27 April 2010

M&A - good or evil ?

Hertz announced today its acquiring Dollar/Thrifty for $1.2B. My initial reaction was "Great, rates are going to go up." And they will. I was also reminded of how I really never understood a rental car company's business model. I was in philly a few weeks ago and rented a midsize car for $40 for three days. And that was after $15 of airport fees. No advance reservation required, no cancellation fees (you can just not show up and you won't be billed). How does this business make money? I heard its on insurance (vis -a vis-the Circuit City "warranty" model) - we know how that generally works out in the long-run.
It may be at the business-customer level. But I digress.

It got me thinking about something very personal. Is M&A good or evil ? Is it a net gain or loss for society as a whole ? Being a corporate M&A guy, it behooves me to think the former, otherwise it's like I'm working for Microsoft :). But looking at it from a purely long-term, Atma standpoint, i'm not so sure. Just to clarify, i'm talking about mega-mergers such as the Hertz/Thrifty deal.

First - lets look at it from a shareholder point of view. Everyone's heard the old adage that at least 80% of all mergers fail to create shareholder value. The hedge funds have this right - buy the acquiree, short the acquiror. Synergies are never fully realized, but more often than not, it comes down to simply overpaying. So why does EVERY corporation try to beat the odds? The quick answer is that Management is incentivized to do so. It's much easier to do one big acquisition then try year over year, quarter over quarter, to churn out consistent growth. But in the end, shareholders always lose.

Now - the employees. Initial view is that layoffs are always part of a megadeal. "Cost synergies", while I argue should be last on the list of benefits, are always the first to be announced. It's almost as important as the deal itself. Although short-term, this looks like a negative, it may not be in the long-run. If the company being acquired is poorly run or not competitive, a merger may actually save more jobs than the failing company could do on its own. Its sort of like the concept of "outsourcing". Even though its a net gain to the US (US multi-nationals realize the biggest returns on outsourcing), people are a bit myopic and see the short-term cuts as bad. So my vote here is that its "too close to call."

Now us as consumers. We ALWAYS lose. Even if some synergies are realized, those profits stay within the companies (look at the massive cash balances on most large company's books) or show up as bonuses to executives. Plain and simple - there is one less competitor in the marketplace. The impact varies from case to case. If #1 buys #2, forget about any consumer benefits. If #1 buys #10, it may have a much lesser impact. But the impact will generally be negative nonetheless. Prices generally rise (after an initial integration period where companies change as little as possible so they don't frighten away customers and other stakeholders), and selection generally drops. With Hertz, you're going to get increased pricing all around. Has anyone bought a razor blade under $20 bucks these days? Gilette (now P&G) did a great job of swallowing its peers. Look at consolidating markets; it's hard to find true competition in those arenas. The good news is technology and internet are game-changers that will impact even the most monopolistic industries.

So what about the historical strategic deals ? You know those instances where 1 + 1 = 3 ? The ones that the thought leaders describe as brilliant, or light years ahead of its time ? AOL + Time Warner. Sprint + Nextel. Can anyone name any of these that fit this category ? Any ideas ? I can't think of one.

So who wins? Well, for one, its the bankers and attorneys. The fees generated are sick. I'm all for the market dictating the price for goods and services - but even a free market capitalist like me has a hard time justifying the excessive advisor fees. For two, its management. I alluded to this earlier, they all have employment agreements which pay huge sums of money (in the form of cash, unrestricted stock, in the money options, etc..) for a "change in control." Huge. All in, these fees can easily total 10 -15% of the overall deal size (depending on circumstance of course). Hard to find synergies to compensate for that ? So are they acting in the best interest of sharholders or themselves ?

So all signs point to Evil ? We'll i hate to sound like a cynic, but generally on the mega deals, I think its true. There is so much execution risk and so many wrong incentives by executives trying to "push" deals through that shareholders, employees (maybe), and consumers are generally worse off.

So where is the good ? I think its in upstarts. In new ideas not acquired ones. Businesses built from the ground up, not from the top of the ivory tower. It's the Buffets, and Rockfellers, yes and even the Gates of the world that become respected industrialists by just that. They weren't "Barbarians at the Gate" or financial engineers, or even people that buy companies for a living (present company excluded). So in my opinion, business is good if it creates a tangible benefit to consumers, not just recycled through retained earnings.

So you tell me, is this post good or evil ? Right or Wrong ?


  1. evil for shareholder...only megadeals that have been successful (that I can think of) are again in the oil and gas world....Exxon-Mobil and Chevron-Texaco

  2. ah yes "Cost synergies"..when companies limit the decision makers involved to a group of fewer, smarter people, many more costs would be realized and more efficiencies found. sadly for shareholders of the acquiring company, the opposite is usually the case.

  3. I love this topic. I agree that mega-mergers are not the best solution for the consumer. Of course, these mergers only happen when the industry is mature, as are the companies. They get fat, bloated, and from a competitive advantage standpoint a bit cocky. From an entrepreneurs' standpoint, these mega-mergers mean an opportunity to create a competitive advantage in a highly targeted niche. You can grow quickly with the target of eventually being eaten by the major market participant (ala Gillette, Microsoft, Google, etc). Being eaten (by us small guys) only means we will be eating better ourselves :)

  4. I totally agree with you. But are we giving a double standard here by giving entrepreneurial companies a pass, and megaclomerates a slap on the wrist ? And at what point/size does M&A go from bad to good ?