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chief executive special report: mergers & acquisitions

Making the Most of M&A Deals There’s no denying the allure of growth through acquisition. At the same time, the M&A road is riddled with potholes, treacherous curves, detours and dead ends—and once deals do come together it can be hard to assess whether the value created justified the chaos they entailed.


In this special report we offer tips from successful dealmakers on smoothing the acquisition and integration processes. We also present two methods of quantifying the outcome of a deal, demonstrate the application of those metrics to six recent transactions and identify the takeaway for would-be acquirers. And finally, for those on the selling side of the equation, we explore the preparatory steps necessary to garner an optimum price.

Secrets of the Great Deal Makers Top dealmarkers identify four imperatives for M&A sucess. by Russ Banham

What is it that separates winners from losers in M&A transactions? To get a grip on the answer, Chief Executive turned to some of the world’s top dealmakers. By and large, they all agreed the more deals you do, the better you become at it. A few clunkers along the way and a humble assessment of why they failed also sharpen one’s acumen to avoid similar pitfalls in future. Not to mention the acute need for

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mergers & acquisitions both parties to leave the negotiating table feeling good about the transaction; otherwise one of the companies will feel like the victor’s spoils. To divine other secrets of the great dealmakers, we sought the imparted wisdom of two former CEOs of the Year and two others leading formerly small to midsize organizations that are fastgrowing, thanks to their leaders’ M&A acumen. To follow are a few highlights from the insights they offered. For more wisdom from the M&A mavens, visit ChiefExecutive.net/M&AReport. Secret #1: Know Thy Target It should go without saying that knowing the target company inside out is the most vital consideration before phoning the other CEO, yet many dealmakers merely kick the tires and hope. “It’s the most strategic question one must ask—‘Is this the right company for us to buy?’” says A.G. Lafley, former CEO and chairman of Procter & Gamble, who ran herd on 10 to 20 acquisitions and divestitures per year over his nineyear tenure at the top of P&G. During that period, the multinational manufacturer more than doubled its sales, as its portfolio of billion-dollar brands expanded from 10 to 22. Driving the deals was a strategic imperative to expand in the beauty, health and personal care market and exit the food and beverage, and commodity segments of household cleaning products. Lafley says during his time at the company (he retired in 2010), P&G maintained a list of strategic acquisition targets. One of those targets was Richardson-Vicks, on the defense from a hostile bid by Unilever. “We were always interested in acquiring the Vicks brand, which fit our strategy,” he notes. “The company also was in the overthe-counter consumer health care market, which was important to us. Yet, it was the other prizes that we didn’t at first appreciate that put it over the top.” He’s referring to Pantene and Oil of Olay, two little-known beauty brands in the U.S. at the time. P&G turned Pantene into the No. 1 haircare product in the world, taking it from under $50 million in sales at deal closing to approximately $3 billion today.

“Dealmaking is akin to dating and falling in love. If you don’t think the behavior of the other party is something you can live with from a cultural point of view, you have to grit your teeth and simply say ‘No. We’re done.’” —Sandy Weill, former CEO of Citibank

