When business pops the question

In the case of DaimlerChrysler, what was billed as a friendly merger was really a takeover by the German car maker, leading to resentment on both sides and making integration of the two firms difficult.

Without question, in the three years since the DaimlerChrysler merger, the US firm has proved to be a huge financial drain on its German partner, announcing a loss of £425m in the first quarter of 2001.

Six of Chrysler’s US car plants are to be closed, 36,000 jobs are to be cut worldwide and it is facing a £5.3bn lawsuit by US investor Kirk Kerkorian, whose hostile takeover bid failed in 1995. He claims investors were misled over the nature of the agreement.

Back in 1998, it seemed like the two companies were made for each other. Mercedes-Benz was a luxury car maker whose biggest market was Europe; Chrysler was a mass-market producer whose sales, apart from its Jeep subsidiary, were mainly in the US. Surely both could gain from economies of scale and better access to each other’s markets? Where there are obvious synergies, there are compelling reasons for two companies to merge.

Not least of these is the favoured buzzword of the moment – globalisation and the consequent need to grow to gain economies of scale and compete across world markets. Shareholders provide an added pressure for firms to increase their returns through acquisitions.

But do mergers and acquisitions really offer the kind of returns companies and their shareholders expect, or could firms be putting their own futures on the line by buying up the competition?

In the case of DaimlerChrysler, what was billed as a friendly merger was really a takeover by the German car maker, leading to resentment on both sides and making integration of the two firms difficult, says Michael Hitt, professor of business administration at the University of Arizona.

‘There were a lot of potential synergies between the two firms, but because it ended up being a takeover, not a merger, they’ve lost most of the key employees that were involved at Chrysler, so they’ve lost a lot of the talent and knowledge they acquired.’It has also taken them much longer to implement the positive features of Daimler into Chrysler, because they were fighting rather than co-operating with each other,’ says Hitt, author of the recently published book, Mergers & Acquisitions: A Guide to Creating Value for Shareholders.

But while the problems at DaimlerChrysler and the failure of BMW to make a success of Rover may have come as a shock to industrialists in Stuttgart and Munich, some argue the odds were never really in their favour. The success of mergers can be difficult to judge, as it often takes two or three years before it becomes obvious whether they have really gone to plan. But according to Hitt, about 30% of companies sell most of the assets they have acquired within five years of a merger. Of course, some of these companies may well have bought a firm to get their hands on one particular division, and always intended to sell off the rest later. But many more found themselves stuck with a burden they had to dump before being dragged down along with it.

The potential for this is real, says Hitt: many companies go bust each year because they bite off more than they can chew.

‘There are firms that are simply in too much debt, and that’s often in combination with paying too high a premium for the company, so that even if there are synergies between the two businesses, they just can’t recoup what they paid for it.’

Then there is the added expense of securing the deal itself. Investment bankers, management consultants and lawyers all take their slice of the cake when two companies decide to merge. Hammering out the small print in the deal between engineering firm GKN and Brambles of Australia cost £45m in professional advisers’ fees, of which GKN will pay £30m.

Around 3% of the value of any deal is spent on the transaction itself, says Jeremy Stanyard, a member of PA Consulting’s management group. But how can companies be sure they are getting value for money from these advisers? A percentage of advisers’ fees should be tied to the long-term success of the merger, says Stanyard. ‘Some advisers walk away with massive fees for negotiating a deal that later turns sour – that doesn’t seem right.’

The idea is unlikely to be popular among investment bankers, but Stanyard believes that more and more chief executives will demand contracts where future performance is taken into account.

While pressure from investors can be one of the main reasons to buy another company, most deals fail to offer genuine shareholder value.

A recent survey by consultant KPMG found only 30% of mergers increase shareholder value, while a similar proportion resulted in a decline in value. Instead, the winners in any deal are often the shareholders of the acquired company, says Stanyard, because firms lose interest once the excitement of the merger talks is over. ‘There is a general appetite for doing the deal, but not for making it work afterwards. Companies don’t focus enough on planning, and underestimate the difficulties of integrating the businesses.’

One of the big problems at DaimlerChrysler, post-merger, has been the exodus of key US employees. One of the attractions of Chrysler had been its emerging reputation for producing innovative designs, including a series of concept cars which it successfully turned into niche models such as the Plymouth Prowler and the PT Cruiser. Many of the people behind those models have since left.

Companies should take the issue of keeping hold of staff more seriously, says Valerie Garrow, researcher at training consultants Roffey Park, and co-author of a report into effective mergers and acquisitions. ‘You don’t want everyone to leave by the time the merger is completed. You could throw money at them and hope they’ll stay, but often highly skilled people are not motivated by money alone; they want an interesting job where they feel their skills are valued.’

