The Dow Chemical Company and DuPont today jointly provided an update on the status of the anticipated merger of the two companies. The Boards of Directors of both companies reiterate their support of the merger agreement. In addition, as announced, both Boards support a comprehensive portfolio review for DowDuPont, which is intended to assess current business facts and leverage the knowledge gained over the past year and a half to capture any material value-enhancing opportunities in preparation for the intended creation of three industry-leading companies.
The Boards have jointly commenced the review and have engaged McKinsey & Co. to assist the companies in this assessment. The lead independent directors of each company are working together to oversee the process. The DowDuPont Board is expected to review the results soon after the merger closes.
“The management teams and directors of both companies are in regular dialogue with our shareholders, and we have undertaken significant preparation work in advance of the close,” said Jeff Fettig, Lead Director of Dow. “As a collective board we are committed to delivering maximum, long-term shareholder value by ensuring that each of the intended companies will have clear focus, an appropriate capital structure, a distinct and compelling investment thesis, scale advantages, and focused investments in innovation to better deliver superior solutions and choices for customers.”
“Dow and DuPont leadership are committed to maximizing the tremendous value creation potential of the merger and anticipated spins,” said Alexander (Sandy) Cutler, Lead Director of DuPont. “Our review will provide an in-depth look at the portfolio mix and alignment across divisions to ensure we capitalize on all value-enhancing opportunities. The output of the review will be an immediate focus for the DowDuPont Board following merger close. If the results of our review demonstrate there is net greater long-term value creation to be realized through a change in the portfolio, it will be pursued.”
The companies reaffirmed their expectation to close the merger in August 2017, with the intended spin-offs to occur within 18 months of closing.
Dow combines the power of science and technology to passionately innovate what is essential to human progress. The Company is driving innovations that extract value from material, polymer, chemical and biological science to help address many of the world’s most challenging problems, such as the need for fresh food, safer and more sustainable transportation, clean water, energy efficiency, more durable infrastructure, and increasing agricultural productivity. Dow’s integrated, market-driven portfolio delivers a broad range of technology-based products and solutions to customers in 175 countries and in high-growth sectors such as packaging, infrastructure, transportation, consumer care, electronics, and agriculture. In 2016, Dow had annual sales of $48 billion and employed approximately 56,000 people worldwide. The Company’s more than 7,000 product families are manufactured at 189 sites in 34 countries across the globe. References to “Dow” or the “Company” mean The Dow Chemical Company and its consolidated subsidiaries unless otherwise expressly noted.
DuPont has been bringing world-class science and engineering to the global marketplace in the form of innovative products, materials, and services since 1802. The company believes that by collaborating with customers, governments, NGOs, and thought leaders, we can help find solutions to such global challenges as providing enough healthy food for people everywhere, decreasing dependence on fossil fuels, and protecting life and the environment.
M&A can prove horribly expensive. First you have to hire the bankers, lawyers and PR people. Later, there are pricey redundancy packages and site closures, typically referred to as “one-off costs”. If you’re lucky, synergies will cover the takeover premium and cost of capital. Often they don’t.
Slower earnings growth, shifts in technology, interest rates that could soon rise and record stock prices have combined to create a perfect storm for mergers and acquisitions. And some are concerned that the whirlwind also could be signaling dark days ahead.
The recent upsurge bears striking similarities to prior waves in the late 1990s and mid-2000s. And while certain market conditions are different now, historical comparisons suggest the surge in deals may be nearing its peak.
Peak M&A activity reflects inflated stock prices, which is often followed by a market correction or crash. This happened in both the late 1990s with the tech bubble, and in the mid-2000s with the housing bubble. Clearly, 2014 and 2015 look like the upswing of a new peak, so it’s easy to infer what happens next.
There’s no one element driving the trend. Rather, it’s a confluence of market conditions and major changes in technology that are transforming multiple industries. To be sure, one major influence is low interest rates. Rates are expected to rise as soon as next month, which will make borrowing money more expensive. Striking deals now is a useful way to lock in the historically low rates we are seeing. In addition, companies are sitting on a lot of cash. Corporate share buybacks, which had surged in recent years, have finally slowed down. So companies need to find alternate uses for that cash. Mergers and acquisitions fit the bill.
