The benefits of mergers and acquisitions (M&A) include, among others:
- a diversification of product and service offerings
- an increase in plant capacity
- larger market share
- utilization of operational expertise and research and development (R&D)
- reduction of financial risk
However, time and again, executives face major stumbling blocks after the deal is consummated. Cultural clashes and turf wars can prevent post-integration plans from being properly executed. Different systems and processes, dilution of a company's brand, overestimation of synergies and lack of understanding of the target firm's business can all occur, destroying shareholder value and decreasing the company's stock price after the transaction. This article presents a few examples of busted deals in recent history. (Learn what corporate restructuring is, why companies do it and why it sometimes doesn't work in The Basics Of Mergers And Acquisitions.)
New York Central and Pennsylvania Railroad
In 1968, the New York Central and Pennsylvania railroads merged to form Penn Central, which became the sixth largest corporation in America. But just two years later, the company shocked Wall Street by filing for bankruptcy protection, making it the largest corporate bankruptcy in American history at the time. (For related reading, see Taking Advantage Of Corporate Decline and An Overview Of Corporate Bankruptcy.)
The railroads, which were bitter industry rivals, both traced their roots back to the early- to mid-nineteenth century. Management pushed for a merger in a somewhat desperate attempt to adjust to disadvantageous trends in the industry. Railroads operating outside of the northeastern U.S. generally enjoyed stable business from long-distance shipments of commodities, but the densely-populated Northeast, with its concentration of heavy industries and various waterway shipping points, created a more diverse and dynamic revenue stream. Local railroads catered to daily commuters, longer-distance passengers, express freight service and bulk freight service. These offerings provided transportation at shorter distances and resulted in less predictable, higher-risk cash flow for the Northeast-based railroads. (Learn about the importance of commodities in the modern market in Commodities That Move The Markets.)
Short-distance transportation also involved more personnel hours (thus incurring higher labor costs), and strict government regulation restricted railroad companies' ability to adjust rates charged to shippers and passengers, making cost-cutting seemingly the only way to positively impact the bottom line. Furthermore, an increasing number of consumers and businesses began to favor newly constructed wide-lane highways.
The Penn Central case presents a classic case of post-merger cost-cutting as "the only way out" in a constrained industry, but this was not the only factor contributing to Penn Central's demise. Other problems included poor foresight and long-term planning on behalf of both companies' management and boards, overly optimistic expectations for positive changes after the combination, culture clash, territorialism and poor execution of plans to integrate the companies' differing processes and systems. (Learn why a merger and acquisition advisor is often the best choice when selling companies in Owners Can Be Deal Killers In M&A.)
Quaker Oats Company and Snapple Beverage Company
Quaker Oats successfully managed the widely popular Gatorade drink and thought it could do the same with Snapple. In 1994, despite warnings from Wall Street that the company was paying $1 billion too much, the company acquired Snapple for a purchase price of $1.7 billion. In addition to overpaying, management broke a fundamental law in mergers and acquisitions: make sure you know how to run the company and bring specific value-added skills sets and expertise to the operation. In just 27 months, Quaker Oats sold Snapple to a holding company for a mere $300 million, or a loss of $1.6 million for each day that the company owned Snapple. By the time the divestiture took place, Snapple had revenues of approximately $500 million, down from $700 million at the time that the acquisition took place. (Read Mergers And Acquisitions: Break Ups to learn how splitting up a company can benefit investors.)
Quaker Oats' management thought it could leverage its relationships with supermarkets and large retailers; however, about half of Snapple's sales came from smaller channels, such as convenience stores, gas stations and related independent distributors. The acquiring management also fumbled on Snapple's advertising campaign, and the differing cultures translated into a disastrous marketing campaign for Snapple that was championed by managers not attuned to its branding sensitivities. Snapple's previously popular advertisements became diluted with inappropriate marketing signals to customers. While these challenges befuddled Quaker Oats, gargantuan rivals Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) launched a barrage of competing new products that ate away at Snapple's positioning in the beverage market. (Read about the importance of memorable advertising in Advertising, Crocodiles And Moats.)
Oddly, there is a positive aspect to this flopped deal (as in most flopped deals): the acquirer was able to offset its capital gains elsewhere with losses generated from the bad transaction. In this case, Quaker Oats was able to recoup $250 million in capital gains taxes it paid on prior deals thanks to losses from the Snapple deal. This still left a huge chunk of destroyed equity value, however. (To learn how to offset capital gains at the individual level, read Seek Out Past Losses To Uncover Future Gains.)
America Online and Time Warner
The consolidation of AOL Time Warner is perhaps the most prominent merger failure ever. Time Warner is the world's largest media and entertainment corporation, with 2007 revenues exceeding $46 billion.
The present company is a combination of three major business units:
- Warner Communications merged with Time, Inc. in 1990.
