Creating value in M&As
Understanding the key types of strategic rationale for acquisition is the first step towards success
By
Till Vestring And Mike Booker
CURRENT mergers and acquisitions (M&A) transactions under discussion in Singapore are worth a staggering $60 billion - exceeding the total value of transactions completed during the past five years. Many of these could fundamentally alter the nature of competition in businesses such as banking (OCBC/Keppel Capital; UOB/OUB), airlines (SIA/Virgin Atlantic), telecommunications (SingTel/Optus, SCV/StarHub) and contract manufacturing (Solectron/NatSteel).
As some of these deals begin to close, the management teams of the acquirers will need to shift their focus to realising the full value of these transactions. But the odds will be against them, with studies showing that only 25 to 50 per cent of acquisitions create shareholder value.
Looking at recent M&A transactions in South-east Asia, there have been a number of notable successes, such as Malaysia Tobacco Company (BAT/Rothmans) where the share price has risen 50 per cent since the merger announcement, while the KLSE Index has gone up only 10 per cent.
However, the jury is still out on several other high-profile deals such as Cycle & Carriage/Astra, where a significant portion of the initial investment has been written off, and DBS/Thai Danu which has only just started to show a profit after three years of sizeable losses.
So what can acquirers learn from history? Fortunately for them, the pitfalls are well known - poor strategic rationale, overpayment, inadequate integration planning and poor execution, lack of leadership and communication and severe cultural mismatch.
Getting it right
Of these, getting the strategic rationale right is crucial. Being clear on the nature of the strategic levers is critical both for pre and post-merger activities. Indeed, failure in this regard can trigger the four other causes of failure. The strategic rationale will determine the valuation of the merger, what leadership and communication style to adopt, how to plan for post-merger integration and how to manage the cultural integration.
The entire integration approach needs to be highly tailored to the strategic rationale and focused on the few drivers of value for the combined entity. Too many companies follow a 'cookie cutter' approach to merger integration, leading to an overly complex approach that does not deliver what shareholders, management, customers and employees expect.
Therefore, understanding the key types of strategic rationale is the first step to creating value. So what are the key types of strategic rationale? How do they impact the integration approach? And what are the key success factors?
There are six key strategic rationales for M&A activity and these lie on a continuum, from deals that play by the rules of merger transactions and integration to those that transform the rules.
The first rationale is active investing. This is where, for example, a private equity company acquires a business and runs it more effectively. This is achieved through a combination of financial engineering, management changes and incentives, aggressive cost reduction and selling non-core assets. As such, these deals do not change the rules of competition.
For instance, when Schroder Capital Partners acquired Parkway, it created value through the sale of the non-core properties business and through cost reduction, revenue enhancement and regional expansion in the healthcare business leveraging on Schroder's experience in this sector.
Growing scale is based on gaining scale in specific elements of a business and using these elements to become more competitive overall. Getting scale-based initiatives right requires correct business definition and correct market definition.
For example, DBS became the leader in retail banking and significantly increased local scale through the acquisition of POSB. Merged Neptune Orient Lines and APL became a top five global container shipping line achieving global scale. Both these mergers reaped substantial synergy benefits.
Building adjacencies entails expanding into highly related or adjacent businesses - that is, new geographic markets, new customer segments or new products. Most importantly however, the new business must be closely related to a company's existing business.
Raffles Holdings pursued adjacent expansion through its acquisition of Swissotel Hotels & Resorts. This provided substantially increased global reach and a portfolio of four-star hotels to complement Raffles' predominantly five-star hotel portfolio. SingTel, SIA, PSA and DBS are further examples of Singapore-based companies that are trying to build adjacencies by acquiring businesses overseas.
Almost all recently completed deals and deals under discussion in Singapore are driven by either scale or adjacency rationales. For these deals it is possible to 'plan by the numbers'. One can, in advance, calculate goals for combined market share and cost reduction, plan steps to achieve them and create measures for performance improvement. These types of merger place great demands on a CEO's ability as a manager to cope with complexity. The task may not be easy, but the leader can craft a plan before the transaction and execute it after the merger. The key success factor for these deals is a high-quality and flawlessly executed integration plan.
Broadening scope entails buying companies to either accelerate or substitute for in-house new business development or R&D. GE Capital, Cisco and Intel are global examples of companies using the scope acquisition model. For these companies, organic development would be too expensive, too slow and/or would dilute focus on their existing businesses. Faced with losing its exclusive distributorship of Mercedes in Singapore, CCL, which also assembles and distributes vehicles in Malaysia, broadened its scope of involvement through the acquisition of Astra in Indonesia. Increased scope included among other things: auto component manufacture, finance and insurance, motorcycle assembly, distribution and finance, and heavy equipment assembly, distribution and leasing.
Redefining the business is an appropriate strategic rationale when an organisation's capabilities and resources grow stale very suddenly due to, for example, a major technological change. In such cases a firm cannot refresh its technology or knowledge quickly enough through organic means.
The proposed merger of SCV and StarHub has the potential to redefine both businesses. StarHub could deliver fixed telephony services over SCV's cable network and the merged entity would be Singapore's first integrated communications provider, offering broadband Internet, cable TV and fixed and wireless telephony.
The last rationale is redefining the industry. Sometimes a bold, strategic acquisition can redefine an entire industry, changing the boundaries of competition and forcing rivals to re-evaluate their business models. For example, the AOL/Time Warner merger could potentially rewrite the rules for communications and entertainment. Beyond creating new distribution channels for content, and new content for the Internet, the merger could allow the new company to choose to take profit in either content or distribution, depending on customers' preferences. No other competitors have this choice.
The acquisition of HKT by Pacific Century CyberWorks is the closest we have seen to this in the region, with CyberWorks attempting to create a regional broadband media powerhouse by using HKT's traditional business model and strong cash-flow to develop a new, Internet-based business model.
Very few of Singapore's, indeed Asia's, M&A deals are based on these last two rationales. It is difficult, if not impossible, to forecast the financial results of new entities created by such deals. Vision and business model are more crucial than clear targets for cost reduction. The post-merger integration plan will be much less detailed and more flexible than that of a scale or adjacency transaction. The key success factor for integration in these types of merger is bold leadership. The stellar rise and subsequent crash of CyberWorks is a clear warning of how difficult and risky it is to attempt to redefine an industry.
Thus a transaction's strategic rationale is ground zero for planning and the foundation for capturing the value that spurred the acquisition. It will be critical for business leaders in Singapore involved in M&A to clearly understand and articulate the strategic rationale for the deal and to tailor the integration plan, leadership and communication accordingly.
In the next article, we will explore in more detail the different approaches to integration for each strategic rationale.
Till Vestring is the global head of Bain & Company's Merger Integration practice and a partner and vice-president in Singapore. Mike Booker is a manager with Bain & Company in Singapore and has extensive M&A experience in South-east Asia.
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