What Makes An M&A Deal Work?

By Marv Dumon AAA

Companies buy other companies for a variety of reasons. Whatever reasons drive a particular deal, mergers and acquistions (M&A) are considered successful when multiple synergies are realized and when the business combination increases the net cash flow of the merged business beyond what each entity could have achieved on its own. Here we'll examine what makes a successful acquisition and take a look at three companies that have pulled it off.

What Does a Company Stand to Gain?
A newly combined company can capture significant revenue growth by utilizing the following new tools in its shareholder value-creation toolkit:

Business combinations can also provide cost savings, primarily achieved by eliminating redundant functions, idle capacity and operational inefficiencies. Ideally, for revenue- and cost-type benefits to materialize, the target company should easily integrate with the acquiring entity.

News Corp Acquires MySpace
In the summer of 2005, News Corp. owned by Rupert Murdoch acquired the highly popular social-networking site MySpace for $580 million. News Corp. (NYSE:NWS) is one of the world's largest media conglomerates (with 2007 revenues exceeding $28 billion), with various holdings in books, newspapers, magazines, radio, sports franchises and television. At the time of the acquisition, MySpace was the fifth most visited internet domain in the U.S., and News Corp. envisioned taking advantage of MySpace's large following by conducting cross-marketing efforts between MySpace and News Corp's numerous media divisions. (Read about investing in conglomerates in Conglomerates: Risky Proposition?)

With the huge and fairly rapid success of Google (Nasdaq:GOOG), New Corp's executives wanted to capitalize on the continuing shift from traditional hard-copy, radio and television marketing to online advertising. Around the time of the acquisition, MySpace had over 20 million users, all using the social-networking site that has an online advertising revenue model.

While multiple and smaller social-networking sites competed with MySpace in the mid-2000s, News Corp. made the right decision to acquire MySpace. The site was quickly establishing itself as the dominant player not just in the social-networking sphere, but in cyberspace in general. The company also had ample financial resources, IT expertise, server and hardware capacity and operational savvy to ensure both the retention of existing users as well as capturing new users.

As of 2007, ad revenue for MySpace stood at $525 million; as of 2008, MySpace has over 100 million users around the world and is considered one of the fastest-growing websites of all time. Not bad for a website that was launched in 2004. While News Corp. did conduct cross-selling efforts, it was also careful enough to provide MySpace executives with enough independence to allow the division to thrive as an entrepreneurial and trendy outfit. In short, MySpace continued to have excellent execution after the acquisition. (Conglomerates: Cash Cows Or Corporate Chaos? outlines some of the perils of merging unrelated companies.)

Finally, MySpace not only continued to thrive under its own culture after the acquisition, but was also empowered with additional resources from a large conglomerate in order to pursue further growth opportunities. This is one of the few instances in which a much larger and more bureaucratic acquirer underwent a successful business combination with an entrepreneurial and trendy target. (Read more about varying corporate cultures in Fitting In At Your Firm.)

M&A Lesson: By acquiring MySpace, News Corp. possessed new sales and advertising channels. Additionally, News Corp. was able to buy a thriving and wildly popular entity with superior offerings that were not easily copied by potential competitors. News Corp. was able to provide operational and financial resources, which gave MySpace the tools it needed to maintain and increase its standing as a social-networking hub.

eBay Acquires PayPal
PayPal is an internet-based financial-services provider that enables users to make electronic payments and transfer money online without the use of credit cards. PayPal's operation was being tracked as a natural fit by the executives at eBay (Nasdaq:EBAY), a huge online auction marketplace. In the late 1990s, eBay made its first attempt at securing an in-house electronic payment system by acquiring the lesser-known (and lesser-used) Billpoint. Billpoint was much less popular than many of its competitors, and this lack of following led to frustration and lack of familiarity for eBay's users, who wanted to conduct buy or sell transactions with ease. (Read about the evolution of the internet's influence in The History Of Information Machines.)

After acquiring Billpoint, eBay made a run at the much more popular PayPal in the fall of 2002, for an acquisition price of $1.5 billion. By this time, eBay had clearly become an online-marketplace powerhouse. As one of the most successful companies in the U.S., eBay possessed a legion of global customers. By acquiring the most popular online payment company in PayPal, both entities leveraged each other's customer base and strategic positioning. In addition, by offering complementary services, both businesses were able to successfully integrate and make the lives of their customers more convenient.

