Global firms such as Johnson & Johnson and GE and Hong Kong groups like Li & Fung regularly undertake acquisitions in order to grow.
Immediate share price reaction to the M&A announcements are usually driven by more easily observable factors like valuations, regulatory implications (e.g. challenges under anti-monopoly regulations), the method of payment and whether the transaction will be hostile or friendly.
However, in the long term, it is “Managerial Ability” of both acquirer and acquiree that holds key to the success or failure of M&A activity, as well to the long-run stock returns.
Based on my recent research, it seems that Managerial Ability does not “move the market” in the short term. Over the long run, however, there is significant correlation in the ability of management to successful M&A activity.
The key implication is that time should be spent when planning a transaction to ensure that the target business has a strong management team (and look at ways to remediate, if not). A critical self-review of an acquirer’s own ability to execute an M&A strategy is also important.
If conditions are not met, delaying an acquisition and looking for a stronger management team may well be a better option. Otherwise, acquiring a new business with problematic management may negatively impact the growth of the new business, while spending time to fix these issues can also distract the acquirer from its existing business.
Companies with outstanding managerial ability, such as GE, appear to have developed significant expertise in integrating companies acquired into their existing businesses, by transferring skills and competencies and effectively capitalizing on synergies between the acquired entity and the rest of their business.
Integrating acquisitions by deeply embedding the acquirer’s own culture and operating models into the DNA of a new subsidiary ensures that management can rely on a common infrastructure.
The stronger the managerial ability of an acquirer, the stronger will be the ability to execute successful acquisitions.
Looking back at 1,957 transactions between 1992 and 2011, my research showed there is a statistically significant and economically meaningful positive correlation between the pre-merger managerial ability of acquirers and the combined improvement of firms in their post-merger operating performance.
There is also a strong relationship between the pre-merger managerial ability of acquirers and the combined firms’ long-run (e.g. over one year in my research) stock returns.
In the Asian context, state-owned enterprises and other entities looking to open new markets for their products have less experience to rely on than companies like GE. In this case, the existing ability of management to continue operating successfully is even more critical, as the buyer typically may struggle to “fix” operating issues in new jurisdictions.
Strong (and well incentivized) management seems to be essential in ensuring that an acquired entity is able to continue developing new products and winning market share independently.
The importance of Managerial Ability at the acquired level ties in neatly to the views of Warren Buffett, who, in his 1988 Chairman Letter stated: “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”
Companies looking to bolster their performance should heed Buffett’s words.
The writer is Asia Pacific and China National Leader of M&A Tax Services at Deloitte China.
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