Book Review: The M&A Failure Trap

The M&A Failure Lure: Why Most Mergers and Acquisitions Fail and How the Few Succeed. 2024. Baruch Lev and Feng Gu. Wiley.

At an early-Nineteen Eighties presentation by a number one funding financial institution to a enterprise college alumni group, the financial institution’s CEO was confronted through the Q&A session in regards to the excessive failure charge of company mergers and acquisitions (M&A), from which Wall Avenue derives a major chunk of its revenues. The CEO responded by stating that corporations’ inside tasks — their investments aimed toward constructing companies from scratch slightly than shopping for them — additionally fail at a excessive charge. He didn’t point out the perverse incentive whereby divestments made within the wake of failed acquisitions generate extra charges for bankers. Neither did he cite any knowledge on comparative success ratios of inside and exterior company progress initiatives.

Because of Baruch Lev, professor emeritus of Accounting and Finance on the New York College Stern Faculty of Enterprise, and Feng Gu, chair and professor of Accounting and Legislation on the Faculty of Administration, College at Buffalo, we now have an authoritative measure of the M&A failure charge. Lev and Gu outline failure by way of post-acquisition gross sales and gross margin developments, inventory efficiency, and goodwill write-offs. Based mostly on a pattern of 40,000 transactions over 40 years, they discover that 70% to 75% of M&A offers fail. That’s twice the 36% failure charge for inside tasks reported by challenge administration utility service supplier Wrike, Inc.

As if these figures weren’t sufficiently dismaying, Lev and Gu report in The M&A Failure Lure that the failure charge is on the upswing. Acquisition premiums have risen, and common goodwill write-offs have gotten bigger. Furthermore, conglomerate acquisitions — purchases of corporations unrelated to the acquirer’s core enterprise—have made a robust comeback.

This comeback has occurred regardless of the de-conglomeration of many of the extensively diversified company giants of the Sixties — after their shares traded at reductions to centered corporations’ shares and administration failed to supply the synergies they claimed would emerge from their frenetic dealmaking. Lev and Gu additional observe that the utilization frequency of “synergy” in company merger bulletins tripled between the 2000s and 2010s.

Traders will discover this guide a useful useful resource. Along with being referred to as upon to vote on main M&A proposed transactions, shareholders generally undergo horrendous losses because of ill-conceived and poorly executed acquisitions. Based mostly on rigorous statistical evaluation of their big pattern of offers, the authors establish 43 various factors that improve or detract from the likelihood of success.

For instance, the bigger the deal dimension, the upper the proportion of the cost for the acquisition that’s made within the acquirer’s inventory, and the upper the S&P 500’s return within the yr previous the transaction, the larger the likelihood of failure. Lev and Gu condense their evaluation right into a 10-factor mannequin that’s sensible for traders to make use of in assessing the deserves of a potential merger.

The authors leaven their considerable quantitative element with colourful prose. They complement their quantitative findings with case research of each profitable and unsuccessful M&A. Such distinguished offers as Hewlett Packard/Autonomy, AOL/Time Warner, and Google/YouTube are examined for clues that may predict the fates of future transactions.

Lev and Gu don’t shrink from figuring out culprits as they discover the underlying causes of the excessive M&A failure charge. These embody (of their phrase) “commission-hungry funding bankers.” Additionally they level to overconfident CEOs and boards of administrators who, regardless of substantial proof on the contrary, think about {that a} transformational acquisition can pull an organization’s profitability and inventory efficiency out of the doldrums. CEOs obtain additional compensation for finishing such transactions however aren’t penalized if the transactions fail.

Flawed incentives for CEOs additionally assist clarify the above-mentioned resurgence of conglomerate acquisitions. Spreading an organization’s operations throughout a variety of unrelated companies offers no real profit to shareholders, who can diversify on their very own by holding shares of corporations in many alternative industries.

In distinction, the supervisor of a single-line-of-business firm has no hedge in opposition to an business downturn that can adversely have an effect on CEO compensation. Spreading threat by reworking the corporate right into a conglomerate makes strategic sense for the CEO, who has a extra direct say than shareholders within the matter.

Along with describing this kind of company value and presenting in depth proof that companies ought to strongly contemplate inside funding as an alternative choice to acquisitions, particularly contemplating the buy-rather-than-build route’s regularly formidable integration challenges, the authors deal with accounting points which might be pertinent to M&A, such because the subjectivity of the truthful worth estimates required for calculating goodwill.

This dialogue attracts on Lev and Gu’s experience in monetary reporting, as displayed of their pathbreaking The Finish of Accounting and the Path Ahead for Traders and Managers (2016), reviewed right here in June 2017. Additionally they write in regards to the disturbing phenomenon of acquisitions made with the intention of terminating a profitable competitor’s operations.

It on no account diminishes The M&A Failure Lure’s total excellence that it contains a few mistaken citation attributions. Publishers must instruct their editors to utilize Quote Investigator®. Had this guide’s editors checked that indispensable web site, they’d have discovered that there isn’t a dependable proof that P. T. Barnum ever mentioned, “There’s a sucker born each minute.”

That’s an instance of an nameless saying being put within the mouth of a well-known particular person, as occurs with many aphorisms. Equally, within the case of “It’s troublesome to make predictions, particularly in regards to the future,” which Lev and Gu (together with many different writers) attribute to the physicist Niels Bohr, Quote Investigator concludes that the writer of the “comical proverb” is unknown. Bohr died in 1962, and no revealed linkage of his title to the witticism previous to 1971 has been discovered.

However these very minor editorial shortcomings, The M&A Failure Lure should be judged a rousing success. Huge M&A offers make headlines however too hardly ever earn cash for stockholders. “Fondly will we hope, fervently will we pray” (sure, Abraham Lincoln did really use these phrases in his second inaugural deal with) that the company executives, administrators, and traders to whom the guide is addressed will imbibe its essential message and adapt their future conduct in keeping with its precepts. The discount in wealth destruction that would end result from such a change would signify a colossal societal acquire.