Here’s something to think about. If you knew in advance, statistically, that by acquiring a company, post-merger, these two things could happen: (1) your own company’s profit margins, earnings growth, and return on capital will fall behind that of your industry peers in the three years following the deal; and (2) in that same three years, the stock returns of your merged company will be, on average, 24% lower than the returns for rival acquirers that you actually beat out on the deal, would you still pursue the acquisition?
It turns out that, despite strong evidence to the contrary, CEOs, their teams, and their investment bankers often pursue ill-advised acquisitions–to their own peril. High Tech Merger and Acquisition strategies have consistently proven to be too challenging, while rarely providing significant value.
Let’s explore some of the more high-profile deals, and then we will circle back with some recommendations to improve your M&A Strategy.
Recent M&A in Tech
Even relatively “small” acquisitions can turn out to be huge headaches. For instance, Facebook’s $2B acquisition of VR startup Oculus Rift is fast becoming a nightmare scenario for Mark Zuckerberg. The adoption rate of VR has been nowhere near forecasts, and to make matters worse, Facebook recently lost an IP theft legal battle against startup Zenimax to the tune of $500M USD. In addition, Oculus Founder Palmer Lucky was fired by Facebook after it was proven that he failed to comply with a non-disclosure agreement, bringing great embarrassment to the social media giant.
The same is true for Uber’s recent acquisition of Otto, a self-driving technology company. Its founder, Anthony Levandowski, previously worked for Waymo, a subsidiary of Google’s parent company, Alphabet. The lawyers for Alphabet have offered evidence that shows Uber was in discussions with Mr. Levandowski prior to his departure from Waymo. Moreover, Uber was allegedly aware of the risks associated with the startup, months before they acquired it for $680M USD. While Uber lawyers anticipated litigation, Mr. Levandowski has also subsequently hired his own legal counsel, who advised him to plead the 5th Amendment to avoid self-incrimination. All these circumstances generated a significant amount of unwanted attention for Uber at an already challenging time in its history.
Problems and Solutions in Mergers & Acquisitions
As a former McKinsey consultant, I have seen my fair share of mergers from the inside. Being a 7-time serial entrepreneur/CXO has also put me right in the middle of several acquisition negotiations, as all seven of my startups were acquired, all by iconic global tech companies. In one of my startups which scaled rapidly through an IPO and reached $180M in annual revenues, we acquired five small tech startups to round out our product line within an 18-month period. Finally, as a startup board member and advisor, I also experienced the M&A process up close and personal.
These experiences have given me deep insights into why so many M&A transactions fail, and I’ll now share these thoughts with you.
In essence, executives vastly underestimate the amount of work required to integrate unique corporate cultures. Perhaps the most egregious example is the merger of United and Continental Airlines. Despite the fact this transaction happened seven years ago, the two cultures remain at war with one another to this day. The two flight crews won’t fly on the same flight even when they are on holiday, much less while working. It’s just remarkable that such issues have not been addressed until now.
The fact of the matter is that the real work in making a merger successful doesn’t end as soon as the contracts are signed and when the US Securities and Exchange Commission approves the deal. When the paperwork is completed, that’s when the work really begins. Few companies understand this basic fact, and perhaps even fewer are capable of starting operations with this in mind.
Successful M&As in High Tech are Rather Rare
There are exceptions to every rule however, and two notable cases are General Electric and Cisco.
As a professor, I have taught the Cisco M&A case, written by the Stanford Graduate School of Business, for many years. It’s long been one of my favorite cases with my MBAs, simply because Cisco was an absolute master in the world of M&A. Of course, nobody is perfect, and their consumer electronics acquisitions of Linksys and Flip proved to be costly failures. Still, it’s worth taking a page out of Cisco’s book when it comes to handling M&As.
Unfortunately, in the world of tech, Cisco is in rare company. Google, with its acquisitions of YouTube, Android, and Waze has had some great successes, although they are only now beginning to monetize the two former acquisitions. Facebook’s investments in Instagram and What’sApp have been similarly successful, but again, they are only now beginning to figure out how to monetize these acquisitions.
Once we get beyond these three stalwarts, the list gets short. Much more common are disastrous acquisitions or those likely to be.
- After a highly public sale process which Verizon “won”–although one can readily argue just the opposite–the company was able to acquire Yahoo. But Yahoo’s business has been deteriorating for years. Even high profile CEOs, including former Autodesk CEO Carol Bartz and long-time Google executive Marissa Mayer, were powerless to stop the decline.
