Post-Merger Growth Due Diligence
A close friend and colleague of mine, Mehdi Farhadi, recently dropped me a line to say hello. He simultaneously passed along one of his recent publications and asked if I’d be willing to share it on mybusinessmusings.com. Without hesitation, I said YES. You see, Mehdi epitomizes what it means to be a guru in the field of mergers & acquisitions. While working together in Germany, back in 2008, on a major global transaction we frequently pontificated and debated various M&A concepts. Strangely enough, it was a field of interest we instantly bonded on. I vividly recall one particular discussion, which revolved around organic vs. inorganic organizational growth. It was one of those pleasant conversations where we 100% agreed on all fronts. Ironically enough, several years later, Mehdi has put together a great piece that took that discussion to a whole new level. This article will actually appear as a chapter in a book he will be releasing in the near future called “Value in Due Diligence”. Give it a read as the perspective is invaluable. I especially love the chart he’s put together as it really tells a significant story. Enjoy everyone and thanks for sharing Mehdi:
Business leaders strive for growth. Growth is essential to the well-being of companies. According to Ansoff (1957), “just to retain its relative position, a business firm must go through continuous growth and change.” Most companies consider external growth through mergers and acquisitions (M&A) – both asset and share deals – as one of the quickest ways to fulfil business growth objectives. Corporate marriages help companies to sustain profit growth and gain greater market share.
Acquiring all or part of another firm, however, is complex and fraught with risk. Extant research suggests that M&A transactions are seldom success-ful. Three out of four mergers and acquisitions fail to achieve their financial and strategic objectives (Marks and Mirvis, 2001) .
Frequently cited reasons for the lack of suc-cess are the inherent complexity in integration of or-ganisations in the post-M&A phase. Failure in identifying and realizing credible sources of synergies has been often blamed for disappointing results of corporate mergers. It is vital that acquiring companies pro-foundly understand all facets of the business of the target company, i.e. tangible and intangible assets, pre-merger working capital, future investments, pro-spective risks and eminent challenges.
For this reason, conducting due diligence investigations has been often of significant importance to merging corporations. Inter alia, the objective of due diligence efforts is twofold:
(1) preparing post-merger integration plan and
(2) identifying operating costs and financial synergies. Evidently, though, internal growth following the post-merger phase is prone to be ignored in almost all takeovers and corporate mergers.
In our contribution, we argue that post-merger success ultimately (e.g. increasing shareholder value) occurs only as a result of a continuous internal growth of the combined post-merger organisation. We stress that successful M&A players develop sus-tainable internal growth after the integration phase. Simply put, they generate value, extend customer base, improve revenues, focus on existing and new customers, excel in customer operations and are successful innovators. In contrast, companies that are witness to transaction failure are not able to develop internal post-merger growth on the basis of the acquired capabilities. When they go through M&A deals, they purchase revenue streams of the target and destroy value. Ex-ante, they fail to achieve the strategic objectives underlying the rationale of the M&A option. Their post-merger integration plans do not transform the “pre-merger acquired capabilities” to “post-merger integrated competence.” At the same time, we accentuate that post-merger threshold capabilities permit internal growth following acquisi-tion games.
Post-Merger Organic Growth Dilemma
The illustration below (Figure 1) portrays the post-merger organic growth dilemma faced by many corporations. The hypothetical growth curves represent sales growth for three companies: pre-merger, “Company A” and “Company B” and post-merger, the combined organisation “Post-Merger Firm.” Obviously, Company A and Company B are in a position to grow before their involvement in the hypothetical transaction. At the same time, the following illustration suggests that Company A (acquirer) has been growing slower than the acquired Company B (target); Company B, therefore, can be seen as an attractive candidate. The hypothetical case implies two post-merger contingencies:
(1) inorganic growth following the post-merger phase or takeover
(2) reduction of sales.
Growth Due Diligence
Experience elicits that organic growth after a merger (“post-merger organic growth”) is evidently pone to be ignored by practitioners. It would be reasonable to assume that post-deal organic growth following an M&A deal are largely ignored in almost all transactions.
In our proposed contribution, we argue that during the due diligence audit and integration plan-ning stage the internal growth opportunities and related risks must be isolated and post-merger organic growth strategies need to be carefully crafted and masterminded. In this context, the main question is: Why have practitioners and researchers not seen the importance of this imminent subject matter? In addition, we put emphasis on the following due diligence queries:
(1) what are the determining factors influencing organic growth of the combined organisation following a merger or takeover?
(2) What are the con-sideration for achieving post-deal organic growth following an M&A transaction?
(3) Why do compa-nies fail to sustain post-deal organic growth?
(4) How is a merger failure defined by practitioners and researchers, i.e. through shareholder value corrosion or improvement? Is there any implicit or explicit association between shareholder wealth and post-deal organic growth?
(5) Why do some companies suc-ceed in acquisition games and how is the success of a deal defined?
(6) Is there any association between post-deal organic growth and the success of post-merger integration? And most notably,
(7) what are the key considerations in Growth Due Diligence investigations?
While M&A programme leaders, legal advisors, auditors, tax advisors, strategy consultants, and investment bankers are routinely engaged in identifying credible sources of synergies and realizing them, neither researcher nor practitioners have ever addressed the important role of post-merger organic growth in corporate mergers. The insights shared in this paper draw on the authors’ cumulative experience both as scholars and practitioners of strategic M&A transactions; moreover, the study is based on a current quantitative field research carried out in the area of M&A at Henley Business School.