Oil of Olay fared equally well, rising from less than $100 million in annual sales to more than $2 billion, at present. “The secret was knowing what we wanted strategically, which in this case was to be in the consumer health and beauty care market and having an over-the-counter business,” Lafley says. “We were the ‘white knight,’ but it wasn’t like we hadn’t been thinking about Richardson-Vicks many years before.” Secret #2: Have a “Walk-Away” Price From the Get-Go Knowing when to get out of the game is a critical consideration, says Sandy Weill, former CEO of Citibank. “I’ve been in situations where we’ve got an agreement, and as time goes by the other side sees you getting anxious and raises the price,” he says. “You have to be disciplined at that point, and it isn’t easy. Dealmaking is akin to dating and falling in love. If you don’t think the behavior of the other party is something you can live with from a cultural point of view, you have to grit your teeth and simply say ‘No. We’re done.’” To draw this line in the sand, Jerre Stead, CEO and chairman of IHS Inc., a global provider of market intelligence that Stead has beefed up via more than 25 acquisitions in five years, offers this advice—“Have a walk-away price from the start.” Following this counsel prevents “a potential acquisition from becoming an emotional decision,” he explains. “Set a fair and full value upfront that you know you can stand behind, and stick to it. If it’s not acceptable to all parties, be comfortable walking away from the deal.” Secret #3: Summing Up the Other Side On paper the numbers may add up, but how do savvy dealmakers evaluate the target’s products and services, processes, intellectual property, technology, and most importantly its leadership and senior executives? “You’re essentially agreeing to go into business together, yet you still have to ascertain the substance of the other leader—‘Is this person someone I trust, respect, and has attributes that are consistent with my own?’” says Dave Eslick, chairman and CEO of Marsh and McLennan Agency LLC. I always ask myself, would I feel comfortable inviting this person to my house?” Eslick has had lots of houseguests in his 30 years in the insurance business. He’s presided over more than 100 acquisitions, 50 creating what is now USI Holdings, the country’s ninth largest insurance brokerage, where he served as president and CEO. His track record enticed giant broker Marsh, Marsh and McLennan Agency’s parent company, to hire him to launch and run its start-up brokerage serving the middle market. Since coming on board three years ago, Eslick has snapped up 17 small to midsize agencies worth some $300 million in annual revenue today. Prior to signing off on these deals, Eslick toured their facilities. “I look to see how management interacts with the leader because this is likely how they would interact with me,” he explains. “I’m also trying to assess which talent drove business in past. Organic revenue growth is a great barometer of what to expect post-acquisition.” Secret #4: Deciding Who Gets the Job It’s during the pre-closing planning for post-merger integration that the decision is made who will stay and who will go. “You don’t want to take a long time figuring out which person is better for a particular job,” says Sandy Weill. “Quicker decisions after

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“It’s the most strategic question one must ask—‘Is this the right company for us to buy?’” says A.G. Lafley, former CEO and chairman of Procter & Gamble



the deal closes are much better than taking a long time, and making a few mistakes is better than appearing to be indecisive.” A.G. Lafley addresses the difficult situation through a series of peer assessments. “I interviewed Gillette’s top 15 people, as did our head of HR, to determine if they fit our culture and management philosophy,” he says. “Half of them did. I did the same thing with Richardson-Vicks, and only about two executives made the cut.” How did he make such a Solomon-like decision? “P&G is a company of principles, values and process—you either buy into them or you don’t,” he says. “Respect is a two-way street.”

M&A: Adding Up the Numbers New methodologies offer ways to quantify merger success. by Russ Banham How does one define M&A success? Chief Executive reached out to two respected corporate performance consultancies—EVA Dimensions and Applied Finance Group—and put the question to them. Each came up with what they consider to be the truest test of a flourishing or regretful M&A transaction. The firms applied their metrics to six M&A deals, analyzed in full on the following pages. Measurement Methodology

Before we get to the results, let’s look at each firm’s quantitative methodology: As the table on page 46 illustrates, Applied Finance Group (AFG) scrutinized each of the six deals through the lens of Total Shareholder Return (TSR), which combines share price appreciation and paid dividends to reveal the total return to the shareholder. While the absolute size of TSR varies because of stock market movements, the relative position reflects the market perception of overall performance as compared to a reference group, such as an industry or market. This evaluation methodology considers the TSR over a fiveyear period because most companies tend to develop five-year strategic plans, and presumably this is a long enough period for the synergies and integration benefits to shine. It further includes EM or economic margin, a company’s spread or return above its cost of capital. As a way to help readers understand the

