In June 2020, amid the novel Corona-19, Saudi Aramco formally completed the Saudi Basic Industries Corporation (SABIC) acquisition. The company now owns a 70% stake in SABIC by investing 259.125 billion (US$ 69.1 billion). The pros of the merger include establishing Aramco’s dominance in the petrochemical industry in the global market. It is one industry that has been growing fast because of the increase in global oil demand. In 2019, both the companies’ combined petrochemical production touched 90 million tonnes, a record in itself. The acquisition is a part of its ‘Downstream strategy’, a long-term strategy to grow its refining and petrochemicals capacity. Aramco benefits hugely from this merger, with the investment becoming a case study for industries on how an M&A can be well-planned and bear impressive results.
On a similar line, the acquisition of Careem by Uber in March 2019 was a successful one. For $3.1 billion, Uber Technologies bought rival Careem, thereby establishing its supremacy over the Middle East. The merger was essential for Uber in the UAE and was termed as an ‘important moment for Uber” after it had faced losses in countries like Russia, Southeast Asia, and China.
But not all mergers and acquisitions go this well. The chances of a failure are more, and the reasons can be many. Among the many reasons of why a merger and acquisition may not end up giving the desired results, one vital reason is that acquiring firms are overpaying for an acquisition. This story has remained the same, more or less all throughout history. A perfect example for this is the acquisition of Snapple by Quaker Oats in the late 1990s. Quaker paid $1.7 billion to acquire the other company, but experts believed that the deal was at least $1 billion higher than what it should have been.
It is as if most acquiring companies rush through the process. In the excitement of it all, they fail to ponder on essential aspects of mergers and acquisitions. Many have failed because the integration of the acquired company with the parent has been poor. Take the case of the Quaker Oats-Snapple merger. On the day the merger was announced formally, both the companies registered a fall in share prices. Within a span of 20 months, Quaker Oats had to sell off Snapple at a loss of about 20%. Poor implementation of the deal backed by changing market conditions was cited as the main reason.
Obviously, the issue was the lack of strategic planning and an apparent enthusiasm to acquire on the acquiring company. What could have stopped Quaker Oats to avoid such a financial goof-up were to take the help of proficient mergers and acquisition consulting services. Some feasible questions that need to be addressed in this context are – what is the right amount to pay for an acquisition, or at what point should acquiring companies decide to move out of the M&A?
In a research conducted by the Harvard Business Review, it was found that there is a systematic way of going about the pricing during acquisitions. There needs to be a detailed due diligence where the data related to the target company needs to be analytically evaluated, and stringent discipline needs to be in place for informed decision-making.
Where is the issue?
Usually, when a decision regarding an M&A has to be taken, the board of directors and shareholders need to vote for or against the merger. However, in most cases, it has been seen that the top management decides in favor of a merger, and the board puts its stamp of approval on it. Shareholders rarely go against such decisions. In most cases, it has been found that the short-term gains are what everybody across the board is interested in. In the process, they push the long-term goals behind. Many a time, it has also been seen that the biggest beneficiaries of such mergers are the top management of executives while the overall acquisition proves to be disastrous for the acquiring company.
The best example here is the acquisition of Jos. A. Bank in the US by Men’s Wearhouse in 2014. While it was a fizzled-out decision for Men’s Wearhouse, with share prices immediately declining by over 50%, Doug Ewert, the CEO of Men’s Wearhouse, saw substantial financial gains as he received a handsome bonus on completing the acquisition.
While greed is one major factor that seems to be behind these far-fetched acquisitions, there are other reasons. As per Mergers and Acquisition Advisors and experts, there is a popular theory called the Overvaluation Trap. It is also something that senior executives get into to justify an over-valued price of mergers while promoting what is termed ‘Flashy Acquisitions’. It helps executives distract everyone, including the board and the market, from other inadequacies and failures grappling with the company.
The Pollyanna Principle also plays a significant role in all of this. Overpriced acquisitions often result because people at the top link a previous success and memories of a positive merger in the past. They feel that such memories will keep repeating, and there would be no negative experiences. Plus, the need for senior individuals to stay competitive can push organizations into embracing over-valued acquisitions. One good example of the top guys’ ego issue was explicitly exemplified when Elon Musk decided to bail out a sick company called SolarCity (SCTY). What happened, as a result, was that the shares of his very famous Tesla plummeted instantly.
Overpaying or over-valuation of M&A is a problem that is one of the gross mistakes that acquiring companies commit. The selling company will negotiate hard and tell you when the price you are getting is not enough, but they will never tell you when they are paying more.
So, what is the solution? Companies that want to acquire or merge, or buyout another firm need to hire well-experienced mergers and acquisition specialists to avoid all such discrepancies and eventual losses.
Importance of Conducting a Financial Due Diligence during M&A
When acquiring or merging with a company, it is imperative to conduct an in-depth analysis of the financial status of a business. As part of this analysis, the financial records and statements are reviewed to get a holistic picture on the financial position of the company. The revenues and margins of each product/ service are reviewed. This due diligence is carried out to make a well-informed takeover or merger decision. The financial due diligence has proved to be an essential tool that help businesses avoid risks that can only be understood when the existing conditions are studied in-depth.
Some of the goals of due diligence are:
● Assessing the financial position of a company
● Forecast the Future Cash Flow
● Uncover unrecorded liabilities
● Identifications of Key Financial Risks
● Well-informed decision making
Thus, the major goal of a financial due diligence is to deeply check the company to understand its current financial condition, helping the investors to decide if they wish to proceed with the merger or an acquisition.
How can Mergers and Acquisition Advisors Prevent Companies from Over-Valuation?
The right way to get going on the M&A process is to hire an expert from a Merger and Acquisition services firm. Professional experts use modern-day and advanced tools to carry out a Financial Due Diligence of the target company in the pre-merger stage. A comprehensive financial due diligence review looks into the existing financial and legal aspects of the target company. Going further, M&A advisors evaluate the business risks that the acquiring company inherits from the target company. Experts also assess the synergies between the two companies and how things can work in the post-merger stage.
Experienced and seasoned advisors and consultants facilitates in an independent decision-making rather than supporting vested interest in the acquiring company. They are impartial to the entire scenario and work independently to help the acquiring company identify issues, delve into solutions, and finally take a call.
About Affility Consulting
Affility Consulting is a UAE-based Merger and Acquisition Advisor offering end-to-end advisory services. Thoroughly proficient in Financial Due Diligence, the company is an acknowledged leader in this niche. With an extensive know-how, the team offers out-of-the-box and innovative solutions and strategies that facilitates optimized decision-making. Being a prominent Mergers and Acquisition Specialist in the United Arab Emirates, Affility Consulting provides expert advice and consulting to business owners with goals of buying or selling a business.