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What Is Acquisition Indigestion?
Acquisition indigestion is a slang term that describes the practical difficulties that a company may face while adjusting to the consequences of a merger or acquisition deal. The integration process can be a rocky one.
Employees can become stressed by the uncertainties inherent in a merger or acquisition involving their company. Dual departments can have a hard time combining into one. Rival teams can arise. Corporate cultures can clash. Routine business can be badly disrupted.
Key Takeaways
- Acquisition indigestion is a symptom of a failure in integrating two companies after a merger or acquisition.
- Around 70% of mergers and acquisitions fail or do not live up to the buyer's expectations.
- The purpose of any acquisition is to expand a company's growth potential.
- Poor implementation of a merger can stymie that growth.
- Acquisitions may fail if there is a culture clash between the two companies, or if the target company is overvalued.
Understanding Acquisition Indigestion
When a public company announces a merger or acquisition, Wall Street is often pleased. It's a move that should signal that a company is expanding into a new area, increasing its market share, eliminating a rival player, or some combination of all of these.
However, investors cannot be expected to be particularly patient when the merger or acquisition does not proceed smoothly.
Broadly speaking, acquisition indigestion is a symptom that the company that has made a merger or acquisition happen is having difficulty making the most of it.
It occurs often when a company acquires another company in order to increase its earnings growth, only to find that it lacks the necessary infrastructure to successfully absorb and manage its acquisition.
Taking the Term Literally
The term acquisition indigestion can be taken quite literally. The acquiring firm really has bitten off more than it can chew, and the result is painful.
This outcome can be anticipated if a company chooses a target that is unlikely to integrate well with it, or acquires too many targets too quickly.
One of the most (in)famous examples of acquisition indigestion occurred with the 1968 merger between New York Central and Pennsylvania Railroads. Although the new company was the sixth-largest corporation in America, it declared bankruptcy only two years later.
Risking Acquisition Indigestion
Acquisition indigestion may more delicately be termed integration risk. A merger that looks great on paper may be more difficult to implement than expected. The company that initiated the merger may fail to meet the goals they set for the combined company.
In the end, those high expectations might have caused the buyer to pay more than they should have for the deal.
The shareholders of the company that was acquired, on the other hand, may not suffer from acquisition indigestion. If they time it right, they could walk away with a good profit, leaving others to experience the ill effects.
Reasons Why Acquisitions Fail
One of the most common reasons for an acquisition to fail is that the buyers have misvalued the acquisition target. While the assets and revenues of the acquired company may look good on paper, the accuracy of this information depends on the willingness of employees to report information that may place their managers in a bad light. If the buyers fail to conduct their due diligence, they may end up buying a white elephant.
Another common problem may arise if there is a culture clash between the two companies. This tends to arise in international acquisitions, where the two countries have very different management styles. If the acquiring company replaces managers or sets unrealistic goals, they may damage the morale of their new employees.
Finally, it is possible that the buyers may lose the customers or products that made the acquired company successful. If the acquiring company fails to identify key employees, products, or bottlenecks, they may inadvertently lose some of the acquired company's competitive advantages.
International mergers are particularly susceptible to acquisition indigestion. This is likely because of the difficulty of adapting one company's management style to a different corporate culture and business environment.
How to Prevent Acquisition Indigestion
Around 70% of M&A deals end in failure, according to Victoria Brodsky of Transformation, LLC. In some cases, the buying company may have overestimated the potential synergies of integrating the new company. In other cases, they may inadvertently alienate their new customers by changing the products or prices that made the acquired company a success.
Acquiring companies should not assume that the target's customers or employees will remain loyal. While it can be profitable to start raising the prices of the acquired company's products, such a decision should be carefully researched first. It also helps to benchmark the acquisition against competitors, so that the buyers know what they are really getting.
Most of these risks can be mitigated by careful planning and analysis. Many buyers are tempted to rush through the due diligence or planning stages, but cutting these corners can incur big expenses later on. Successful M&A deals may require reassigning dozens of experts and researchers, just to ensure that the budgets of the two companies line up.
Some of these risks can be mitigated by having a third party validate the deal before the acquisition is finalized. A neutral investment adviser or investment firm can prevent the buying company from falling victim to its own optimism. In addition, hiring a specialized M&A Integration Professional can help ensure a smooth transition between the two companies.
Real-World Examples
Some of the biggest merger and acquisition disasters in American business history are cautionary tales of acquisition indigestion. The 2001 merger between America Online and Time Warner is still considered one of the greatest failures in history, with the new company posting a staggering $99-billion dollar loss the following year.
Most acquisition failures occur before the deal is finalized. Although it's never ideal for an acquisition to fail, this is a much better outcome than spending a fortune to buy a white elephant. Many deals also fail due to unexpected regulatory pushback—such as NVIDIA's failed $40 billion purchase of Arm.
Although M&A deals have experienced a resurgence, many of them failed as a result of the coronavirus pandemic. 66 M&A deals failed within the first month of the pandemic, according to Business Law Today. Most of these deals failed before the deal was finalized.
What Leads to a Failed Acquisition?
While there are many reasons for an acquisition to fail, one of the most common causes may occur if the two companies fail to reach a satisfactory price, or if shareholders reject the deal. Acquisitions may also be blocked by regulators or government bodies.
What Happens If an Acquisition Fails?
Most acquisitions fall through before the deal is finalized. In this case, the acquiring company loses any money they spent researching or negotiating the deal, but walks away with the majority of their capital intact. The losses are more substantial if the acquiring company goes through with the deal, only to lose the target company's customers and employees through mismanagement.
How Often Do Acquisitions Fail?
Between 70% and 90% of planned M&A deals either fail or fall short of expectations, according to Axial. Studies find that the most important component of a successful acquisition is "customer retention and expansion." If the acquiring company fails to keep its new customer base, the deal may cost a lot more than they bargained for.
What Are the Advantages of an Acquisition?
A well-executed acquisition allows the acquiring firm to benefit from synergies with the target company. For example, they might be able to use the acquired company's supply chain and retail locations to improve their own distribution or improve revenues by selling one company's products in the other company's stores. There are also benefits to simply removing a leading competitor from the market. These deals may fail, however, if the buying company overestimates the value of the purchase.
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