The synergy between the two propelled more business for each operation, and PayPal rapidly became the default choice of online transfer payments. Several smaller competitors of PayPal closed shop in the early 2000s. Shortly after the deal, eBay began to require existing and prospective users to utilize PayPal for all transactions. Because PayPal was popular and user-friendly in its own right, eBay's payment mandate was widely accepted and did not stir any significant protest. In effect, eBay's actions introduced tens of millions of new users to PayPal's online payment service, thereby significantly increasing its revenue and global exposure. (Read more about how investors can judge online companies' profitability in Conference Board: Consumer Internet Barometer.)

M&A Lesson: By acquiring PayPal, eBay was able to force its users to use PayPal as a payment services provider for marketplace auctions and transactions. Because PayPal possesses a superior positioning and offering in the payment-services landscape, there was virtually no resistance from eBay's users regarding this move. Thus, PayPal was able to substantially increase its sales volumes while maintaining its dominant presence. (Read more about measuring market dominance in Which Is Better: Dominance Or Innovation?)

National Oilwell Acquires Varco International
In the early 2000s, National Oilwell was one of the world's leading oilfield drilling-equipment designers and manufacturers, as well as supply chain-services provider to the upstream energy sector. In the spring of 2005, as part of a series of strategically positioned acquisitions in the oil and gas equipment space, the company acquired 51% of the stock of Varco International, a leading provider of highly engineered products, consumable replacement parts and value-added maintenance and aftermarket services to the world's oil and gas industry. The merger was a $2.5 billion deal and created the U.S.'s largest equipment maker for oilfield-services companies. Acquiring Varco allowed National Oilwell to provide its oilfield customers drilling equipment, replacement parts and maintenance-related services that provide high margins and recurring cash flow to a company's financial statements. (Read more in Mergers Put Money In Shareholders' Pockets.)

Geographically, National Oilwell gained relationships and customers from Varco's operations in 40 countries and six continents. Additionally, the acquirer gained the ability to leverage Varco's intellectual property and proprietary edges in specialized drilling equipment and technological offerings to enhance its positioning among its competitors. Consolidating these product and service offerings became more critical as National Oilwell looked to have international sales become a much larger component of its revenue stream, as drilling equipment would have to undergo and withstand harsh onshore and offshore environments. (Read more about intellectual capital in The Hidden Value Of Intangibles, and about proprietary technology in Buying Into R&D.)

Separately, National Oilwell and Varco acquired over 100 related companies from the mid-1990s to the mid-2000s. This accumulation play consolidated similar and competing vendors. Thus, customers gradually possessed fewer options for purchasing drilling equipment, parts and services. In the oil patch, National Oilwell Varco (NYSE:NOV) was often referred to as "No Other Vendor," describing the sentiment in response to this quasi-monopolistic acquisitiveness. Company executives, however, work for their investors in executing financial mandates. (Read about some benefits and drawbacks of monopolies in Monopolies: Corporate Triumph And Treachery.)

M&A Lesson: By acquiring Varco International, National Oilwell was able to acquire Varco's highly engineered (non-commodity) product lines, intellectual property and replacement-parts offerings. In the oil patch, availability of replacement parts is critical to ensure continued exploration operations and to prevent very costly work stoppages. NOV's consolidation of drilling equipment vendors has magnified its presence in the energy sector and greatly enhanced cross-selling opportunities. (Read more about the oil and gas industry in Unearth Profits In Oil Exploration And Production.)

Conclusion
When strategic and operational drivers are compelling enough, companies buy other companies in order to enhance their positioning in the competitive landscape, capture growth and realize synergies. Cultures, product and service offerings and strategic direction should be complementary and aligned. When they are, they make the lives of customers better: think what an inconvenience it would be if you had to separately purchase the seat belts, car radio, antenna and cup holders when buying a brand new vehicle. Thankfully, these products already come with the purchase of the car from the dealer.

Executives at both the acquiring and target companies are constantly finding ways to improve their offerings to customers. When the investment premise and subsequent execution prove to be aligned with the "voice of the customer," the deal is a win-win for both consumers and company shareholders.

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