Smart deal-making: how to use mergers and acquisitions to create value

How to use mergers and acquisitions to create value

Deal-making is back in vogue. In 2004, global M&A activity climbed 41% over the previous year; in Canada, it jumped 71%. Behemoth deals have dominated the M&A agenda: SBC/AT&T, Manulife/John Hancock and Jean-Coutu/Eckerd, just to name a few. But success at deal-making is no small feat. Nearly all studies (including our own at Bain & Co.) have shown that only three in 10 large deals create meaningful value for shareholders; half actually destroy value. Yet many great companies were built on deals. In fact, Bain's research has found that companies with a strong history of deals earn higher returns than those that do few or none at all. Think of GE, Thomson Corp., Alcan, or Power Financial, which have all flourished through smart deal-making.

It's a classic damned-if-you-do, damned-if-you-don't conundrum. What do successful deal makers do differently?

Build expertise with lots of small deals: Rather than engaging in mega-mergers, top deal makers execute a series of smaller, lower-risk deals, sharpening their skills at evaluating and integrating companies and institutionalizing a success formula before moving to larger deals.

Stay close to the core: Our work and research underscore the value of using deals to bolster a company's core business, as opposed to moving into far-flung adjacencies. Deals that grow a company's scale, by adding similar products or customers, have a higher probability of success. Deals that expand a company's scope, by adding new customers, products, markets or channels—such as Laidlaw's acquisition of ambulance service providers—often disappoint.

Invest with a thesis: Top deal makers develop a clear investment thesis, explaining why and how an acquisition will make their business stronger. The stock market is good at detecting deals with poor investment theses. If an acquirer's stock drops more than 10% relative to industry peers just after a deal announcement, odds are 75% that the share price will still be down one to two years out.

Ask and answer the big questions: Too often due diligence is little more than an “audit,” collecting reams of data but failing to tell executives what they need to know. Top deal makers zero in on the big questions—the ones that, once answered, will demonstrate whether the investment thesis will pan out. What's critical isn't how much you know; rather, it's determining what you don't know and should know, and then nailing that information down.

Corporate buyers can learn a great deal from private equity firms like KKR, Bain Capital and Onex. These firms don't assume they know the business they're buying. They take a critical outsider's view of the company and its market, and don't take for granted anything about its future prospects. Instead, they answer the big questions by building a view from the ground up, getting the information they need first-hand from customers, suppliers and competitors.

Integrate quickly where it matters: Many companies take a holistic, work-plan-centric view of integration. The truth is, only a few integration activities really drive the success of a deal. Scale deals require extensive integration; the holistic approach may be valid in such cases, but companies must home in first on integration activities that will achieve the largest cost savings or revenue gains. Scope deals call for more selective integration, in specific areas where the operations overlap. In all cases, it is critical to move quickly and ensure that the majority of employees stay focused on running the base business.

Expect the unexpected: No deal goes exactly as planned. The best deal makers expect to hit a few potholes. They install early-warning systems to detect problems, and tackle them as soon as they emerge. They distinguish 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 decisive action to put their deals back on track.

One example of a frequent deal maker that has created outstanding shareholder value is Power Financial. Through two of its key holdings, Great-West Lifeco and Investors Group, it bought London Life in 1997, Mackenzie in 2001, and Canada Life in 2003. Power chooses its targets wisely—selecting companies that are close to its core business—and does its due-diligence homework. Power also integrates quickly where it matters, and learns from experience. When Great-West bought London Life, it achieved half the expected synergies in the first year. Six years later, with Canada Life, it banked 85% of expected synergies within the first year. It succeeded to a good extent because experience taught Power's team what few critical integration decisions had to be made at the outset. Power's discipline paid off, and shareholders benefited. One dollar invested in Power Financial 15 years ago would be worth $21 today—compared with only $8 if you invested the same dollar in the financial services index.