INTRODUCTION: When a company experiences slow organic growth and struggles to survive, it has the option to grow faster through mergers and acquisitions (M&As). But M&As are risky – the failure rate is high. Failure could wipe out not one, but two companies. It is thus essential for investors to be aware of the risks of M&As. There are numerous reasons why M&As fail. Value destruction, overpaying, poor communication and integration, and cultural differences are some of the most common reasons. If these issues are not addressed, it can be exceedingly difficult for a M&A to be successful. According to most studies, between 70 and 90 percent of acquisitions fail. Most explanations for this depressing number emphasise problems with integrating the two parties involved. M&As tend to have a significant disruptive impact on the sectors in which the businesses in question operate. But one thing is for sure, the acquirer aims to create value that will not be possible as a standalone business. However, not all deals realise their projected synergies. Throughout history, there has been more than a handful of mergers and acquisitions that have been flat-out disasters.

THE BIGGEST M&A FAILURE IN HISTORY: The consolidation of America Online (AOL) and Time Warner is perhaps the most prominent merger failure ever. In January 2001 AOL acquired Time Warner in a megamerger of $165 billion, the largest business merger up until that time. Shortly after the mega-merger, however, the dot-com bubble burst, which caused a significant reduction in the value of the new company’s AOL division. In 2002, the company reported an astonishing loss of $99 billion, the largest annual net loss ever reported, attributable to the goodwill write-off of AOL. In 2009, Time Warner spun off AOL into a separate publicly traded company. The failed merger led to massive value destruction.

WOOLWORTHS: South Africa also experienced big M&A failures. One of the common reasons why 70% to 90% of M&As fail is overpayment. In 2014 Woolworths (WHL) South Africa acquired the 180 years old Australian retailer David Jones. The plan was to create the biggest retailer in the southern hemisphere. WHL paid R21.4 billion to acquire the entire issued share capital of David Jones for a cash consideration of A$4.00 per share. The price represented a 25.4% premium to the closing David Jones share price on 8 April 2014. WHL’s Chief Executive Officer (CEO) Ian Moir commented: “This transaction provides us with the scale and opportunity to deliver significant benefits to our shareholders, and our customers in South Africa and Australia.” In 2022 Moir’s successor, Roy Bagattini, sold David Jones to a private equity fund for R1.6 billion, resulting in a loss of, and value destruction, of around R20 billion.

PICK n PAY: Pick n Pay is an older M&A casualty. In 2001 it bought Franklins, an Australian discount supermarket chain selling packaged groceries and perishables, for R1.34 billion and invested a further R832 million in the company. Franklins continually made losses. In 2010 Pick n Pay sold Franklins to Australian-based Metcash for R1.4 billion. One of the common reasons why 70% to 90% of M&As fail is overpayment. Pick n Pay’s “deadly” sin was overpayment.

FAMOUS BRANDS: Famous Brands (FBR) is a recent M&A casualty. It bought the upmarket UK burger-chain, Gourmet Burger Kitchen (GBK), in September 2016 for R2.1 billion, about three months after the UK voted to leave the EU in a shock outcome that dented consumer confidence. The chain has been losing money ever since. In 2020 GBK was put under administration and acquired out of administration by the Boparan Restaurant Group for £6m. More than 360 people were made redundant and 26 sites were closed. FBR clearly overpaid for GBK.

SHOPRITE: Shoprite was shrewd enough not to overpay for its many acquisitions. When Whitey Basson, CEO of Shoprite, initially approached Meyer Kahn, chairperson of SA Breweries, about buying its subsidiary OK Bazaars, Kahn’s price was R350 million. They ended up, years later, paying just R1.00. The struggling OK Bazaars had 200 stores and assets worth more than R540 million. It was lossmaking, incurring losses at a rate of R1 million per day. It had built up a substantial accumulated taxable loss. Christo Wiese, chairperson of Shoprite, put a value of R1 billion on OK Bazaars. Meyer Kahn was dealing with the formidable team of Christo Wiese and Whitey Basson. In 1997 Shoprite bought OK Bazaars for just R1.00. In 2016 SA Breweries itself was acquired by Anheuser-Busch InBev. The acquisition was successful and created a beer behemoth with a market value of over $250 billion.

Even when the best strategies are followed, a mere 10% to 30% of M&As are successful. Some managers believe a M&A should be big enough to “move the needle.” Brian Joffe is one of them, and he has been remarkably successful. He has turned Bidvest into a multibillion-rand conglomerate. He is the exception, one of the 10% to 30% successful ones. For the rest of us the safer route is to incrementally focus on smaller, and lower risk, “bolt on” acquisitions. Research by PwC has proved the power of incremental momentum in business performance. A series of small bolt on acquisitions can lead to a bigger overall result. Companies can get the type of disruptive innovation they need to survive, without moving fast and breaking things. The power of incremental momentum can be attained through a strategy of small bolt on acquisitions. This is in contrast to the ‘big bang’ headline-grabbing M&As which may not produce the desired benefits.

Taking a step-by-step approach is often the best strategy. When contemplating a deal, managers at both companies should list all the barriers to realising enhanced shareholder value after the transaction is completed. A major barrier is cultural clashes between the two entities. It often means that employees do not execute post-integration plans. As redundant functions often result in layoffs, scared employees will act to protect their jobs, as opposed to helping their employers realise synergies. Additionally, differences in systems and processes can make the business combination difficult and often painful right after the merger.

BOTTOM LINE: Overall M&A is a complex process. Shares on the JSE are currently trading at low prices, the Price Earnings ratio for the JSE Alsi index is below 12x. Valuations provide fertile ground for companies to be acquired as they are cheap, but investors should keep their eyes open when a company in their portfolio is the acquirer, especially when it relates to big M&A. If you are interested in investing and want to avoid the pitfalls of M&As, please contact one of our financial advisors.