expectations of an acquisition, AFG developed two EM add-ons— Invested Capital and Productive Capital. The difference between them is that EM-Invested Capital considers the cost of intangible assets, whereas EM-Productive Capital does not. Why is this important? “When the EM Differential between the two ratios is high, it indicates that the company paid an excessive amount for future growth and cash flows that have not yet materialized,” explained Michael Burdi, AFG portfolio consultant. By contrast, an EM Differential that is low indicates the company got a good deal at the time, not that this alone promises success. That’s why we’ve provided the expectations reflecting the EM Differential (high or low) along with the execution (good or bad). EVA Dimensions, on the other hand, measured the acquirer’s stock price return from two weeks before the deal announcement to two weeks after, and then compared this to the S&P 500 return over the same period. It also calculated how much the acquirer’s shareholders as a group were ahead, or behind, compared to investing in the S&P 500 (labeled as “MVA Impact Test” in the table on page 47). MVA, for market value added, is the difference between the capital invested in a company and its market value, or to put it more bluntly, the measure of how much wealth a company has created or destroyed. “The initial MVA reaction tells us whether investors think the buyer is getting more value or less than what it’s paying,” says Bennett Stewart, CEO of EVA Dimensions. Another method of establishing success or failure is following profit performance in the wake of a deal. To do that, EVA Dimensions computed how much EVA (economic value added) profit the buyer had earned when the deal was announced, versus five years later. EVA is a measurement of profit minus the cost of invested capital, including both equity and debt. As Stewart sees it, “It asks, ‘Did management earn a decent return

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mergers & acquisitions on the total capital it paid, or did it pay too much for the benefits that were achieved?’” To delineate this, EVA Dimensions computed “EVA Momentum,” a measurement of the five-year change in each buyer’s EVA, divided by its sales in the period leading up to the deal. It then subtracted the EVA Momentum generated by the S&P 500 over the same five-year interval. What’s left is the “Alpha,” an indication if the buyer generated more or less EVA profit growth than other large companies. Still with us? The purpose of the metrics is to lend financial credence to calling a deal a success or a failure. As for the tales told within, we turned to a group of M&A specialists. Their comments are useful to companies of all sizes plotting an acquisition strategy.

Procter & Gamble/Gillette While the metrics indicate P&G set high expectations in acquiring Gillette—represented by the high price it was willing to pay—the deal ultimately paid off for shareholders. “It’s a story of pretty good timing and synergy,” says Burdi. “Even though they didn’t steal the company, they had complementary products that eventually created revenue and cost synergies.” Sharing this view is Robert Bruner, dean of the Darden Graduate School of Business at the University of Virginia, where he teaches business administration. “P&G could bundle Gillette’s products with its own products, resulting in

significant distribution savings,” says Bruner, author of the M&A book Deals from Hell. “Since they each distributed to drugstores, supermarkets and the like, they would now only need one distributor, providing economies of scale and possibly even a volume-based discount.” Another academic and author, Mitchell Marks, professor of business at San Francisco State University and author of Joining Forces—Making One Plus One Equal Three in Mergers and Acquisitions, chalked up the transaction’s success to P&G’s vaunted strategic deal capabilities. “Like Cisco and Google, they’ve built an internal competency in M&A management,” Marks explains. “They don’t pick up the phone and call McKinsey when they want to make a deal; they’ve got their own SWAT team inhouse. At most companies, they turn to someone who has a fulltime job in finance or legal and toss M&A integration at them. The problem is there are only so many hours in a day.” Stewart has a different take: “It’s a story of great management overcoming an overpriced acquisition. Still, this was an awfully expensive way to get there.” Key Takeaway: Paying a high price won’t kill a deal, unless there is no strategy for integration.


Bob Bruner

The Total Return Test

Conoco-Phillips netted the best outcome in an outcome measurement based on total shareholder return and economic margin. P&G/Gillette



AOL/Time Warner


Boston Scientific/ Guidant to Lane via Insite








EM -Productive Capital







EM - Invested Capital







EM Differential







5-Year Net TSR







High Expectations/ Good Execution

Low Expectations/ Good Execution

Low Expectations/ Good Execution

High Expectations/ Bad Execution

High Expectations/ Bad Execution

High Expectations/ Bad Execution


A high EM differential indicates a company paid an excessive amount for future growth and cash flows that have not materialized. EM = Economic Margin, or return above cost of capital; TSR = Total Shareholder Return Source: Applied Finance Group

