Mergers succeed by following the rules

Sunday, March 27 
St Louis Post-Dispatch Business F7
"Mergers succeed by following the rules"


St. Louis stalwarts are part of the acquisition flurry.
Mergers are back. More mergers and acquisitions were done in 2004 than in the previous three years combined. The pace has accelerated even more in the last five months.

Nationwide, according to Thomson Financial, December's $147 billion in deals was the biggest month since October 2000. January's $138 billion was the largest for that month since 2000. St. Louis companies are in the thick of the activity. Most notable are the recent announcements that Federated will buy May Department Stores and Lee Enterprises will buy Pulitzer Inc., owner of the Post-Dispatch.

With all the activity, however, most acquisitions and mergers fail to create value for their shareholders. A McKinsey & Co. study found that 72 percent of large companies destroyed value through their acquisitions.

Yet, some companies create enormous value that way. Another McKinsey study looked at 16 major companies that made at least 10 sizable acquisitions. These firms outperformed the overall stock market by almost 50 percent. The same study also looked at 37 large financial buyers. They averaged returns above 25 percent annually, "with many producing returns above 40 percent."

Let's look at the clear set of rules these successful acquirers follow:

 

  • Make only acquisitions that fit your existing strengths.  Diversification destroys value. Related acquisitions have a 40 percent greater chance of creating value than unrelated acquisitions, according to the first McKinsey study. Stay in business areas you know well and where you have above-average management capabilities. Develop a disciplined profile for acquisition candidates, and stick to it

 

  • Make smaller acquisitions... they succeed far more often than large acquisitions. The first McKinsey study showed that small acquisitions (less than 10 percent of the size of the acquirer) are twice as likely to succeed as larger ones. Large acquisitions pose greater political and cultural challenges than smaller ones. You'll spend too much time managing conflict.
  • Don't overpay. In his 1997 book "The Synergy Trap," Mark Sirower, then at the Wharton School of Business, found that value is destroyed linearly with the premium paid for an acquired company. Acquisition premiums average 35 percent for contested acquisitions vs. 20 percent for friendly mergers. Therefore, takeovers tend to destroy more value. Sirower also found that acquirers are more prudent when paying with hard cash than with stock.
  • Use the best experts. Don't try to do it all yourself. "It's terribly important to have the right team," said Alan Johnson, senior vice president of KV Pharmaceutical and founding partner of the Clayton law firm Gallop Johnson & Neuman. "Your lawyer, investment banker and CPA can each be crucially important.



"Operating executives often can't devote the necessary time to the deal while also doing their regular jobs. Also, they usually don't have the depth of skills and experience in mergers and acquisitions."

Several St. Louis companies are among the 28 percent of acquirers who succeed. Two excellent local examples are Emerson Electric and Harbour Group of Clayton. Let's take a look at how Harbour Group does it.

To begin with, Harbour Group sticks to its strengths - acquiring and operating smaller companies in fragmented, low-tech, manufacturing and distribution industries. Harbour Group's disciplined profile of candidates has two crucial characteristics due to their small size: They have lots of overhead - great opportunity for cost reductions - and they can be acquired for earnings multiples significantly below those of larger companies.

Harbour Group first makes what is called a "core" acquisition in an industry. Alone, this acquisition won't create a lot of value. But then, Harbour Group acquires a series of smaller companies in the industry, "tuck-ins," and merges them into the core business.

In the first year, Harbour significantly increases the new entity's profit by eliminating redundant plant and administrative overhead. Then, it uses its operations expertise to increase sales and operating profit. After several acquisitions and internal growth, its industry position reaches critical mass. The goal then is to take the combined company public or sell it to a strategic buyer.

According to its Web site, Harbour Group's sales and profit have grown more than 25 percent a year since its beginning in 1976. That means a $10,000 investment would have grown to $6.5 million.

Harbour Group demonstrates that mergers can create huge value through disciplined execution of compelling rules.

 

 

 

 

Bill Finnie, a business consultant and adjunct professor at Washington University, writes about the do's and don'ts for success.

E-mail BIll  This e-mail address is being protected from spambots. You need JavaScript enabled to view it.

The St. Louis Post-Dispatch and William C. Finnie share the copyright on this column. Individuals and their organizations may use these columns for their internal use. Publication for use outside of your organization, however, requires written permission from the St. Louis Post-Dispatch or William C. Finnie.