Why mergers seldom work

It’s tough to make predictions, Yogi Berra said, especially about the future. But if history is any guide, the merger of Hewlett-Packard Co. and Compaq Computer Corp. will probably flop.

According to Joseph D’Cruz, a professor

of strategic management with the University of Toronto’s Rotman School of Management, 70 per cent of mergers fail to meet their stated objectives — in the new HP’s case, to build a technology powerhouse capable of rivaling IBM Corp. in the burgeoning services market.

“”Generally they don’t work, in anything, but especially in tech,”” he said.

From AT&T’s purchase-and-release of NCR Corp. to Worldcom Inc.’s debt-laden purchase of MCI Group, mergers of large companies with other large companies rarely bear fruit. D’Cruz said CEOs have been over-eager to see their companies merge because such unions boost their own take-home pay.

“”Executive compensation is based on a corporation’s size so there’s an incentive to grow organizations at the expense of shareholders,”” he said.

AT&T paid US$7.4 billion for NCR in 1991, but failed to effectively integrate NCR’s brand of specialty computing and set the company loose on the first day of 1997.

“”It was a huge clash of corporate cultures,”” D’Cruz said. “”AT&T was a utility and NCR was a product oriented company with a strong sales force. The strong sales force lost out.””

A similar fate befell the 1984 purchase of computer telephone systems manufacturer Rolm Corp. by IBM Corp.

“”That was a total failure,”” D’Cruz said. “”The two cultures never worked together and there’s a chance this could happen with HP and Compaq.””

Though D’Cruz said it is too early to pass similar judgement on Compaq’s 1998 purchase of Digital Equipment Corp., he suggested Compaq’s strength in sales might not mesh well with HP’s focus on research and development.

Theo Peridis, a professor of strategic management at York University’s Schulich School of Business, said there are three reasons why tech mergers usually fail. One of these is hubris. “”CEOs think they can take a company that competent managers have not been able to turn around, and they can do it,”” he said.

Another problem, he said, is that the drive to make the deal happen is not extended to the actual integration of the companies. “”The synergies don’t happen by themselves,”” he said. “”You have to work to make them happen.

Finally, there is the matter of valuations, namely, that acquiring companies pay too much, though rationalizing how much is too much became more difficult in recent years, as buyers were paying with what turned out to be very overvalued stock. JDS Uniphase Corp.’s stock-based purchase of SDL Inc. was valued at US$41 billion when the deal was announced in July 2000. But by the time the agreement received shareholder approval in Feb. 2001, the stock of Ottawa-based JDS had lost about 60 per cent of its July 2000 value. Peridis said it is too early to judge that merger.

“”It’s very hard to say the acquisition was flawed or if it was the market. The valuations were through the roof, but everybody was paying with stock so it was irrelevant,”” he said.

Peridis points to the 1998 purchase of Bay Networks by Nortel Networks Ltd., which paid .60 Nortel shares for each Bay Networks share, as a successful merger involving a Canadian company. The merger was a success, he said, because it expanded Nortel’s product offerings.

But in general, mergers involving Canadian companies have not fared incredibly well. According to a study released in Oct. 2001 by consulting firm A.T. Kearney, 45 per cent of merged companies in Canada failed to increase shareholder value by as much as industry competitors two years after the mergers took place. The study, which measured 40 Canadian mergers from 1990-1999, noted that mergers of equal-sized companies achieved shareholder returns four per cent below industry averages while in instances of companies acquiring firms significantly smaller than themselves, shareholder returns were 14 per cent above industry averages.

Cisco Systems Inc. is an example of a large company that has done well acquiring much smaller firms, according to D’Cruz. “”It’s been the most successful company of all time in terms of integrating the merged organization into the parent company,”” he said.

Both D’Cruz and Peridis expect the HP-Compaq merger to fail. But they disagree about the success of the 1986 Burroughs Corp. and Sperry Rand Corp. merger, seen as an HP-Compaq precursor because it was also designed as a union to battle IBM. While D’Cruz said the resulting company, Unisys Corp., was a failure because it never challenged IBM, Peridis said the marriage was necessary for both companies’ survival, a claim that has been echoed by HP chairman Carly Fiorina in her attempts to win shareholders over to the union with Compaq.

“”One should consider it a success in the sense that if they were left alone, the companies wouldn’t have survived,”” Peridis said of Sperry and Burroughs. “”Even though the press releases were saying (Unisys would challenge IBM) people in the industry knew it was just survival mode.””

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