The record level of the stock market also influences the pace of deals, because many companies use their shares as currency, creating higher premiums for sellers. The S&P 500, Dow Jones industrial Average and Nasdaq Composite Index are all at or near record highs.
Another major influence is technological changes. Deals like AT&T-Time Warner and GE-Baker Hughes reflect strategies designed to address major shifts in their respective industries. AT&T, for instance, knows it will not be able to continue to rely on its phone services to drive growth, so it is aiming to vertically integrate. Likewise, the GE-Baker Hughes deal will create a new type of oil services company that combines an industry-leading equipment manufacturer with one of the top services firms. There are fundamental things happening in these industries” that are pressuring these companies to come up with new business models. Those are fundamentally important deals that have been thought about and worked on for months. Deals like these are mainly traditional M&A transactions that are built around perceived synergies.
Another category that has gotten a lot of attention, but in some cases has been stymied, is tax inversion mergers, aimed at reducing corporate tax levels by transferring ownership to lower-taxed countries. Some are expecting tax reform that could reduce the desire for tax inversion strategies, and possibly see a good chunk of the corporate cash stashed overseas brought back to the U.S. and made available for new deals. That could change the M&A landscape.
Another significant contributor to the merger trend is the slow pace of profit gains. Sales and earnings growth are at their lowest levels in five quarters right now and companies are searching for ways to solve this problem. It’s hard to grow revenues organically, and even harder to find new ways to cut costs. Mergers and acquisitions can solve both problems.
Particularly in sectors like consumer staples, technology and pharmaceuticals, acquisitions can provide new markets, sales channels and geographies for acquiring companies’ products and drive revenue higher. And, they can create cost efficiencies by allowing companies to take advantage of economies of scale and scope, pricing and purchasing power and back-office consolidations.
Acquisitions are also a useful way to supplement — or substitute for — internal research and development and innovation. Internal development is costly, risky and time consuming, so companies will often turn to M&A as a result. Acquisitions can be cheaper, faster and less risky to get to market than internal R&D. The major downside is that companies risk becoming overly reliant on M&A as a growth strategy and risk limiting the development of the company’s internal knowledge base, thereby threatening future R&D and creating a vicious cycle, where more acquisitions are necessary to keep growing.
With the pace of technological change and new market development around the world, R&D or innovation deals are very necessary these days. It’s really difficult for any company to stay on top of all changes in the competitive landscape, and it’s not necessary.
There’s nothing wrong with pursuing innovation through acquisition. You can’t really be desperate and try to do something and have that be a good bet every single time. But if you do it as a supplement — use alliances and outsourcing and acquisitions — there’s nothing wrong with that, and that’s a good corporation innovation strategy. Companies that successfully use acquisitions for growth generally do so as only a small part of their overall strategy.
Even with interest rates at historic lows, there is concern that companies on acquisition sprees are running up too much debt. Companies are leveraging up significantly. One of the reasons for the increase in debt is that investors have a lot of money and few good options for it. Hedge funds, VCs, private equity, they don’t know what to do with their funds, so they are willing to buy corporate bonds that are funding M&A. There’s not a lot of opportunity right now. But while prior eras of rising debt were driven by leveraged buyouts and competition among private equity racing to grab high-flying names, this time the debt has better fundamentals.
Debt levels are all relative. It’s never about the absolute level of debt; it’s about the ratio of debt to earnings. If companies are making $10 and borrowing $5, that’s more concerning than if they’re borrowing $50 and making $1,000. The debt-to-earnings ratio has increased, but it is still nowhere near the leverage mania that we had prior to the financial crisis. It’s not a red flag, but it is a yellow flag.
