Merger in the dark
Mergers and acquisitions, the big business of the story of the 1990s, look to be picking up again. In the news are the Glencore-Xstrata merger in the energy sector and talk of a bid by UPS to buy TNT Express.
Indications are that the Asia-Pacific not only bucked the global M&A downturn last year but is poised to furnish an impressive number of deals this year.
All of this begs the question whether major mergers work. The relevance to investors is clear: the value of their share holdings can be turned upside down by a big merger, as was seen in the massive drop in equity value of Hongkong Telecom following its acquisition by PCCW.
The overwhelming evidence is that most such transactions fail to achieve their objectives; yet a fixation with expansion through acquisition seems to pulsate through boardrooms globally.
Everyone knows the theory of why companies get involved in M&As. It starts with the notion that bigger is better because there are economies of scale to be had, synergies to be exploited and, when it comes to megamergers (those in the US$5 billion to US$10 billion-plus region), there is a conviction that global players can only thrive if they scare off potential competitors by the sheer scale and capability of their operations.
Before anti-competitive practices legislation became widespread (with the notable exception of Hong Kong), there was also the comforting notion that the market's dominant players could control the prices for their goods and services.
In the much-cited book, Megamergers: Corporate America's Billion-Dollar Takeovers, author Kenneth Davidson is clear that most of the mergers he looked at were unjustifiable and of no benefit to the companies that initiated them. A widely quoted statistic is that 70 per cent of mergers fail to achieve their anticipated value.
In 2000, when the dotcom boom seemed unstoppable, America Online embarked on a US$350 billion merger with entertainment and news group Time Warner. Steve Case, then chairman of America Online, waxed lyrical about the promise of 'multimedia content and e-commerce opportunities'. In fact, AOL's stock plummeted, the synergies never materialised and the merger had to be unwound.
Two years previously, Germany's Daimler-Benz swept in to 'save' Chrysler in a deal valued at some US$75 billion. There was talk of synergies and developing a 'common culture and common mission', but things went sour quickly. Daimler ended up dumping its American partner in a fire sale.
For people in Hong Kong, perhaps the most telling M&A experience is that of HSBC, which decided it needed to become a 'world bank', as opposed to an Asian regional player. This meant rushing off from the region with the highest economic growth and plunging into American and European acquisitions that, to this day, have never fulfilled their promise.
Dissident shareholders Knight Vinke and the Calpers pension fund estimate HSBC spent US$40 billion on non-Asian acquisitions, which they say depressed the share price and sapped resources that could have been used for growth at home.
Yet not all mergers have failed. US-based Datamonitor published a study in 2009 looking at the 22 biggest pharmaceutical mergers since 1995. It found that buying growth and scale worked and that M&As might contribute 63 per cent of the sales growth in these companies by 2014.
The study suggests that some industries are more amenable to growth by acquisition than others. This was traditionally true in the oil industry and seems to work better in other manufacturing and raw materials industries.
This may be because economies of scale are more easily identified in these industries, as they relate to concrete objectives, unlike the vague promises of, say, synergy in the entertainment industry.
Moreover there is evidence that some of the best mergers are the least hyped and least ambitious. To go back to HSBC as an example, it is now clear that one of its best acquisitions was the then ailing Hang Seng Bank. The Hongkong Bank's arm had to be twisted to take on this local institution, but it ended up providing a steady source of strong income for the bank.
Which suggests that mergers can work, but heavily hyped megamergers deserve scepticism.