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The MVA Impact Test

The metrics below bring in various factors such as market value added (MVA) and economic value added (EVA) to establish a method of comparing an acquirer’s shareholder value versus the S&P 500 over a particular duration. For instance, the Conoco/Phillips merger generated 25.6% more economic value than the S&P 500 over five years, while the AOL/Time Warner merger lost a comparative 101.28% in value. Procter & Gamble’s acquisition of Gillette exceeded the S&P 500, but the other deals—Sprint/Nextel, Boston Scientific/Guidant and Hewlett-Packard/ Compaq—all lost economic value. HP/








Boston Scientific/ Guidant













Stock Price 2 Weeks Before







Stock Price 2 Weeks After







S&500 Price 2 Weeks Earlier







S&500 Price 2 Weeks After







Stock Performance







S&P 500 Performance













-$9.54 Billion

-$9.99 Billion

-$0.29 Billion

-$26.7 Billion

$1.33 Billion

-$1.62 Billion













TFQ EVA 3 in Quarter Deal was Closed







TFQ EVA 5 Years Later




$ (6,799)



Buyer’s 5 Yr EVA Momentum 4








Date Announced

Alpha 1 $ MVA 2 Impact Date Closed TFQ Sales in Quarter Deal was Closed

EVA Momentum for S&P 500: Aggregate Results for S&P 500 Companies, as of deal-close dates TFQ Sales in Quarter Deal was Closed







TFQ EVA in Quarter Deal was Closed







TFQ EVA 5 Years Later







S&P 500 5-Year EVA Momentum







Excess EVA Momentum 5







1. Alpha = an indicator of whether a buyer generated more or less EVA profit growth relative to its peer companies; 2. MVA = Market Value Added, the difference between capital invested and current market value; 3. EVA = Economic Value Added; 4. EVA Momentum = delta EVA/base period sales; 5. EVA Momentum = Company’s EVA momentum minus the S&P 500 company momentum Source: EVA Dimensions

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mergers & acquisitions

Time Warner/AOL Ask most anyone for the worst M&A deal in history and invariably they will respond “AOL/Time Warner.” The metrics indicate high hopes for the transaction to rain dollars on shareholders. Instead, it just rained. What went wrong? “AOL at the time of the announcement had a stupendous market value of about $123 billion and had invested capital of just around $8 billion, so it was trading for an MVA premium of $115 billion, which is incredible,” says Stewart. Why? “Because MVA has to come from the present value of the EVA profit a company can earn in the future,” he explains. “As a result, AOL would have had to increase its EVA profit, at the time running at $66 million, by over $1 billion each and every year, for the next 20 years, to justify that kind of MVA. A little math and economic logic would have shown the utter folly in taking AOL stock as currency for the sale of Time Warner.” Burdi concurs: “Time Warner shareholders paid an astronomically high price for AOL, setting them up for failure from the beginning. Plus, they bought an unproven business with unproven cash flows—a veritable recipe for disaster.” Key Takeaway: Theories are not a replacement for strategy, timing and stiff price negotiations.

Hewlett Packard/Compaq By contrast, HP’s acquisition of Compaq came at a good price and performed admirably over the five-year span, even though HP’s board initially expressed reluctance. “Hewlett’s son, who sat on the board, was dubious, at best, and a big battle ensued,” says Marks. “But, in the long run, they had very good execution, a consequence of HP’s sharp transition teams. Both companies also agreed to build one new company with one new culture, as opposed of pockets of this and that, and it worked.” Bruner agrees. “Carly Fiorina (HP’s CEO at the time) touted the cost savings and revenue growth synergies, even though the board at first demurred, and she made good on them within three years,” he says. “Over the five-year horizon, Compaq strengthened HP’s franchise with a strong offering in the server market, not to mention the consulting services that HP was moving into.” “It was the longest running soap opera in business when it was announced,” Stewart says, “but the good news is that both companies happen to be in a great business and they were able to ride the next wave up, even though the initial stock price reaction was horrible. HP surprised people by how well they were able to integrate Compaq and make it a pretty successful PC business, at least for a while. They saw the PC becoming a commodity and captured a strong niche at the lower end.” Key Takeaway: A well-executed post-merger integration of two companies will overcome critics’ initial skepticism.