Synergies have been used to justify some of the worst and best M&A transactions in history. M&A is supposed to be about value creation, and for many deals, synergies are cited as the primary means to that end. But relatively few companies provide hard numbers to support these claims. Even seasoned executives and M&A advisors use the term in varying ways that engender different interpretations. And empirical evidence on the role of synergies in determining M&A outcomes is hard to find.
Start with a straightforward definition: synergies are the source of the tangible expected improvement in earnings that occurs when two businesses merge. When it comes to synergies, value-creating acquirers are different from others in the way they do three specific things: They limit the control premium that they pay on the basis of a rigorous assessment of the synergies that they expect to achieve. They are candid with their investors about their synergy expectations, publicly describing explicit synergy commitments when they announce a deal. They practice rigorous postmerger integration (PMI) to capture synergies fully and rapidly, and they are transparent with investors about their progress.
Not all M&A is pursued in the name of achieving synergies; for example, sometimes an asset simply may be perceived as undervalued and therefore a good deal. In other cases, companies want to acquire a critical technology or capability that they lack.
Acquirers should do their homework: they must be in a position to publicly announce the synergies they expect to result from the combination. Most successful acquirers go after a significantly larger synergy number than they publicly announce, and they achieve the synergies much faster than they project publicly. The thinking is simple: if we can’t get the synergies within 12 to 18 months, they are not likely to happen. Management teams that put themselves on the line do so secure in the knowledge that they plan to outperform—a good strategy for management and shareholders alike.
In the competitive bidding market for corporate assets, many acquisitions transfer all, if not more than all, of the synergy value from the acquirers’ shareholders to the seller’s shareholders. This is why more than half of all deals destroy value for investors.
Value-creating M&A requires discipline in the assessment, valuation, and delivery of synergies. Take the example of Martin Marietta and TXI. The two companies announced a $2.7 billion merger in January 2014 to “create a market-leading supplier of aggregates and heavy building materials, with low-cost, vertically integrated aggregate and targeted cement operations.” The combined company had a market capitalization of about $9 billion. The announcement highlighted the expectation of significant synergies: “The transaction is expected to generate approximately $70 million of annual pretax synergies by calendar year 2017.”
Martin Marietta paid a P/E of synergies of 5.8x, which is lower than our data set average of 6.5x for the materials industry. Investors reacted to the deal with a 20-day rTSR of 18.7%. Martin Marietta followed up on its synergy estimates on February 11, 2015, indicating that the company expected to exceed its original estimates by 40%. Nine months after closing, the company’s TSR had outperformed the industry index by 8.3 percentage points.
Every merger or acquisition is different, yet many companies stick to the same integration playbook. Companies doing their first deals can learn much from active acquirers that have experienced M&A deal teams and sophisticated integration playbooks to get integration off to a fast start. But even active acquirers may stumble, as their experience may encourage overreliance on a standard approach (the muscle memory built by long practice). This one-size-fits-all mentality can be particularly risky in today’s environment, where deals are increasingly bigger, more complex, and focused on revenue growth, not just cost synergies.
Serial acquirers can learn much from agile acquirers. Serial acquirers do not outperform first-time acquirers unless they consistently tailor their integration approach to the specifics of each deal.
To understand whether, when, and how M&A-driven companies tailor their integration approach to deal rationale and sources of value, we surveyed 638 experienced merger-management leaders across a broad range of company sizes, industries, and geographies. We also assessed the impact of tailoring on the deal performance reported by the companies.
More than half of M&A top performers (those that consistently achieve revenue and cost objectives) tailor their approach to deal rationale and sources of value.
This is especially true of top performers that pursue multiple types of deals (at least three distinct types), as the deals’ different sources of value are likely to require different integration approaches. For example, the goals and integration requirements look very different for deals to consolidate company presence in mature markets, deals to expand geographically, and deals to place strategic growth bets on new businesses. According to our research, among companies that report doing several deal types, low performers are 44 percent more likely to follow a standard approach than adapt their approach to the specifics of each deal.
Not surprisingly, top performers said that three factors signal the need to tailor their integration approach:
- The cultures of the target and the acquirer differ significantly—the values they stand for and the way they get things done are materially different.
