A Mania for Mergers

Mergers and acquisitions follow the stock market. M&As peaked in 2000, with $US3.4 trillion spent on almost 39,000 deals, and dropped considerably when the market crashed. But over the past few years, as the market has rebounded, the number and value of M&As have crept back up. In 2004 companies spent $US1.9 trillion on M&As; a year later, it was $US2.7 trillion. Through November 2006, companies spent $US3.3 trillion on almost 33,000 M&As, a rate that puts 2006 on pace to be the largest year ever for M&As.

Dan Dalton, a professor at Indiana University's Kelley School of Business, says that companies have gone on an acquisition binge because record profits and soaring stock prices have left them more liquid than at any time in the recent past, and there are only three things they can do with the cash: save it (an option that executives favour but investors frown on); pay it out to shareholders in the form of dividends (which investors like but executives don't); or use it to grow the business by acquiring another company (which, if it works, makes both executives and investors happy).

Unfortunately, M&As usually don't work.

Anywhere from 65 percent to 80 percent of M&As never deliver a real return on investment, according to Stephen Kaufman, a senior lecturer at Harvard Business School. "They end up destroying shareholder value rather than enhancing it," he says.

There are two principal reasons why M&As fail. First, to acquire a company, one has to pay more than it's worth — "10 to 15 percent above market value", says Dalton, who says the extra cost covers the premium necessary to convince a company to sell as well as the debt the buyer assumes to fund the acquisition. The result is that acquirers invariably start off in the hole.

The second problem is that while acquisitions are almost always made with a clear goal in mind — for instance, expanding one's presence in a market or entering a new one — integrating the two companies can take so long that it throws off the calculations that were used to determine whether the deal was a good idea in the first place.

"Indecision is the worst and most corrosive chemical in a merger," says Kaufman. Each minute spent trying to decide the best way to integrate is a minute spent paying for things that are not generating value. That's why, Kaufman says, "It's better to be 100 percent fast and 70 percent right, than 70 percent fast and 100 percent right."