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CORPORATE FINANCE: M&A SURVEY – Strategic M&A fit: suits you.

The last two years have seen a boom in the merger business. But they’re not all multi-billion dollar deals creating 400lb gorillas in the corporate jungle. So what drives the smaller scale M&A deals that never make it into the national press? What problems are faced by acquisitive companies buying rivals at home and abroad? And how do acquirers cope with tricky post-merger integration? Financial Director and Collinson Grant Consultants surveyed leading UK executives responsible for 105 M&A deals with companies based worldwide over the past five years to answer these questions, and found that cost cutting appears surprisingly low down the list of respondents’ motivations. It transpires that 40% of deals are motivated by marketing issues, with much of the impetus for acquisitions coming not from head office, but from divisional or regional managers who have spotted opportunities at the front line. The business development director of one FTSE-100 company said: “We constantly create awareness in company circulars like the report, the accounts and internal financial statements, that we are acquisitive.” This policy encourages his divisional managers to keep an eye out for opportunistic buys. Delving deeper, two other factors feature prominently in the survey: the need for the acquirer to gain new skills or resources; and for it to improve the performance of the target company. Hence the finding that acquisition target selection is generally a job for the purchasers’ own managers rather than some external selection team. Instead of building a business on low costs, managers are looking for strategic synergies that can generate long-term value, and this requires a deep knowledge of the sector. About three-quarters of respondents rate internal research as their most important factor when selecting targets, while external advisors like lawyers and accountants rate only medium importance for a quarter of those surveyed. Finance is not generally considered a major headache for acquisitive companies and it is only in finance and legal matters that external experts are trusted to have a significant say in acquisitions. It is worth remembering that external experts are especially interested in fees. One group FD ran into problems after the acquisition target had been selected. “Lawyers caused issues to be raised which neither side wished to consider difficulties until the lawyers blew them up,” he said. “With hindsight, there were no actual difficulties.” For 95% of respondents all the project management for the acquisition was done in-house, and 55% of respondents also have a small, full-time acquisition project management team handling their buys. Almost half (49%) of respondents claim that they expected no difficulties with their deals. Of the remaining half, 60% feared the amount of management time and effort the process would take, with integration of acquired management, difference in corporate culture and the risk of lost sales from either party also featuring strongly. Only 11% anticipated national cultural problems. In the event, many of the problems that were anticipated as likely to be “considerable” turned out even worse than expected, but “modest” problems generally became less troublesome. For example, the 60% who anticipated problems with drains on management time rose to 69% who actually experienced difficulties after going through with the acquisition. A similar pattern appeared for the integration of new management and distraction from the core business. “This is one of the main things that stands out in this survey,” says Andrew Collinson, director at Collinson Grant Consultants, which prepared the survey with Warwick Business School. “Whilst you’re driving through an acquisition, it’s vital to keep an eye on the other parts of your business.” Fewer problems than expected arose with losing customers and sales, however. Some industries have a particular problem with this, but only 11% of survey respondents cited it as an actual effect against 22% who had feared such losses before the acquisition. The area where respondents most severely underestimated difficulties was in market changes. None of the acquirers identified it before they started their deal, but 27% finished the process with major problems thanks to shifts in the market. One FD made a particularly disappointing acquisition. “We had an unforeseen rise in raw materials prices and the development of severe competition during the same period,” he says. Perhaps the most obvious segmentation of the deals we looked at is by region. We discovered that most acquisitions within the UK are driven by a need to consolidate or expand market share, whereas in Europe and the US, opening new markets is the key. Presumably, although the research is inconclusive on this, acquisition is more attractive than organic growth overseas because target companies have local knowledge. Looking at the figures more closely, in Europe, developing market presence is clearly the most significant motivation for M&A deals. With US acquisition targets, the third significant group in the survey, motives are more mixed. As in Europe, new market presence is important, but, rather like the UK, the expansion of market share and extending product ranges are also key drivers. Only one factor showed up consistently across the regions: unsurprisingly, M&A deals aim to improve financial performance, both of the acquirer and the target. European, and to a lesser extent US, acquisitions present managers with important corporate and national cultural problems, amongst other more measurable hurdles. While most of the respondents had few problems with US acquisitions (the US and UK track each other on most of these nation-specific issues), in western Europe there are some tricky areas, while eastern Europe is bordering on a basket case. (For example, the former communist bloc was the only region where respondents cited personal physical security as a major concern.) The trend seems to be that financial issues are much more significant in the Anglo-Saxon countries than in continental Europe, where labour laws and cultural differences are higher up the list. The one notable exception, which is common to all deals, is the problem acquirers have with vendors’ perception of value. Maximising your side of a deal has been and will always be a fundamental aspect of business, regardless of corporate culture or nationality, and shareholders rarely think a swift deal is worth a few pennies off the acquisition share price. But small deals can be more simple in this respect. As