Why do companies want to merge?
From a purely positive or optimistic perspective, companies must conduct mergers and acquisitions in order to achieve the following goals:
- Acquire technology and R&D team.
- Obtain marketing or sales network channels.
But in fact, most corporate mergers and acquisitions are not the case. There are mainly the following common reasons:
- Hostile mergers and acquisitions: There are many reasons for hostile mergers and acquisitions, such as coveting the huge profits of the target company, especially private equity companies most like to adopt this kind of merger. Or simply want to obtain a controlling stake in the company in order to carry out a reorganization that is beneficial to himself.
- Eliminate potential competitors: The best example is the integration of Facebook (ticker: META) into its WhatsApp and Instagram. In fact, more than ten years ago, Microsoft (ticker: MSFT) also used the same method to eliminate potential competitors.
- The institutional imperative: This is the most common reason given to shareholders by listed companies, that is, corporates do mergers and acquisitions just for mergers and acquisitions. And usually the scale is not small, the cake (prospect) is drawn very large, and most of them end in failure. Regarding the institutional imperative, please refer to my other article “Institutional imperative – the good, bad, and ugly” for detail.
Where does the fund come from?
We are talking about large sums of fund here, not small sums of fund. It can be roughly divided into three categories:
- If the private equity business is the acquirer: They incline to take the assets of the acquired party, pledge to the bank, and borrow. It is mostly used in the case of privatization, or taking advantage of the situation of looting. Private equity players usually only hold it for five years, after reorganizing the company, waiting for a better appearance, repackaging and going public, arbitrage, and then find the next goal to repeat the same method.
- Unlisted companies: Generally speaking, companies are small in scale and have not yet been listed, so financing channels are limited. The smaller it is, the less conducive it is to financing. They can only be controlled by others. Even if banks agree, the interest rate is very high; therefore, many can only find private equity or venture capitalists, but the price paid is very high, and considerable control power of stake must be sold. This is also the reason why companies must go public to avoid being dominated by others when they need to raise money. Please see my article “Why company go public?” on this topic.
- General listed companies: generally do not get rid of three ways:
- Issuing new shares (the worst practice, it will greatly dilute the shareholders’ interest, but it is the easiest and most common way).
- Issuing corporate bonds (it will also dilute equity and also have interest pressure)
- Borrowing from the bank (it has big pressure of interest). If the market value (in fact, the shareholder’s equity ratio) is too low, it will increase the long-term debt ratio and cause the company’s valuation to fall.
Why do most mergers and acquisitions end in failure?
I mentioned it in the book “The Rules of Super Growth Stocks Investing“, section 4-1; countless examples in business history prove that less than one-fourth of corporate mergers and acquisitions are successful. But why?
- Institutional imperative: Because most of the mergers and acquisitions are the result of the chief executives’ expansion of their powers and their ‘personal’ success. No surprises, failure is the inevitable result. However, it is difficult for investors and small shareholders to know, and the financial report is not visible at all.
- Overwhelmed by huge borrowings: For mergers and acquisitions, a large amount of money must be raised. Most companies do not spend money in the private pockets of the management team. In order to complete the merger, they usually accept interest rate conditions that are not conducive to shareholders and bear a large amount of money. In the long run, few companies can bear the burden of interest, and paying interest will put the company at a long-term financial disadvantage. What’s worse is to sell the interests of shareholders and dilute the equity.
- Few employees of the incorporated company can stay (unless the conditions are set first), and after one to two years, they usually leave voluntarily or involuntarily. When people are gone, the technology, or market, and access that were claimed at the beginning are simply impossible to stay.
- Except for a few exceptions, there are few employees of the incorporated company, even if they are willing to stay, generally speaking, it is impossible to integrate into the new company.
Investing Gurus’ Views
This is why Peter Lynch called it “diworsification”, the corporate mergers and acquisitions shown the reason for the miserable management.
Buffett wrote in his 1997 shareholder letter: “In some mergers there truly are major synergies — though oftentimes the acquirer pays too much to obtain them — but at other times the cost and revenue benefits that are projected prove illusory. Of one thing, however, be certain: If a CEO is enthused about a particularly foolish acquisition, both his internal staff and his outside advisors will come up with whatever projections are needed to justify his stance. Only in fairy tales are emperors told that they are naked.”
Companies that are more successful in M&A
As far as the industry I know better, it is similar to the survey, that is, most of the original M&A purposes cannot be achieved. Among the super-large U.S. stock-listed companies, I think two of them can be good examples of other companies:
- Accenture (ticker: ACN): Accenture has been very successful in mergers and acquisitions, and there are many that can be used as role models for other companies:
- Limited to only small company mergers and acquisitions, the risk is relatively small.
- Basically every M&A case has a clear purpose, mainly to obtain the latest technology, or a team of professionals.
- Accenture itself is the world’s largest consulting company, with its own unique methodology, which is Accenture’s core competence. The company uses this method to ensure how the acquired company personnel integrate into Accenture.
- Accenture’s former parent company was one of the world’s top five accounting firms, and every merger and acquisition has been reviewed for financial risks assessment.
- Apple (ticker: AAPL): The five major technology giants, because they have a lot of cash piled, most of their mergers and acquisitions are paid in cash, which will not affect their financial health, mainly because they have too much money. Apple is more exaggerated and different from the other four:
- The purpose of its mergers and acquisitions is mainly to obtain the latest technology, or a team of professionals, and it is very low-key, not publicity, so there is little resistance.
- Apple prefer small startups and rarely conduct mergers and acquisitions of more than 100 million US dollars. The purchase of Intel’s mobile phone chip division three years ago and the previous purchase of HTC’s Beats are the rare large-scale mergers and acquisitions in my memory.
- CEO Cook revealed in 2019; Apple acquires a company every two weeks on average.
Mergers and acquisitions are not a panacea for the growth of enterprises, and they are not worthy of the help to the company. Most of the mergers and acquisitions are blind, waste of resources, and even detrimental to the value of the enterprise itself. In short, most of them are mergers and acquisitions for the sake of mergers and acquisitions, and the reasons are far-fetched.
The data speaks for itself. According to a report by Dr. Zhang Hua from China Europe International Business School (CEIBS): from a global statistical perspective, the failure rate of corporate mergers and acquisitions exceeds 50%. In China, the failure rate of corporate mergers and acquisitions exceeds 60%, and the failure rate of cross-border mergers and acquisitions exceeds 80%.
- “Why most mergers and acquisitions end in failure?“
- “How Buffett Views Mergers and Acquisitions“
- “Buffett’s Acquisition Criteria“
- “Berkshire’s acquisition model“
- “Why Buffett prefers minority stake to entire company?“
- “Institutional imperative – the good, bad, and ugly“
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