Source: theHRDIRECTOR
Date: March 2007

After three strong years for takeover activity, 2006 saw all records broken with deals worth a staggering $3.5 trillion around the world. but are companies getting any better at M&AS and, if so, what they are doing differently? And what role do HR teams play in making deals work? Marco Boschetti, Principal at Towers Perrin, considers these questions.

Once, not that long ago, the words ‘merger’ and ‘acquisition’ would spread panic among the ranks. For many, they were synonymous with upheaval, cost-cutting and closure. More often than not, HR professionals were presented with a fait accompli, and asked almost as an afterthought to sort out the people issues. But if experiencing an M&A at the sharp end wasn’t much fun, it often proved no more agreeable for shareholders. After being heralded with bold promises from chairmen and chief executives, most M&As failed by their own measures, whatever the stated aim of the deal.

However, recent takeovers are doing well. Research by Cass Business School in London in conjunction with Towers Perrin shows that the current cycle of M&As is proving to be much more successful than previous waves in the 1980s and 1990s. Success, in this exercise, was measured by the change in share price from six months before the deal and six to eighteen months after, compared to the rest of the market. A quantitative analysis of around 1,500 deals in total around the world, each worth at least $400 million, showed that M&As in 2004 outperformed the market index by seven per cent, compared to underperforming by 2.5% and 6.4% in 1998 and 1988 respectively.

This improvement is no coincidence: companies are doing things differently this time round. Indeed, assisting more than 400 companies a year in transactions in a variety of sectors, we see that M&A knowhow has significantly improved in three key areas. First, we see better governance of the deal itself. Companies manage the M&A process better and select targets more carefully. In earlier waves, the motives for takeover bids were often non-financial. This resulted in price myopia, defensive acquisitions and irrational bidding. Occasionally takeovers were agreed at a high level, and material financial surprises only emerged after it was too late. Now we observe much closer alignment of management and shareholder goals, together with greater scrutiny of executives’ actions and transparent governance processes. There is no room for hubris any more.

Second, companies are carrying out due diligence with more rigour, and pricing targets more realistically. Few acquirers in the UK, for example, would omit an analysis of a target’s corporate benefits programme, particularly its pension liabilities. And this is true even outside the UK: in a recent instance, Towers Perrin was advising a client in a deal worth around €4 billion when due diligence of benefits plans uncovered an unrecognised pension liability of €1.4 billion. It didn’t fatally impact the deal, but it made a colossal difference to the purchase price!

“far more realistic people integration plans”

The third major learning is the increased focus on integration, in order to deliver the financial synergies offered by the deal. Here, we see a much greater dedication to actually making the integration happen, taking the required hard decisions in ambitious timeframes, in line with pre-deal shareholder commitments. Strong evidence also reveals that buyers are amplifying the role of HR specialists and bringing them in earlier in the pre-deal phase, rather than just dumping the integration on them after the deal (and the damage) is done. In this way, we see far more realistic people integration plans being set out – and priced – up front.

Overall, the decisive element in successful M&As is good leadership from start to finish. Many individuals are involved in preparing and implementing the deal, all susceptible to sudden distractions and conflicting priorities. The importance of crisp decision-making and keeping the main goals in mind is selfevident, but it demands clear-thinking and determined leadership to ensure it happens. Accordingly, the top priority is to put in place the leadership team that will run the enlarged organisation from the outset. When the top echelon is appointed early, with politics and uncertainty out of the way, it can get on with the difficult job of integration. HR professionals have a crucial role in identifying the right leaders and defining a clear, effective remit for them.

During the pre-deal phase, as an integral part of due diligence investigations, buyers must begin to understand the business they are acquiring and devise an implementation blueprint showing how the new operations will be merged, spelling out what needs to happen, by whom, when and how. As well as meaty operational issues such as production or distribution, there are huge planning challenges for HR specialists. How will employees be rationalised? How will pay programmes and benefits be aligned? What retention mechanisms will be needed? How do we communicate all these in a way that keeps our people, new and old, fully engaged?

The financial implications of such blue-prints need to be allowed for – in full – in the valuation model of the target business. That is why HR’s early involvement is vital. The downsides of no HR involvement are serious; most notably there is significant risk of either over payment, or reliance on ‘un-implementable implementation plans’. After the deal is closed, the challenge is to execute the blueprint flawlessly, which demands both focus and – again – leadership. Naturally, some implementations are easier than others. The Cass – Towers Perrin study found that the scale and difficulty of integration influenced the outcome. Deals were categorised as either medium-sized ($400 million to $1.5 billion) or ‘mega-deals’ ($1.5 billion plus). In the post-deal euphoria six months downstream, mega-deals looked strong, outperforming the market by 13.9%. After 18 months this dwindled to just 1.1%.

By contrast, medium-sized deals performed consistently, outperforming the market by around 7% both after six and 18 months. This confirms what is intuitively obvious – medium sized transactions tend to be easier to integrate than larger ones. Indeed, for larger deals, short-term euphoria driven boosts to the share price becomes hard to sustain in the longer term, when companies must integrate people, brands, intellectual assets,
systems and processes. Together, these pitch a tougher, more subtle challenge: to retain and engage employees at all levels. Medium sized deals fare better. Part of the reason lies with the smaller scale of integration – fewer people, processes and operations reduce the magnitude of the task. These are often mere on-boarding processes (albeit on a more material scale) rather than large scale transformational changes.

“two conflicting cultures can be the cause of deep divisions in the workforce”

Companies that acquire domestically fare better than those which carry out cross-border deals. Distance and remoteness of the target company’s operations play a part, but more significant is the difficulty of getting to grips with the unfamiliar culture. The difference is remarkable: the Cass – Towers Perrin research shows that companies making a domestic acquisition out-performed the market by 11.4%; those involved in a cross-border deal underperformed the market by 2.6%. In terms of shareholder value against the market, we see a 14 percentage point difference between making an acquisition in the same country and abroad. The gap emphasises a huge benefit when the company they own stays close to the employment and regulatory culture it knows. Even so, takeovers in the same country can bring about a clash of corporate cultures. Much depends on the relative sizes of the merged operations. If the target is a comparative minnow, its culture will be absorbed. Where the parties are closer in scale, two conflicting cultures can be the cause of deep divisions in the workforce.

Once again, the pace is set by leaders – extensive research consistently shows that leaders drive the culture by exhibiting the behaviours others will emulate. Cultural ethos, therefore, as well as chemistry, is a key consideration for HR specialists helping to select the top team. When a company is acquired, change is inevitable, but employees do not always react adversely. In some instances employees greet the takeover with cautious enthusiasm, particularly if the deal brings the prospect of additional personal opportunity. An essential aim of the integration blueprint is to retain and engage the whole enlarged workforce. The key drivers of engagement and retention – such as opportunities for training and development, compensation and benefits programmes, fair and consistent criteria for determining pay and promotion – need to be planned and budgeted in detail. Towers Perrin research (2006 Global Workforce study) concludes that the number one factor in retaining staff is that the company keeps its skilled employees. Put simply, to hang onto your staff,  you have to keep your good people. The hand of HR professionals, therefore, is strongly evident in the success of the recent takeover wave.