Tragedy of the Commons in M&A

Attached is a piece on the tragedy of the commons in banking. It refers to a chain reaction (AKA herding?) in which the action of one bank triggers reactions from other banks leading to a dangerous race to the bottom in risk standards. It underlies the boom and bust cycles in many deal markets including M&A. As Ralph has noted in his anticipation article, once one competitor starts buying firms, others in the industry react. Early buyers tend to get better prices than late in the cycle buyers. Nonetheless, late in the cycle buyers are under pressure to “do something” so as not to be left behind. Hence they make over priced acquisitions. The key takeaway is firms do not operate in a vacuum and are influenced, sometimes negatively, to respond to competitor actions.

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Shuffleboard, Chess and the Pilgrim, Hillshire Deal

Business strategy can learn much from chess, but in many ways it is considerably more complex.    In chess and in business, it is not enough to envision your next moves, you must anticipate your competitor's response to those moves and the other actions they are taking.  Thus an game theoretic approach is essential.

But the chess analogy only takes us so far.  In business, moves are made simultaneously, not sequentially as in chess.  In addition, the rules of the game (think regulations) are frequently changing and the space (chessboard) on which you play is constantly changing.  Moreover, your competition is not a single opponent but every player in your industry and every player in related industries.  

In today's news, the analogy to shuffleboard also seems appropriate, where a well placed move is slammed aside by a competitor.  Hillshire Brands had wanted to acquire Pinnacle foods for some time.  Recently it made a $4.3 billion bid for the company touting the synergistic possibilities of the deal.  

Those plans were disrupted today as Pilgrim Foods (owned by JBS)  offered to acquire Hillshire for $45. a share, a 25% premium to recent market prices.  However, the deal is contingent on Hillshire abandoning the Pinnacle deal.  The market prices of Pilgrim and Hillshire rose while those of Pinnacle declined.  

Also, of interest, is that Hillshire was aware of the interest by Pilgrim over two months ago.  In chess, white moves first and has a slight advantage.  One can only wonder if the Pinnacle deal was responsive and defensive, designed to thwart the revealed interest from Pilgrim.  

Unlike chess, the market continually appraises the value of the players.  The market price of Hillshire closed above the bid price of $45.  producing a negative speculation spread.  Apparently, the market expects further revisions to the Hillshire bid.  (Additional details are found in the Wall Street Journal.)

All the best,

Ralph

Synergies and Anticipating the Competition

  Today's post continues the discussion of the 14 Keys to Acquisition Success that we posted in early September.  We are actually combining points five through nine in that earlier post.

5.   Beware of unrealistic projections.  Understand the source of synergies.  Why are these synergies available to you and not other buyers?

6.     Beware the winners curse – you win the auction not because you are the smartest, but because – you paid the highest price.

7.     Most deals fail to reach their full potential because of issues in integration. Don’t underestimate the costs and problems of integration.

8.     In mergers, 2+2 can equal 5, (3 is also a distinct possibility)!

9.     Think strategically, but understand that your competition is doing the same.

Mergers can be wonderful opportunities for value creation through synergies.  But synergies can also be negative (point 8).  When that happens it is usually because of unrealistic projections on the front end, inadequate due diligence, or poor integration (point 7).  Destruction of value also occurs when bidders overpay and Joe and I have warned repeatedly about hubris and the winner's curse (point 6).  That is, you 'won' the deal not because it creates value but because - you paid the most for it.  And given a world of smart, competitive bidders, this likely means you won not because you were smarter than the other bright lights in the room, but simply because you were willing to pay the most.  

But synergies do occur and mergers on average, create wealth for the target shareholders and even for the combination of target/bidder shareholders.  So how do you know where to look for synergies and how do you avoid overestimation?  The key is to look for your own sustainable, competitive advantage.  What is it that your company can do better than anyone else in the near future?  The point about the near future gets at the sustainable part.  Having a sustainable advantage in the long run, is of course, even better - but in the long run, most strategies and abilities can be copied or learned or acquired.

So we have to continually ask ourselves:  where do these synergies come from?  And, at least as important - why is no one else able to achieve the same synergies?  What is it that makes them unique between our firm and the firm we are acquiring.  Remember that if the synergies were not unique to our firm, it is likely that other firms would be bidding as well.

Finally, and related to all of the above - think strategically.  It is simply not good enough to anticipate your next moves or acquisitions assuming that the status quo in your industry is maintained.  There is a tendency to project our cash flows assuming our competitors are not also anticipating and adapting to the future.  So think strategically, but understand that your competition is doing the same (point 9).

All the best,

Ralph