Sunday, January 15, 2006

I don’t understand Mergers and Acquisitions

As regular readers of this blog known I read the Financial Times daily. Never a day goes buy without some story about company X buying company Y, or merging with Z, or problems with the purchase, or problems with the result. Thing is, given all these problems I don’t understand why companies do it.

There has been plenty of research in the last few years that show is how company mergers and acquisitions destroying shareholder value. Merging company X and Y is expensive, time-consuming and distracts the management from running either business.

It is often said about national political leaders, specially US Presidents in a second term, that when it becomes difficult to achieve anything domestically their attention and efforts are redirected to foreign policy. You can’t focus on too many things, when you focus overseas you miss things at home - this happened to Tony Blair before and during the Iraq war.

I think something similar happened companies. Rather than work creating growth, improving the company or making it more efficient leaders look for an external activity.

(I know a lot of my readers work in the software technology fields so a word of encouragement, this blog entry does come back to software and technology at the end.)

To be sure, it isn't always the companies that come up with the ideas for mergers and acquisitions. Investment banks (who often seem to function more as financial consultancies) make a lot of money mergers and acquisitions, consequently it is often bankers who dream of the idea of company X buying company Y. They then go and persuade the managers at X to do it and a their bank a lot of money for advice.

For example, after months of saying future investment and business growth would come from developing countries and South America the Spanish telecoms operator Telefonica decided to buy O2 recently. O2 is big in the UK, Germany and Ireland, hardly developing countries and defiantly not in South America.

Another current takeover that I believe will end in tears is the proposed purchase of Virgin Mobile by NTL. It seems that NTL have decided on a grand new strategy called a “quadruple play” whereby they will sell their customers cable TV, broadband Internet, telephone services and now mobile telephone services. This is a classic Grand Strategy but I believe is destined to fail simple operational reasons.

This is the NTL that has just emerged from Chapter 11 bankruptcy and the same NTL that is in the middle of merging with Telewest (another former bankrupt). Neither NTL or Telewest have particularly outstanding reputations.

Indeed I once spent three hours trying to get NTL to fit a telephone line to my house only to find out they were not fitting any more telephone lines. And Telewest once advertise their new broadband service close to my house but did not actually provided it in my area.

Indeed NTL and Telewest may be cheaper compared to BT but their customer service is abysmal. I don't know of anybody with a good word about NTL or Telewest customer service. (Not that BT customer service is outstanding either.)

Virgin on the other hand may not have a spotless customer service record (think of Virgin Electric or Virgin Trains) but are pretty good generally (think of Virgin Atlantic). My guess is there is a culture clash on the way.

Regardless of culture clash I would expect NTL to ruin the customer service and operations of Virgin Mobile. Consequently don't expect to see much customer growth.

And talking of their customers, what do the customer bases of the two countries have in common? Virgins phones are predominantly sold to younger customers with few responsibilities i.e. teenagers and students, while NTL's customer base is home owners. I don't see much prospect of cost selling.

Another recent deal that doesn't make any sense to me is Boots merger with Alliance Unichem.

Boots has been in trouble for some time, they used to be the safe brand that all Brits went to for medicines, soaps, shampoos, makeup, etc. Two forces have conspired to undercut Boots's market.

Firstly supermarket retailers such as Tesco and Asda-WalMart started selling the same goods at lower prices. Secondly, Boots value lay in its brand, the rise of more branded goods which could be bought at any outlet meant the Boots brand was less necessary for it purchase, and brands such as Superdrug and Tesco could offer a similar reassurance at sale time.

So at the second or third time of trying to respond Boots has decided to merge with the arrival, namely Alliance. But what will this bring to Boots? Sure they will have more purchasing power to demand lower prices and their suppliers but will they be of to match the purchasing power of Tesco and WalMart? Is the scale the answer?

Neither will the deal do anything to the Boots brand. If anything it will confuse managers who now have two brands to manage and in time it will confuse customers.

Obviously things are more complicated than this and I don't have the information Boots and Alliance managers have, but from where I sit Boots would be better off concentrating on improving its operations and supply chain so it can compete with Tesco and Superdrug.

Of course there are good reasons for mergers that may make the pain worth doing. For example if your company has a surplus of something then maybe buying someone to use that surplus might make sense.

For example, suppose you have an established sales force and customer base. Over time your sales force will sell all of your products to all of your customers so will be nothing new to sell. Buying a company with a good product and a weak sales force may be good for both sides, your sales force get a new product to sell and the bought company gets its product sold.

Another example: suppose your management is particularly good, say they are good branding or supply chain management, then perhaps you can use their surplus skills in another company so you buy it.

Takeovers also make sense in private equity. Private equity and Venture Capital investors buy and sell companies all the time - that is their skill. No company is bought without a plan to sell it and one frequent route of exit (although not the most common by far) is to float the company on the stock exchange - an IPO. Trouble is, to IPO a company it needs to be big enough to float, consequently it is common to see private equity owned companies buying other companies to bulk up in the hope of a flotation.

This might have been happening at QinetQ. (No don't ask me how to pronounce this name, I usually say “Q i net Q” but I think I once heard it pronounced “Kinetic.”)

About 35% of QinetQ was sold by the British government to the Carlyle investment house with the intention of floating the company on the stock market. Since then the company has made several purchases of related companies. Of course this isn't just about bulking the company up for flotation, it can be about creating a more rounded company and one that will survive over the years.

The thing is, many of these mergers are explained under the banner of “getting technology”, “synergies of technologies” or “getting access to knowledge”. In the software world these explanations sound good usually don't hold water.

About 1994 Computer Associates (CA) bought the Ingres database company. They bought the product sure, they bought the team that developed the product but within a few days of purchase the team had walked. In this industry it is more the people than the product that are important, takeovers often scare people away.

Neither is it is simple as buying the technology and using it. Software is complex stuff and marrying a different code base to yours can be a serious undertaking.

Back in 1997 Netscape decided it's application server needed a boost in the market so they bought Kiva. They then forced the two products together, that is they forced to code bases together. I'm told by people familiar with the code that it was something of a disaster.

Of course time went by and eventually Netscape was carved up by Sunand AOL. This time Sun attempted to merge Netscape server code with its own products resulting in another code mess.

Merging code bases doesn't happen overnight, it takes time (say 6 months), time you can spend developing new features anyway. When you merge a second code base you might get a whole bunch of new features but your also get a whole bunch of new bugs, customers see a more complex product, and under the hood a lot of consistency is lost, consequently future developments will be slow down.

Business people are familiar with the concept of culture clash in merged organisations, and they know about the need to consider different corporate cultures but how many of them really understand the difficulties of merging similar but different technologies?

So there you are, some of the reasons why I don't understand mergers and acquisitions.