Student View: Takeovers and Mergers and Shareholder Value

James Mansell writes about the frequency with which mergers and takeovers often lead to a steep reduction in shareholder value

“The Olympics and corporate takeovers are similar in one respect, for either city or company makes predicted gains which are normally overtly optimistic, which consequently are impossible to realize. Inflated benefits arise due to the megalomania sometimes present in governments or board rooms; and these supposed gains are what drive mergers in the case of the latter.”

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Mergers and acquisitions, known as M&A, have historically come in waves: each with their own specific characteristics. The fifth wave started in 2000 and is ongoing; cross-border mergers are the target, in order to expand into emerging markets full of untapped possibility. The evidence for this shift to foreign acquisitions is shown in figures; for the year to date emerging market M&A is $575.7bn, whilst European volume is lagging at $550.2bn. The large quantities of money indicate the popularity of takeovers; however only 35% of deals are beneficial in terms of increased profit, for over 60% of companies who engage in M&A the result is often a decrease in shareholder value.

The Olympics and corporate takeovers are similar in one respect, for either city or company makes predicted gains which are normally overtly optimistic, which consequently are impossible to realize. Inflated benefits arise due to the megalomania sometimes present in governments or board rooms; and these supposed gains are what drive mergers in the case of the latter. Ideologically executives overseeing a company have an over-arching purpose to maximize shareholder value; in reality self interest is often exercised to the detriment of investor’s returns. This corporate ‘empire building’ is an attempt to enhance management’s image to further career prospects, yet even this can backfire. For example the case of Sir Fred Goodwin: who went on an acquisition spree acquiring 26 companies during his tenure as CEO of RBS, and now is known affectionately as ‘Fred the Shred’ for his contribution to the part nationalization of the bank.

One of the most ill-fated mergers was between AOL and Time Warner, in the midst of the dotcom euphoria a deal was agreed which would eventually wipe out 97% of shareholder value. This combination between companies failed because of the lack of integration, tempers within the board room meant the corporation was effectively split into two fiefdoms of AOL and Time Warner; nullifying any usefulness of the arrangement.

The synergies within the companies never materialized, for they were too different; Time Warner being a blue chip company with an extensive history and AOL being a relatively new internet startup with fewer tangible assets. This was a case of myopia by leadership on both sides, the end of the dotcom bubble was not seen as possibility and the internet was still viewed as the land of exponential opportunities. Gains which had been predicted never materialized because the merger was never an intelligent grouping between two companies which could effectively coalesce; instead it was a product of an economy with boundless and irrational optimism for everything to do with the internet.

British Commonwealth and Atlantic computers merged in 1988, the former was a financial services company with a wish to expand and diversify. Shareholder value could have been augmented if the deal was successful and the asset bought was of sound quality. However Atlantic computers used a system of accounting known as mark to mark accounting (the same one to be used by the notorious American energy giant Enron a decade later) which eventually proved fatal. With future profits booked at the time of sale growth had to be perpetual to remain afloat, therefore British Commonwealth acquired what turned out to be a toxic asset, whose liabilities eventually bankrupted the whole company. The whole deal was flawed due to an improper investigation into the target, and consequently shareholders suffered due to the ineptness of the management in properly assessing the takeover objective.

Mergers and acquisitions depend upon timing; a stark example of this was the merger between Taylor Woodrow and Wimpey. Both companies were involved within the construction sector and had diversified to only a small extent. After the merger was completed the housing market crashed, with sales falling by 35% in 2008, causing £4bn to be written off the value of the business. There were large overlaps between both corporations and the merger should have been in all counts a success, however “you cannot beat the market” and global conditions meant that fulfillment of shareholder value remained elusive. In this case the predicted gains could have been realized in part or full, yet the crash upset what seemed to be a carefully considered merger; blame could be pinned on the management for failing to anticipate the direction of the market in which they were operating.

Companies are instrument through which holders of equity are meant to profit to the utmost extent, M&A is meant to be an aid to that goal. However predicted gains are often left unrealized because those predictions are mostly optimistic, as well as flaws within management which leave much to be desired (as was the case in AOL-Time Warner). Self interest is a motive behind acquisitions and is the main contributor to the unraveling of it, for executives often have their own interests in mind rather than those of whom they are supposed to represent.