During the Verizon acquisition process, it was discovered that Yahoo’s servers were breached not just once, but twice, and the company failed to report these proactively. As a result of the massive data breaches, from which the cyber criminals were able to steal information from over 500 million user accounts, Verizon sought to reduce the consideration for the deal by approximately $1B USD. Despite this, Yahoo was able to preserve all but $250M of the original deal value of $4.5B.
- HP has had a decidedly mixed acquisition track record. Notoriously, its 2011 acquisition of Great Britain enterprise software vendor Autonomy which focused on Big Data analysis, was an unmitigated disaster. HP paid approximately $11.7B USD, an 80% premium over market value. It later came to light that HP’s own CFO felt that the company was vastly overpaying and did not support the deal.
Within a year, it had written off $8.8B USD, a whopping 75% of deal value. This was followed by a spate of accounting scandals and nonstop legal maneuvering, creating an ongoing distraction for HP executives. HP recently sold off the remaining assets of Autonomy, a deal which will live in the annals of history as one of the worst M&A transactions in enterprise software history.
- On a more successful note, HP (now HPE) purchased hardware disk array and storage management software vendor 3PAR in 2010. The transaction commenced in a bidding war against Dell, and HP ultimately paid 2X Dell’s original offer of $1.15B USD. Despite this, the transaction is widely considered successful and 3PAR was folded into HPE as a wholly owned subsidiary in 2015. More recently, HPE paid $650M for Simplivity, acquiring contemporary software-defined storage and hyper-converged infrastructure capabilities for its storage portfolio. It was considered a sound strategic move, given both the high price and the maturity of the 3PAR product line.
Less sound and widely criticized by industry insiders is HPE’s acquisition of 10-year old mid-range all-flash array vendor Nimble for $1B USD. While it does provide HP with a strong number 2 position in the external array market, behind unit share leader EMC and just ahead of NetApp, the merger will likely serve to confuse both HPE’s customers and its own sales channels. While some suggest HPE purchased Nimble specifically for its InfoSight analytics platform, this makes little sense as they would have been better off purchasing or developing on their own a unified analytics platform that seamlessly spans across both 3PAR and Simplivity.
Critics suggest that Nimble investors hit the critical 10-year exit threshold for VC fund liquidity which put the company in play, and HP, widely known to overpay, bit on the deal. Now they will need to figure out how to deliver the business case, considering the fact that Nimble’s 10-year old architecture is mature and its product is undifferentiated. That’s a tall order.
6 Recommendations for Improving Your M&A Strategy
Recognize that no organization has ever bought its way into being an innovative company. It's only one of several levers that companies can use to remain on the cutting edge. High tech M&A is fraught with risk and the failure rate approaches 90% or higher. In light of this, what’s an acquirer to do?
- First, go in with your eyes wide open. Realize that, based on historical data, the odds of acquisition success are stacked against you. This will create the proper level of humility–and yes,paranoia–as you start the process. Can you develop the capability yourself? If so, are you being honest with yourself? If not, why not? Do viable acquisition targets even exist? These are some important questions that you need to seriously consider beforehand.
- Second, if you do decide to take the M&A route–and this is not an overnight process, develop a corporate culture support that respects entrepreneurs. Allow them some autonomy to continue to do what led you to be interested in acquiring their company in the first place. There must be a way for Horizon 1 (mature core) and Horizon 2 (future looking growth businesses) senior leaders and their teams to productively coexist in an environment of respect. It doesn’t always have to be a zero sum game of contentious resource grabbing.
- Third, be clear about what you are trying to accomplish with your planned acquisition. Involve relevant experts both from the Line of Business and from the Corporate Development office to ensure that any deal makes sense “on the ground with customers.” Acquiring multiple, overlapping assets will only lead to confusion and may undermine all your hard work.
- Fourth, approach leaders of the acquisition and check for cultural fit. Do they really have the personality to sincerely work with your core business leaders in a meaningful way for at least 18 to 24 months to properly integrate the businesses? Can they control their egos in service of the greater good? Can your own executives do as well? If these characteristics are absent, stop the presses. If there is genuine chemistry, then it makes sense to move into formal due diligence.
- Fifth, pay special attention to IP rights and accounting regularities. In this era of growth for growth’s sake, too many companies are cutting corners to achieve a short term edge. This will turn into a massive legal distraction if the deal is consummated prior to finding irregularities. Learn from the failures of the big organizations cited above.
- Finally, over-communicate. Bringing different corporate cultures together is as hard a challenge as management change. Put your best people on this and don’t tolerate provincial thinking and actions. Inculcate a One team, One fight mentality among your people.