- In 2001, America Online acquired Time Warner in a megamerger for $165 billion - the largest business combination up until that time.
Respected executives at both companies sought to capitalize on the convergence of mass media and the Internet. (Read about how the Internet has changed the face of investing in The History Of Information Machines.)
Shortly after the megamerger, however, the dot-com bubble burst, which caused a significant reduction in the value of the company's AOL division. In 2002, the company reported an astonishing loss of $99 billion, the largest annual net loss ever reported by a company, attributable to the goodwill write-off of AOL. (Read more in Impairment Charges: The Good, The Bad And The Ugly and Can You Count On Goodwill?)
Around this time, the race to capture revenue from Internet search-based advertising was heating up. AOL missed out on these and other opportunities, such as the emergence of higher-bandwidth connections due to financial constraints within the company. At the time, AOL was the leader in dial-up Internet access; thus, the company pursued Time Warner for its cable division as high-speed broadband connection became the wave of the future. However, as its dial-up subscribers dwindled, Time Warner stuck to its Road Runner Internet service provider rather than market AOL.
With their consolidated channels and business units, the combined company also did not execute on converged content of mass media and the Internet. Additionally, AOL executives realized that their know-how in the Internet sector did not translate to capabilities in running a media conglomerate with 90,000 employees. And finally, the politicized and turf-protecting culture of Time Warner made realizing anticipated synergies that much more difficult. In 2003, amidst internal animosity and external embarrassment, the company dropped "AOL" from its name and simply became known as Time Warner. (To read more about this M&A failure, see Use Breakup Value To Find Undervalued Companies.)
Sprint and Nextel Communications
In August 2005, Sprint acquired a majority stake in Nextel Communications in a $35 billion stock purchase. The two combined to become the third largest telecommunications provider, behind AT&T (NYSE:T) and Verizon (NYSE:VZ). Prior to the merger, Sprint catered to the traditional consumer market, providing long-distance and local phone connections and wireless offerings. Nextel had a strong following from businesses, infrastructure employees and the transportation and logistics markets, primarily due to the press-and-talk features of its phones. By gaining access to each other's customer bases, both companies hoped to grow by cross-selling their product and service offerings. (Read about the ideal outcome of a M&A deal in What Makes An M&A Deal Work?)
Soon after the merger, multitudes of Nextel executives and mid-level managers left the company, citing cultural differences and incompatibility. Sprint was bureaucratic; Nextel was more entrepreneurial. Nextel was attuned to customer concerns; Sprint had a horrendous reputation in customer service, experiencing the highest churn rate in the industry. In such a commoditized business, the company did not deliver on this critical success factor and lost market share. Further, a macroeconomic downturn led customers to expect more from their dollars.
Cultural concerns exacerbated integration problems between the various business functions. Nextel employees often had to seek approval from Sprint's higher-ups in implementing corrective actions, and the lack of trust and rapport meant many such measures were not approved or executed properly. Early in the merger, the two companies maintained separate headquarters, making coordination more difficult between executives at both camps.
Sprint Nextel's (NYSE:S) managers and employees diverted attention and resources toward attempts at making the combination work at a time of operational and competitive challenges. Technological dynamics of the wireless and Internet connections required smooth integration between the two businesses and excellent execution amid fast change. Nextel was simply too big and too different for a successful combination with Sprint.
Sprint saw stiff competitive pressures from AT&T (which acquired Cingular), Verizon and Apple's (Nasdaq:AAPL) wildly popular iPhone. With the decline of cash from operations and with high capital-expenditure requirements, the company undertook cost-cutting measures and laid off employees. In 2008, the company wrote off an astonishing $30 billion in one-time charges due to impairment to goodwill, and its stock was given a junk status rating. With a $35 billion price tag, the merger clearly did not pay off. (Read about the implications of this label in What Is A Corporate Credit Rating?)
When contemplating a deal, managers at both companies should list all the barriers to realizing enhanced shareholder value after the transaction is completed.
- Cultural clashes between the two entities often mean that employees do not execute post-integration plans.
- As redundant functions often result in layoffs, scared employees will act to protect their own jobs, as opposed to helping their employers "realize synergies".
- Additionally, differences in systems and processes can make the business combination difficult and often painful right after the merger.
Managers at both entities need to communicate properly and champion the post-integration milestones step by step. They also need to be attuned to the target company's branding and customer base. The new company risks losing its customers if management is perceived as aloof and impervious to customer needs. (Read about the importance of branding to retaining market share in Competitive Advantage Counts.)
Finally, executives of the acquiring company should avoid paying too much for the target company. Investment bankers (who work on commission) and internal deal champions, both having worked on a contemplated transaction for months, will often push for a deal "just to get things done." While their efforts should be recognized, it does not do justice to the acquiring group's investors if the deal ultimately does not make sense and/or management pays an excessive acquisition price beyond the expected benefits of the transaction.