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Life After M&As
Are M&As about empire-building or are they based on a rational motive? What
is the fate of the acquired assets after M&As? This article, based on a
research paper entitled "Post-Merger Restructuring and the Boundaries of the
Firm" by Professors Gordon Phillips, N R Prabhala, and Vojislav Maksimovic,
all from the Robert H Smith School of Business, University of Maryland,
explores these questions along with the implications of M&As on the existing
assets of the acquirer. The research paper is forthcoming in the Journal of
Financial Economics.
Mergers and Growth
Mergers are a fast way for firms to grow. Through mergers, firms can rapidly
expand market presence, acquire new strategic capabilities, or deploy
in-house talent to quickly exploit new business opportunities. Mergers are
also one of the most significant investment decisions made by firms. The
worldwide M&A volume for 2010 exceeded $2 trillion. The Indian M&A market
has also grown rapidly with several multibillion dollar deals such as the
Tata-Corus, Tata-British Salt and Hindalco-Novelis acquisitions. Similar
growth is also expected for the broader Asia-Pacific region. In a 2010
Bloomberg survey, over 45% of financial markets have picked Asia-Pacific as
the major growth hub for M&As in 2011 and beyond.
What Happens After a Merger?
Although there exists vast literature on M&As, relatively little is known
about what the firms do with the assets acquired in a merger. Questions
remain such as: Do acquirers keep most assets, or do they sell and close
significant parts of the newly-acquired assets? What kinds of assets do they
tend to keep? What is the performance of the kept and sold assets and how
does this impact an acquirer’s existing assets? Our study provides insight
on these questions using a sample of over 1,300 US M&As in the manufacturing
sector from 1980-2000.
Post-Merger Restructuring: Extent and Direction
First, we found that acquiring firms do not passively retain assets after a
merger. Rather, a merger starts a vigorous restructuring process that
involves significant sell-offs and closures. 46% of the target’s plants are
sold or closed within three years of a merger. These results do not support
the view that mergers are driven by acquiring managers’ tastes for large
empires. If this were the case, we would expect passive absorption of
newly-acquired assets from a target into an acquirer’s existing portfolio.
Instead, we see sell-offs and closures of close to half the acquired plants.
Second, we found that acquirers selectively keep or dispose off assets based
on the fit of the assets and an acquirer’s capacity to manage the new assets
successfully. For instance, acquirers are more likely to retain target
assets if they are related to their own existing businesses or core
competency. On the other hand, unrelated assets that do not fit are likely
to be sold off. A critical determinant of the asset retention decision is
the acquirer’s skill in running peripheral businesses. Acquirers who are
less efficient in running their non-core, peripheral businesses are likely
stretched. They cannot easily absorb and run new acquisitions efficiently.
On the other hand, acquirers who are highly productive in their peripheral
businesses have the capacity to take on new businesses. These firms tend to
retain more assets after a merger.
Industry booms amplify the role of peripheral skill. When industry demand
surges, both efficient and less-efficient producers benefit. However, the
more-skilled firms now have greater comparative advantage compared to their
less-skilled counterparts. Thus, plant retention is more likely when an
acquirer is skilled and the plant is in an industry that experiences an
unexpected shock. The patterns of sell-offs and retention indicate that
after acquisitions, firms reset the boundaries of their operations in a
manner that exploits their operating side skills at growing and managing
their newly-acquired assets.
While the above tests show that operating-side skills shape an acquirer’s
boundaries after a takeover, one question is whether the financing side
matters. . We found that the financing side also affects post-merger
restructuring. Plants are less likely to be sold when acquirers are cash
rich or have lower levels of debt. Financially-constrained firms are more
likely to sell target assets to generate scarce resources to pay for the
target businesses that they intend to keep. Retention is more likely when
acquirers pay for targets in cash and less likely in stock-financed
acquisitions.
