David Weidner’s article in last week’s Wall Street Journal, “Wall Street’s Biggest Con Is M&A ‘Advice,’” asserts that practically all merger and acquisition (M&A) activity destroys long-run shareholder value. While M&A activity pursued to jump start stalling returns or along visions of imperialistic expansion generally results in value destruction, strategically placed acquisitions of businesses, technologies and assets that leverage in-house innovation and operational excellence predictably create long-run synergistic value for shareholders.
While the pursuit of non-core or diversified revenue streams is not an appropriate justification for M&A, there are other methods via which these opportunities can be capitalized, the most prominent of which is the formation of alliances and partnerships. Alliances and partnerships are to mergers and acquisitions what derivatives are to equity: they allow for the levered, customizable and contractually-based ownership of a set of cash flows. Though Google is not a paragon of acquisition strategy (reminiscent of the dot-com era, it paid $1.7B for YouTube, a company with no revenues), it does engage in a practice of leasing off its search business while leasing in space from major internet portals. Under this arrangement, Google has to front cash only when a service is delivered or received and can terminate agreements should the market landscape shift, a luxury ill afforded by an acquisition.
It is important to note here the difference between businesses pursuing an M&A strategy and investment funds, such as those run by private equity firms, engaging in M&A. The managers of an investment firm involved in M&A spend most of their time on high-level issues, free from the day-to-day distractions of a business. A business delivers value to its shareholders as a function of how well it delivers value to its customers. An acquisition occupies valuable company time and energy, which can detract from its core value offering. For a business there is only one type of acquisition strategy that can predictably produce positive effective returns over the long-run.
Strategic M&A is the art and science of leveraging internal innovation and operational excellence over acquired businesses, technologies and assets. In early 2005, Apple acquired FingerWorks, developer of a multi-touch gesture recognition technology. After a long series of small, private acquisitions combined with Cupertino’s unique flavour of technological disc-jockeying, Apple revealed its market-disrupting iPhone. In late 2006, Hewlett-Packard acquired VoodooPC, a ultra high-end luxury PC manufacturer. By leveraging its global supply network, Hewlett-Packard was able to squeeze higher margins out of VoodooPC than it could have generated independently. In both instances it is the assets of the acquirer, not the acquired, that is the driving factor for value generation. Also relevant is the degree to which the cellular walls of the acquired firm are broken down; though a spectrum exists between Apple’s style of complete dissolution and HP’s method of maintaining the original skeletal structure, some degree of integration must occur for the critical synergistic bonds to form.
Strategic M&A is more challenging than imperialistic acquisition because it requires a more extensive and innovative type of due diligence and analysis based on a concrete understanding of one’s business. This has the consequence of somewhat disintermediating the M&A advisory role. The current M&A model provides large incentives, both financial and social, to bankers who close large dollar value deals. A shift to a model that encourages simultaneously pursuing many small deals would preserve the present fee revenues while moving closer to strategic advising as opposed to transaction advising.
While many large, public M&A transactions may be pursued for the wrong reasons and deserve the criticism they receive, it is incorrect to induce from these deals, which by deal count make up a small minority of M&A activity, the nature of the M&A industry as a whole. Though the large fees earned through M&A advisory are an easy target for journalists and politicians, these margins have stood the test of time. There is something to be said about the value of a business that repeatedly withstands the rigor of the markets during times both bullish and bearish.
