Why mergers fail

In the corporate world, there's probably nothing more exciting--or risky--as mergers and acquisitions. Why do companies merge? Why do they fail?

Mergers and acquisitions, M&A, business development, strategic development, corporate development, there are lots of names for the business of acquiring companies. They all sound important, even exciting. But whoever said, "may you live in exciting times," didn't necessarily mean that to be a prophecy of good things to come.

On the contrary, if you're like most investors, employees or executives, it's more of a curse. You see, in the corporate world, exciting usually means risky. And there's probably nothing riskier or more prone to failure than merging with another company.

I can cite lots of studies, but anyone in the business knows that most big mergers fail. Moreover, companies that have demonstrated a competency for acquiring companies--like Cisco and Broadcom, for example--are few and far between.

Just to be clear, for purposes of this post, we'll use the terms merger and acquisition interchangeably. The difference is primarily related to accounting, and nobody gives two beans about that...except the accountants.

So, what exactly is a failed merger? I define it two ways. Qualitatively, whatever the companies had in mind that caused them to merge in the first place doesn't work out that way in the end. Quantitatively, shareholders suffer because operating results deteriorate instead of improve.

Here's a list of 10 notorious failed mergers that I've evaluated in one way or another: AOL/Time Warner, HP/Compaq, Alcatel/Lucent, Daimler Benz/Chrysler, Excite/@Home, JDS Uniphase/SDL, Mattel/The Learning Company, Borland/Ashton Tate, Novell/WordPerfect, and National Semiconductor/Fairchild Semiconductor.

Some failed so spectacularly that the combined company went down the tubes, others resulted in the demise of the executive(s) that masterminded them, some later reversed themselves, and others were just plain dumb ideas that were doomed from the start.

In my mind, the two big questions are: Why merge to begin with? Why do mergers fail?

Companies merge when, for one reason or another, their strategic plans indicate they should. I know that sounds trite, but there are too many permutations to go any deeper.

That being the case, there must also be operating synergies between the two companies. In a nutshell, that means the whole will be financially healthier than the sum of the parts. Said differently, at some point after the merger is complete and the companies are integrated with redundant functions eliminated, shareholder value should increase. It's as simple as that...theoretically.

I experienced one merger firsthand: National Semiconductor's acquisition of Cyrix. On the surface, the deal seemed to make sense. National needed Cyrix's microprocessor technology to realize its strategic vision of becoming a system-on-a-chip company. Cyrix needed National's manufacturing technology to effectively compete with Intel.

However, once you got down beneath the surface, well, let's just say there were holes in the strategy so big you could drive a truckload of MBAs through them. This is in hindsight, mind you. Some of it I saw coming, some of it I didn't.

First, National's own strategy was flawed, merger or not. The market for its Cyrix-based system-on-a-chip products never really materialized.

Second, National didn't anticipate what competing head-on with Intel would do to its own operating results.

Third, when Cyrix's designs were produced in National's fabs, the chips didn't perform as hoped. That's about the most even-handed way I can put it.

As if that wasn't enough, National was probably too heavy-handed with its integration strategy. The two companies were culturally incompatible, and most of Cyrix's top engineers quit when their retention agreements expired.

The result was ugly. National's operating results went from black to red immediately following the merger, and the combined company continued to hemorrhage red ink until National sold most of Cyrix. A year and a half and more than $1 billion in cumulative losses and write-offs later, National was back to normal.

It's important to note that the usual three-month due diligence process didn't uncover any of the potential flaws in the deal. That's because merger due diligence processes typically have only one goal--to shield executives and directors from shareholder litigation. That, the companies did successfully. Shareholders lost their class action suit.

In summary, the planets have to align for a merger to be successful. In other words, for every way to do a merger right, there are probably 10 ways to do it wrong.

Here are my top 10 most common, preventable merger failure modes. One is enough to spell doom, but the more the merrier the train wreck:

1. Flawed corporate strategy for either or both companies
2. One company sugarcoats the truth, the other buys a PowerPoint pitch
3. Sub-optimum integration strategy for the situation
4. Cultural misfit, loss of key employees after retention agreements are up
5. Acquiring company's management team inexperienced at M&A
6. Flawed assumptions in synergies calculation
7. Ineffective corporate governance, plain and simple
8. Two desperate companies merge to form one big desperate company
9. CEO of one or both companies sells board and shareholders a bill of goods
10. An impulse buy or panic sell gets shoved down the board's throat

Last word
From a corporate governance standpoint, all significant mergers should be scrutinized by some really smart, experienced and disinterested (and therefore objective--this is key) people. Why boards don't do that as a matter of course I have no idea.

The burden of proof for mergers to make sense should be as high as their risk, their failure rate and the pain they inevitably cost shareholders.

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