Here We Go Again?

The best of deals are made in the worst of times while the worst deals are made in the best of times. We may be seeing a replay of this mantra in the current M&A market. Coming off a deep post crash low, M&A activity has sharply rebounded. This reflects a recovering economy, booming capital markets and rising managerial and investor optimism. The activity is driven by strategic buyers instead of private equity. The number of large deals over $5B has also increased. Larger deals are froth with danger given the potential to over pay and heightened integration problems associated with larger deals. The buyer’s shareholders usually react negatively to the announcement of such deals-and for good reason. Their track record underlies this reaction; namely, 50% of targets are disposed of within 10 years of the closing.

Yet, such deals are now receiving a largely positive response from the buyer’s shareholders. Some possible explanations for this development include:

1)     Buyers are getting better at making acquisitions (AKA this time is different).I have seen no evidence to support this possibility.

2)     We are early in economic and M&A cycles. Thus as the cycle continues we will see mean reversion.

3)     Shareholders are confusing size and growth with value creation.

My concern is a toxic brew may be developing. This brew includes investor bias towards growth combined with managerial overconfidence. Board selection of CEOs favors over confident CEOs who are viewed as decisive optimists. The process favors the lucky risk taker with a “successful” track record -think of past Hewlett Packard CEOs Carly Fiorina and Leo Apotheker who both engineered disastrous acquisitions.

So what can boards do to prevent future over priced ill conceived acquisition disasters? It is unlikely subordinates will question CEO’s who want to do the deal. What is needed is a strong experienced lead independent director who can challenge-not second guess- large scale transactions by considering the following:

1)     Does due diligence support the deal’s thesis?

2)     Is there a detailed integration plan based on the strategic rationale of the deal?

3)     Have competitor responses been considered?

4)     How will changing economic and industry conditions impact deal economics?

5)     Are CEO incentives tied to the success of the acquisition?

The real key is to run alternative stress case projection scenarios reflecting what could go wrong not just what is expected. A useful approach is to consider what could cause your deal to fail financially in the next few years. If you cannot think of any - then think again - they are out there.

J

Forgive Them (Not)-They Do Not Know What They Do: Hewlett Packard Again

Hewlett Packard’s (HP) Autonomy acquisition is back in the news again. I previously covered this tale of woe back in 2012. HP was the target of lawsuits following the botched acquisition. The terms of a recently settled suit are pretty interesting. How HP missed “accounting irregularities” so large that they were forced to write-down $8B of the $11B acquisition soon after the close has always puzzled me.

As part of the settlement HP agreed to establish an M&A related risk committee to incorporate the views of the investment, finance and technology committees - now there is a novel thought (get other points of view). Also, they will require their due diligence teams to be better trained - you mean they have to know what they are doing? My God, now they decide to better handle M&A risk and due diligence more than three years after the disastrous Autonomy deal! What were they doing before that deal and since it closed? To be fair this is probably legalese - form over substance.

What I find especially appalling is that the current CEO, Meg Whitman, was one the board members who approved the deal over the objections of HP’s CFO - so much for accountability! You don’t need enhanced risk committees and better due diligence to know that it is a BIG-BIG-BIG red flag if the CFO objects to a deal. Some other less obvious indicators include:

1)     Pressure to grow: looking to cover up weak core operations with a large acquisition is always troublesome as was the case here.

2)     Transformation: big acquisitions away from your core rarely end up well.

3)     Over Priced: the CFO objected, inter alia, that the deal was massively over priced at 11X sales v comparables at 3X.

4)     Dissenting views ignored: like the CFO’s.

5)     Weak Due Diligence: everyone knew the answer the then CEO wanted and no one was going to stand in the way-at least not if they liked their job.

The incident is another example of a board rubber stamping the CEO’s wishes. Of course boards cannot run the firm. This does not excuse boards from exercising some minimum of oversight and basic judgment. This is critical when the board’s CEO selection track record is weak - as it was with HP prior to Autonomy with substantial CEO turnover. CEOs are frequently selected based on luck not skill. A CEO candidate who has a “successful” track record is deemed skillful, when in fact he could have been simply lucky. Such CEO candidates are frequently over confident AKA decisive. Thus, absent a strong board they are prone to behavioral errors in an acquisition setting.

J

Hell or High Water Deals

I enjoy reading the M&A Law Professor blog, and often find it quite relevant to the types of things we think about at MergerProf.  Such is the case with last weeks link to another post about Hell or High Water Deals - deals that are designed to close no matter what - once they are signed, they close.  No major MAC clauses, etc.  The post contains a cute animated video illustrating some of the concepts involved and noting some of the great problems from the sellers point, of a deal not closing (loss of morale, loss of employees, uncertainty, etc.) [I know it is a link to a link, but let's give credit to the place where I read this.] The post also notes that deals that close 'no matter what' are extremely rare.  Well, maybe.  It seems to me that the Dow Chemical - Rohm and Hass deal came pretty close.  After the financial crisis Dow tried to walk away from the deal and found that they couldn't.  But anyway, enjoy the post.  You can find it here.

Due Diligence in M&A: HP, Quaker, BMW, Daimler, Mattel, etc.

In our last post, Joe commented that there were No Do Over's in M&A.  Indeed!  Why do disasters occur?  We've discussed many reasons in this blog, from Any Deal is a Bad Deal at Some Price, to The Winner's Curse, and many others.  And we've noted that Value is Estimated, Price is Paid.  But in many cases, errors in estimated value should be caught in the due diligence process.  Due Diligence is a crucial step in verifying assumptions and representations, assessing risks and beginning the integration process.  Too often it is fraught with errors.   Firmex provides the following list of the top ten due diligence disasters in M&A.  Quite an interesting list.

All the best,

Ralph

[Via: Firmex: Virtual Data Rooms]