the group financial controller of one company pointed out: “Private acquisitions are more personality related, but much easier to complete.” Sometimes, whether through unfamiliarity with overseas accounting practices or regional markets, things can go wrong. One group financial controller complained: “Hidden pricing arrangements at the acquired company seriously inflated the value of one of its major businesses.” Another had personal problems with the boss of the target: “The vendor did not understand his (small, publically-owned) business. Negotiations were difficult at times because he did not comprehend exactly what he was selling.” In general, executives tend to find all aspects of a deal more difficult in Europe than in the US or UK. The point of least conflict is the quality of information in western Europe, although even in this aspect cultural misunderstandings and rogue elements like differing accounting standards have caused problems. Once the deal has been done, integration becomes a priority. Although few of the respondents identify cost-cutting as a motivation for embarking on an acquisition, it was one of only two post-acquisition tasks for which companies comprehensively prepared. Clearly the value of acquisitions isn’t in the lower costs, but an acquirer would be insane not to reduce costs after the purchase. The other key area for post-acquisition planning is minimisation of risks. This includes managing the retention of customers and key members of staff, maintaining margins and avoiding disruptions to information systems. Overall, the most successful acquisitions tend to be in the US, although the evidence is not conclusive. It seems that UK acquisitions fare worse than those in Europe, possibly because there was a greater expectation of long-term problems on the continent. In the UK, buyers expect plain sailing and are disappointed if problems arise. What constitutes success? The survey suggests that a company’s finance function is the ultimate arbiter, with net profit, cashflow, return on capital employed, earnings per share and recovery of premium paid the most important metrics. Other than these financial considerations, only customer retention showed up on the radar. The importance of finance is also borne out by an analysis of the companies that made better than expected headway with their acquisition. For these model performers, well managed cashflow, good returns on capital employed and quick recovery of premiums paid are considered vital. There are also some more personal experiences. For example, one FD notes that he had been disappointed with the results of an acquisition because he had “misplaced the pace of integration. I now know that you need to impart the new corporate culture as quickly as possible and ensure it is understood that it is the only culture from now on.” Communication with managers in the acquired company is vital if common goals are to be achieved. Experienced hands at the M&A game had some sound advice. “Be prepared to supplement skills by recruitment – do not try to make do,” says one FD. Others stressed the importance of remembering that, after the deal, the company will be financially and operationally different from the two businesses that entered into it. With management time pressure also in the mix, another pointed out, that this can cause serious difficulties. “We had insufficient management to make the most of the new opportunities we had created,” he says. Another overcame both national and corporate culture issues with a wide-ranging incentive scheme, right down to the shop floor. “You must create profit centres which have a sense of overlap (between the companies) right down to the lowest level,” he advises. But perhaps the most useful overall advice from respondents was the simplest. The essence of a successful acquisition is to “make realistic expectations and conservative projections, but still to expect problems.” Following these rules should help ensure that, at the very least, neither party is disappointed. At best you might have success on a par with the jubilant FD who declared: “The strategic fit of the two companies strengthened our market position and underpinned our price levels.” That’s the kind of deal that would suit every single one of us. KEY FINDINGS – 49% of respondents anticipated “few or no difficulties” before they embarked on the acquisition process. – in 69% of deals, the demands on managers’ or employees’ time had caused “considerable difficulty”. – distraction of managers from running the core business was a more severe problem than expected: 26% had “considerable” and 11% “extreme” problems with this. – market changes caused “considerable” or “extreme” problems in 27% of deals. No respondents had expected or anticipated such difficulties. – 58% of respondents experienced “some or considerable difficulties” with differences in corporate culture after acquisition. – national cultural differences caused “considerable problems” in 23% of deals; 23% also suffered “some difficulty” in this area. – companies based in the UK and US are simplest to integrate with; integration is most difficult with eastern European companies. – 95% of acquiring companies used internal resources to project manage their purchases. 55% have a full-time function devoted to it. KEY FACTORS FOR SUCCESSFUL ACQUISITIONS – sector knowledge – effectiveness of communication with acquired managers – selection and retention of key staff – previous experience of managing change programmes – placing key staff from the parent in the target company – thoroughness of pre-acquisition planning – skills of the workforce – reduction of raw material costs. Surprisingly, the effectiveness of performance measurement, management controls and the thoroughness of financial due diligence were considered the least important factors in successful acquisitions. TOP FIVE PROBLEMS FOR ACQUIRERS IN THE UK, USA AND WESTERN EUROPE UK Vendor’s perception of value Managerial control information Entrenchment of senior managers Ease of completing due diligence Accuracy of financial information USA Regulatory approvals Vendor’s perception of value Taxation Ease of due diligence Managerial control of information Western Europe Unionisation/restrictive practices Employment and social costs Employment laws Vendor’s perception of value Accuracy/disclosure of financial data SURVEY ENVIRONMENT – average annual sales of respondents: £1.4bn – period of analysis: 5 years – number of deals surveyed: 105 – acquisitions in UK: 59% – in North America: 17% – in western Europe: 9.5% – in SE Asia: 2% – in other regions: 12.5%

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