Post-Merger Performance of Kept and Sold Plants
We examine the performance changes of the plants transferred in acquisitions
after the merger takes place. Are acquisitions followed by improved or worse
performance? To examine this issue, we track plant productivity over three
years after an acquisition is consummated. Here, we find sharp differences
between plants retained by acquirers and the sold-off plants. Plants
transferred in an acquisition and kept by an acquirer show fairly sharp
increases in productivity. The performance changes are economically
significant. For instance, the average increase in total factor
productivity, which is the value of the output minus the inputs required to
produce the output per industry norms, increases by 6.3% over the three
years after an acquisition. What types of acquisitions result in greater
performance improvements? The efficiency changes are greater when both the
target and acquirer are relatively efficient. In other words, efficient
firms appear to acquire efficient targets and generate further improvements
in performance.
The performance changes are quite different for plants sold off after the
acquisition. The change in total factor productivity of sold plants is 1-2%,
only about one-third to one-half of that for kept plants. Thus, acquirers
appear to shed assets that they have no comparative advantage in running and
only keep assets that they can improve operationally. It is worth stressing
that while the productivity changes of sold plants are small, they are
nevertheless zero or positive on average. There is little evidence of
real-side value destruction in these plants.
The performance results of sold plants come down against the “bust-up” view
of mergers. Under this view, unproductive assets are trapped in targets
unwilling to shed these assets. M&As work by liberating trapped assets. If
this were the case, we would see particularly pronounced improved
performance for assets acquired and sold off. However, the significant
performance improvements are concentrated in kept plants. The evidence is
more consistent with acquisitions being driven by acquirers redefining their
boundaries and expanding scope to exploit their comparative advantage..
We also examine acquisitions conducted by serial acquirers, who may have
particularly strong tastes for empire-building with less regard to
operational improvements. We find no evidence that repeated acquirers are
more prone to empire-building. Their later acquisitions are in fact more
likely to be sold off, and the kept plants in later acquisitions show
greater improvements in performance. Repeat acquirers appear to learn the
acquisition game and improve over time.
Do Acquirers’ Existing Assets Suffer or Benefit from M&As?
We consider the existing assets of an acquirer. A common concern with
acquisitions is that they distract management and divert attention from
their core businesses. Senior managers of acquirers spend a lot of effort in
post-merger integration of the newly-acquired assets. This attention to the
new acquisitions may result in step-motherly treatment of an acquirer’s old
assets, which may suffer declines in performance. These declines could
offset the gains from improving the kept plants in an acquisition. On the
other hand, the restructuring after a merger could improve the match between
the remaining kept assets and the existing assets of an acquirer. We find
evidence for the latter view. The existing assets of an acquirer show a
significant improvement in performance after an acquisition. Once again,
among the existing assets, there is an asymmetry between the kept and sold
plants. Although both plants have positive performance changes, the kept
plants show greater improvement in productivity compared to the sold plants.
The asset complementarities and synergies between the existing and the
newly-acquired plants appear to outweigh any effects due to distractions
from the acquisitions.
The Bottom Line: What Do Managers Need for Successful M&As?
What lessons do the results convey in terms of thinking about mergers
and acquisitions? There are two major takeaways. First, successful M&As
appear to be driven primarily about the potential for real side synergies
and complementarities. As Amit Kalyani, Executive Director, Bharat Forge,
says, “…Each acquisition gave us something new – access to the new passenger
car market, to the global market for aluminium components, to the US pick up
market, to the engine business in Europe… To them, we offer technology,
money, and a strategy to grow their business worldwide.” As Kalyani’s
statements indicate, M&As are primarily about expanding firms’ boundaries to
exploit organisational skills and capabilities. M&As are not really about
expansive empire-building by managers with a taste for large size.
Second, the results suggest that managers need a somewhat unexpected skill
set to be successful at M&As – skill at restructuring targets. Mergers are
not about passive absorption of targets. Rather, an M&A sets in motion a
vigorous restructuring process in which a large proportion of the target
assets are hived off. Firms tend to retain plants in which they have a
comparative advantage and improve their productivity but they tend to sell
or close other plants. Given the extensive restructuring that follows
mergers, successful acquirers should be skilled at restructuring – in
deciding what to keep, what to sell, what to close, and how to extract
improvements and synergies from what is kept – all within a short period of
time. The more effective the planning and execution of the post-merger
restructuring, the more likely it is that an M&A is successful..
Professor N R Prabhala is Associate Professor of Finance at the Robert H
Smith School of Business, University of Maryland and a visiting scholar at
the ISB.