Sprint/Nextel There are good integrations and then there are truly terrible ones—the case with Sprint’s acquisition of Nextel. Making matters worse was that the telecom paid too much and, as Stewart comments, “still didn’t build the scale it would need to battle the giants—AT&T and Verizon.” Faisal Hoque, founder and CEO of management solutions provider BTM Corporation, is equally critical. “It exemplifies poor integration from a product, cultural, infrastructure and organizational standpoint,” he charges. “The end result was a nosedive for shareholders. The deal was a disaster—the company wrote down nearly $30 billion of the $36 billion it paid for Nextel, wiping out 80 percent of Nextel’s value at the time of the acquisition.” The integration was made especially difficult by the companies’ technological incompatibilities. “Nextel’s ‘push-totalk’ network, which runs on a unique technology called iDEN, was unsuited to Sprint’s, and this limited its selection for smartphones,” explains Hoque, author of The Power of Convergence. Marks agrees. “They had serious network incompatibilities, which should have been considered in the due diligence,” he says. “But, they overlooked it, probably because of the ego of the CEO and senior team. They got so caught up in closing the deal because walking away would’ve been viewed as a failure by shareholders and the business press. Of course, losing billions of dollars in shareholder value is a much larger failure.” Key Takeaway: One apple plus one apple equals two apples; one apple plus one orange makes one apple plus one orange. Make sure the pieces fit.


Faisal Hoque

Conoco/Phillips Timing is everything. Just ask Conoco and Phillips Petroleum, two integrated oil and gas companies that merged as oil prices began rising. Not only did the deal carry a fair price, the partners pulled off a quick and commendable execution. “Most of what is called M&A today is a behemoth scooping up a much smaller rival, but this was a real merger of equals or as close to that as possible,” says Hoque. “Phillips shareholders would own 56.6 percent of ConocoPhillips, with Conoco shareholders coming away with 43.4 percent. That’s still pretty close to equal.” Burdi agrees. “As the EM differential (1.7) indicates,

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mergers & acquisitions Conoco didn’t pay a premium when the companies merged—it was a true merger of equals,” he says. “The deal was very carefully set up so all the synergies were identified and in place once the ink was dry.” Marks, who worked on the integration in a consulting capacity, confirms that “both companies’ leaders and managers were prepared for the rigors of the M&A process,” he says. “It took about six months for the deal to get approved, but nobody sat around navel-gazing. They conducted a series of workshops for managers to understand what would be needed once they gained approval. Legally, they can’t open the kimono too much to the other side, but they could do things like address the types of data they would need to collect for the integration. These were real team-building sessions that established a high level of collaboration.” After the merger got the nod from the government, oil prices began their stratospheric rise. As Stewart puts it, “Both companies were the lucky recipient of an appreciating asset, but there was still real value to be had through cost synergies and consolidation.” Key Takeaway: Get the integration process ready to go the day the deal closes.


Mitch Marks

Boston Scientific/Guidant Our last example also comprises high expectations (high price) with a bad execution. “The EM differential was very high, not surprising as Boston Scientific was in a bidding war with Johnson & Johnson and topped its bid, paying a whopping $27 billion,” says Burdi. In retrospect, it should have sat on the sidelines. “J&J had uncovered some issues with Guidant’s main products (defibrillators and pacemakers) and lowered its bid,” says Marks. “This didn’t stop Boston Scientific, which paid 80 times Guidant’s earnings to buy it.” “Then bad things happened,” Burdi notes. Boston Scientific had to fork over $296 million to the federal government after Guidant pleaded guilty to criminal charges for selling defective defibrillators, followed by another $22 million to settle charges that Guidant’s sales reps gave kickbacks to doctors who bought the defibrillators, and another $234 million to settle more than 8,000 claims by patients using the device. What else? How about more than $2 billion to settle patent infringement lawsuits brought by J&J. “Obviously, Boston Scientific had to adjust its profits downward and write-off the deal (an eye-opening $4.4 billion),” says Bruner. “The buyer hadn’t done the careful due diligence so necessary in M&A.” Boston Scientific “was guided by price, not strategy,” says Marks. “It jumped at the chance to buy Guidant, rather than do the slower and safer work of studying its options, setting a strategy and finding a target that fits it.” He adds, “Doing a deal to get back at a competitor (J&J) just isn’t a smart move.” Key Takeaway: Bagging a target may bring some early accolades, but your legacy will be determined by the eventual results.