- The target’s core business is relatively unrelated to the acquirer’s core business.
- The target is large relative to the acquirer.
These factors reflect the complexity of integrating two companies that differ markedly in fundamentals like culture, business focus, or size. Top performers emphasized the importance of change-management efforts in these situations.
More than 80 percent of the top performers reported that they always or very often tailor their approach to five critical dimensions of integration:
- governance: who leads and how they do it
- Integration management office (IMO) architecture: who coordinates the integration effort and through what organization
- scope: what to integrate and to what extent
- speed and pace: how fast to go and how coordinated the effort should be
- culture and talent: how to handle people
Top performers adjust the allocation of decision-making authority between acquirer and target management to fit the objective of the deal. They likewise structure the leadership of the integration teams to help them meet that objective.
For example, a large deal that would require building a new culture and fostering collaboration might call for organizing the integration-management teams to include mirrored leaders from the two organizations and splitting decision-making authority equally. But a deal done primarily to retain the acquirer’s culture and operating model would probably see most integration teams and decision-making authority assigned to the acquirer’s leaders.
A global information company set its sights on acquiring a slightly larger target with a much stronger international presence. The acquirer expected the deal to achieve significant cost synergies but also saw retention of the target’s mid-level and top talent as critical to future international business success.
Therefore, the acquirer gave target executives considerable leadership responsibility, during and after the integration. A target executive led the integration effort and, months before close, was announced as the new COO. Leadership of the IMO work streams was mirrored, with each coleader given a fair shot at the final job. These efforts paid off handsomely, as the combined company realized synergies rapidly, increased market share over the number two player, and retained all critical talent.
Top performers tailor three key aspects of IMO architecture to deal specifics:
- size of the IMO (number of staff and funding level)
- use of dedicated and specialized teams (dedicated to value capture, clean team, change management, culture, or communication)
- structure of the integration teams (by geography, business unit (BU), function, or a hybrid)
A serial acquirer in the pharmaceutical industry typically acquired relatively small companies that marketed products in a similar therapeutic area. This acquirer typically staffed a small IMO team and assigned integration responsibility to ongoing business owners so they took control of the target as soon as possible.
Preparing to acquire a high-growth specialty pharma company with a stronger reputation in certain disease areas, the company realized that disturbing the target’s commercial relationships would put significant value at risk. To avoid that risk, the acquirer organized a larger IMO, including a clean team tasked with assessing the degree of physician overlap and the strength of relationships of both sales forces. The company then organized three commercial teams focused on key account retention, contracting review, and sales redeployment. This tailored approach minimized disruption to relationships and captured incremental synergies.
A top biotech company acquired a similarly sized player in the space. While setting up the integration team, the acquirer realized that the two companies had very different operating models. The acquirer was organized geographically, with a small corporate center, while the target had a global business-unit structure.
The acquirer decided to roll out a new matrix-based operating model. Recognizing the tension this would create, the acquirer created an organizational-design team in the IMO, with a dedicated business partner for each integration team. The responsibilities of the business partner included rolling out the new structure, managing talent selection, and communicating the operating principles of the new model. The company moved quickly to the new structure, announcing the top three layers of management before deal close (and only two months after deal announcement).
As appropriate to deal specifics, top performers tailor decisions on the breadth and depth of integration required for critical capabilities, such as sales and marketing, R&D, and product development.
For example, deals to access new technologies or enter high-tech product areas often require decisions on whether to leave the target alone, integrate selectively (in some HR and business-support functions), or integrate fully to bring the acquired product to new levels rapidly (when the target’s product concept is relatively close to acquirer products).
When a large, mature, industrial conglomerate acquired a small, innovative growth engine, the last thing the acquiring CEO wanted was to crush the target’s unique capabilities. He delivered an edict: no one would visit, meet with, or call the target without his personal written consent or face termination. A favored global functional leader who ignored the edict was terminated immediately, setting an example for the rest of the company’s leadership.
