisciplined, broad-brush approach to combining Rubbermaid’s complex operations into its own. The putative investment thesis – to broaden Newell’s scope in branded products – should have called for selective integration. Instead, Newell attempted to “Newellize” Rubbermaid and, in the process, squeezed out what little top talent was left after the acquisition. Newell predicted $300 million in cost savings and $50 million in revenue increases in the first two years. But, when the dust settled in 2001, Rubbermaid had delivered no new sales and only $230 million in cost savings, most of it wiped out by increases in the price of polymer resins, the most important of Rubbermaid’s raw materials.
Faulty corrective mechanisms. Newell, a low-cost producer of largely unbranded housewares, had to learn how to leverage a high-margin brand when it bought Rubbermaid. It sorely underestimated this challenge. A warning system should have set off alarm bells, as synergies failed to materialize, new product introductions were late and key talent began to head for the exits. But it took the company a long time to fully tackle its problems. It wasn’t until two years after the merger, when Joseph Galli, a veteran of Black & Decker, arrived as CEO, that it launched a major overhaul to address the disconnect between cost control and innovation at the two businesses. By then, a lot of damage had been done. Newell has been fighting to regain its footing ever since, and began a second reorganization in 2005. In the middle of it, Galli unexpectedly resigned. But the company now appears to be making progress under its new CEO, Mark Ketchum.
The evidence on deals is overwhelming: experienced acquirers who reinforce their base business, who have done their homework and can put businesses together quickly and flexibly earn outsized returns on deals. Executives who don’t follow those practices only create outsized headaches.