M&A Takeaways for Midsize Companies Just because a company is smaller than an M&A-eating behemoth the size of Procter & Gamble doesn’t mean it can’t pick up a few morsels of wisdom from its experience. That’s the word from Mitchell L. Marks, professor of business at San Francisco State University, and an M&A consultant on the side. The same lessons apply, whether the deal steals headlines or not. “Many CEOs of midsize and smaller businesses deny or think they are immune to the perils of M&A difficulties,” says Marks, author of Joining Forces—Making One Plus One Equal Three in Mergers and Acquisitions. “They’re not, and in some cases there’s more to be concerned about.” He explains that small and midsize company “lack the luxury of a large corporation’s corporate staff and the ‘bench strength’ of upand-coming, high-potential junior executives to manage the merger while keeping the business running.” In such cases, “the acquiring entity can be overwhelmed by the rigors and requirements of M&A integration,” Marks says. “Don’t delude yourself that doing the deal is the hardest part of a transaction. It isn’t. As one of my CEO clients said, buying a company is fun; integrating it is hell.” What’s the secret then in adding up two companies’ strengths and synergies and not ending up with a negative number? “A CEO of a midsize company needs to understand first the synergies and cost savings represented by the deal, and then not overpay for this value,” says Michael Burdi, portfolio consultant at corporate performance advisory firm Applied Finance Group. “If you pay a great price and have great synergies, you will likely succeed at adding value. If you pay a fair price and have great synergies you will likely get an average return. Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of longterm returns.” Practice makes perfect, Marks chimes in. “The best and smartest players in the M&A game have done multiple deals—they learn from their mistakes, and know what they can do on their own and what they need from external consultants,” he says. “The CEOs of large companies with great M&A track records also leave their egos at the door, knowing they can’t possibly bat 1,000 in this game, given the challenges of integration. That doesn’t stop them from trying, however.”

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mergers & acquisitions

Preparing Your Company for Sale As a managing director at FMV Capital Markets, an Irvine, California-based investment bank, Allan Siposs has advised dozens of companies on how best to prep for sale. He calls his process a pre-transaction “Due Diligence Dress Rehearsal.” Here are a few of his thoughts on what to do well before opening night: • Confirm that formation documents, meeting minutes, summary of rights of each class of stock and stock ledger are all up to date and in good order, and address any potential shareholder issues or pending litigation that might derail the company’s sale. • Prepare audited financial statements for at least three historic years, as well as detailed revenue and margin analyses by customer, product, region, etc., and a summary of all outstanding credit facilities. • Prepare a complete set of financial projections. • Create a detailed organization chart and job descriptions for each position, listing key managers and their specific responsibilities. • Provide a list of sales by customer and annual revenue trends for the top twenty customers. • Address all existing or potential regulatory issues, and all potential past and current tax issues. • List all owned facilities and real estate, and summarize the operations, capacity and equipment related to each facility. • Summarize all current and past company trade secrets and intellectual property, including ownership and expiration date of relevant patents.

CEO ONLINE EXCLUSIVE Visit www.ChiefExecutive. net/PreparingtoSell for a one-year plan for preparing your company for sale

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Profile for Chief Executive Group

Making the most of M&A deals  

Article form Chief Executive magazine featuring Faisal Hoque, Sandy Weil, A.G. Lafley and more commenting on M&A deals.

Making the most of M&A deals  

Article form Chief Executive magazine featuring Faisal Hoque, Sandy Weil, A.G. Lafley and more commenting on M&A deals.