Without effective planning, it is not just staff members that can be lost, says Garrow. Customers can also be affected by the changes, as few firms realise the amount of work involved in mergers. ‘Often companies put all their efforts into dealing with the merger, and take their eye off the ball – nobody’s thinking about business as usual, about the customer. Performance can really nosedive.’

This can be bad news, as it comes just at the time when shareholders are expecting a big return on their investment, and customers are sensitive to any slump in service. ‘Getting things to work smoothly during the transition can be difficult. It can be a time of really major confusion for customers and employees alike,’ says Garrow.

This confusion can be particularly pronounced when the buyer and the acquired firms are based in different countries, as both BMW and Daimler found to their cost. Different company cultures plus different national employment laws can equal buyers with a new business they simply don’t understand. BMW’s reluctance to interfere in the running of Rover in the first few years after buying the UK car maker has been blamed by many for its heavy losses. By the time BMW got a firm grip on the steering wheel, it was too late, and a company that had cost £527m in 1994 was sold for a token £10 six years later.

But while BMW left Rover to its own devices for too long, the equal yet opposite risk in overseas acquisitions can lie in interfering too much, says Hans Jonsson, director of special projects at Swedish group SKF.

This risk is greater when the buyer is a large multinational, and the acquired company is only a small firm. ‘The biggest danger is that a large organisation can swamp the smaller one, so friendly mergers are very important,’ he says. After struggling to walk the tightrope between integration and downright interference in the past, SKF now has its own ‘integration manager’, whose role is to protect the newly acquired firm, and stop its staff walking out of the door.

SKF is always on the lookout for new additions, and managers face pressure from above to find as many potential candidates as possible. But the more companies that are considered, the greater the risk of buying a lemon, so good screening is crucial. ‘The assessment has to be done well. We look at a lot of candidates and find during the process that the risks are just too big and we have to pull out.’

Being more choosy over your acquisitions is obviously a good idea, but it’s a little late for DaimlerChrysler. So where does this leave the troubled car maker? The German firm is now having to impose its own systems on a reluctant Chrysler, and while the likelihood is that things will eventually turn around, the chance to integrate the best parts of Chrysler into the new company may already have been lost.

In an engineering firm the old cliché that your people are your greatest asset often holds true. And when acquisitions that start out friendly turn nasty, it is the best of these people that are the first out of the door to your competitors.

So if you want to make the most of a merger and keep your shareholders happy, it’s a good idea to keep things amicable – just like a real marriage.

Sidebar 1: GKN and Brambles: instant approval

The recent deal between GKN and Brambles of Australia was well received. The two companies agreed to combine their industrial services operations, leaving GKN free to operate as a pure engineering firm, focusing on its automotive and aerospace businesses.

The deal, a candidate for the year’s worst-kept secret, pleased investors because the two activities – engineering and industrial services – were not seen as ideal stablemates.

Mark Troman, analyst at Merrill Lynch, says the agreement makes a lot of sense. ‘There is a lot of logic behind it. It will allow GKN to focus on its core engineering business, while value can be unlocked from the industrial services businesses. A single management team will eliminate all possible conflicts.’

GKN, which will now have a market value of £2.4bn, has plenty of cash to spend on acquisitions of its own. These are likely to be on firms that consolidate its automotive and aerospace businesses. ‘We won’t see anything radically different. The market would not want them to broaden out too much. The beauty of GKN’s business is that it’s very focused,’ says Trotman.

Sidebar 2: Smiths and TI: eventually found favour

By contrast the market was none-too-pleased when Smiths and TI announced plans to merge last November. With Smiths’ interests in aerospace, medical engineering and industrial equipment, and TI’s mixture of aerospace components and an unpopular car parts business, initial impressions were that here was an old-fashioned conglomerate with neither focus nor synergies.

While the deal had the advantage of being between two UK firms that knew each other inside-out, investors hate ‘conglomerates’, believing they offer no benefits other than size. ‘It was not well received by the market – there was no real industrial logic behind it,’ says Mike Monkton, analyst at UBS Warburg.

TI’s automotive business was singled out for particular scorn, with widespread over-capacity in the global car industry and the US slowdown hitting the components sector. Smiths had hoped to make at least £1.2bn from the division’s disposal, but venture capitalists offered less than £900m.

The group instead decided to demerge the business into a private company, which has improved its image among investors. ‘Having come up with a solution for the automotive division, investors have realised there is a strategy behind the merger,’ says Monkton.

The group now has a focused aerospace business, with Smiths’ expertise in avionics and control systems, and TI’s success in hydraulics, turbine components, airframes and cockpits. ‘It gives Smiths a chance of meeting objectives – giving them a bulk which will help them do deals in the aerospace industry,’ adds Monkton.