A large universal bank opted for selective integration when acquiring a specialized financial-services company. The acquirer achieved expected cost synergies by fully integrating most target support functions and several BUs but took a different approach to two major BUs.
For one BU where attrition as high as 70 percent looked likely, the integration leader postponed all action until he had met with every team around the world. This delayed integration for two months but limited attrition to a much more manageable 30 percent and prevented significant disruption of BU activities.
The acquirer transplanted the target’s core BU virtually intact in order to preserve a product line new to the bank and take advantage of the BU’s access to capital. The protected BU flourished—launching new products while the integration proceeded elsewhere, losing no key employees, and increasing revenue 20 percent over the next three years in a declining market.
Integrating as quickly as possible usually maximizes value, but not always. Top performers take deal specifics into account as they make decisions on which processes and systems to maintain, how long to evaluate alternative systems in order to find the right answer, how quickly to proceed with integration, and how to pace the integration of each function into the organization. Almost half of top performers (43 percent) called tailoring integration extent and pacing, function by function, critical to their integration approach.
To capture the value of cost synergies, companies tend to make decisions on talent selection and organization well before close, execute right after close, and integrate the target into the acquirer’s systems and processes as fast as possible without slowing to evaluate “best-of-both” opportunities across the two organizations. But this approach can destroy key capabilities or slow business momentum if not aligned with the deal’s sources of value.
For example, when a multinational energy corporation acquired a software firm to manage smart-grid equipment, leadership realized that a one-size-fits-all approach to integration would undermine deal value. Back-office integration started in September, but the acquirer shielded target commercial capabilities until the new calendar year to avoid disrupting the target’s annual revenue cycle. The target sold software through annual subscriptions, and most clients renewed their contracts in November and December.
Many companies launch activities to capture revenue synergies, while delaying cost-integration efforts due to regulatory factors (such as workers’ council review) or reputational factors (such as union relationships). In a recent airlines merger, the company rapidly introduced new alliances and routes, revamped network planning, and revised the customer loyalty program, while slowly integrating day-to-day operations.
As warranted by deal specifics, top performers tailor decisions on which employees to retain and how to align company cultures. Almost half of top performers (47 percent) called efforts to align cultures critical to their integration approach.
In a transformational or new white-space deal, the integration approach usually includes broad retention programs and measures to protect the target’s culture. But in a deal to improve a target’s underperforming operations by strengthening management and introducing superior processes, the integration effort typically moves to capture cost synergies quickly and fold the remaining target employees into the acquirer’s structure and culture.
When two retail banks with high-performance track records and strong results-oriented cultures merged, leadership paid little attention to culture because the banks looked quite similar. But the planning/budgeting process uncovered two very different cultures—one focused on cost management and the other on growth. The new company had to weather a long, painful change management effort, including a new incentive and compensation structure and training programs, to align on a new dual mission.
Later, this same retail bank did a deal to expand into a new geography. Recognizing its limited relationships in this region, the acquirer was determined to retain 100 percent of target staff and so let cultural integration proceed gradually. For a year, the acquirer treated the target as a bank within the bank, operating with considerable autonomy, while the acquirer slowly added key executives to target leadership in order to start the transformation from the top. Today, the bank enjoys growth in the region 1.5 times the rest of the industry and has lost no key management staff to competitors.
The examples outlined above show some of the real challenges posed by integration and the choices that companies must make to address the challenges. Many merger management leaders who have tackled these challenges call the effort a career-defining moment that pays huge dividends down the road. Their experience suggests the value of putting integration agility on the agenda of every integration leader.
Simple list of questions to ask themselves before launching the execution of any deal:
- Do we understand and agree on our reasons for acquiring this target?
- What distinctive capabilities do we have that will add value to the target?
- What distinctive capabilities does the target have that will add value to us?
- Do we understand how the deal will create value (for example, increase sales, cut costs, leverage capital)?
- Do we know which BUs or functions will account for most of the value created? Do we know which BUs, functions, or processes (if any) we should shield from disruption?
- Do we know when we should integrate each department, function, or geography and why?