Deutsche Bank & Commerzbank: What explains the urge to merge?

3rd May 2019

Outside Fortress Europe Excerpts
This Global Business Strategy Blog post is based upon unabridged excerpts from Chapter Nine, Acquisitions, Joint Ventures and Strategic Alliances in Global Business Strategy, in  Outside Fortress Europe: Strategies for the Global Market.

 

Context references

Eley, J. (2019, 26 April). Pain of dashed hopes for supermarket pair: Watchdog block on tie-up leaves Sainsbury’s and Asda grappling for an understanding of how they could get it so wrong. Financial Times, p. 17.
Eley, J., Walker, O., & Pickard, J. (2019, 26 April). Block on £7bn Asda deal puts Sainsbury’s vision in doubt. Financial Times, p. 15.
Storbeck, O., Chazan, G., & Morris, S. (2019, 26 April). Failure of Deutsche merger talks puts Commerzbank up for grabs. Financial Times, p. 1.
Storbeck, O., Morris, S., Massoudi, A., & Crow, D. (2019, 3 May). German national champion fell at first hurdle: How the devil in the detail killed off Deutsche and Commerzbank’s plans to create an industry juggernaut. Financial Times, p. 15.

 

Outside Fortress Europe Excerpt

Mergers & Acquisitions in global business strategy

In textbooks on international business and global strategic management, there is surprisingly little integrated managerial research reported which explicitly explores the complicated issues associated with the pursuit of growth via mergers and acquisitions (M&A) alongside a consideration of the alternative solutions of joints ventures (JVs) and strategic alliances (SAs).

In this chapter, we address this research gap by evaluating the pros and cons of these three broad categories of ‘market entry mode’ from a perspective that begins with the strategic motivations underpinning them but which also addresses the organizational challenges which each option presents.

Before developing this discussion we focus on the unique challenges associated with global business strategy by M&A. This market entry mode is of huge significance as the title of this Financial Times article indicates: ‘Global M&A sprints past $1tn mark in record time after series of megadeals’ (Platt and Fontanella-Khan, 2018, 22nd March). But successful global business strategy via M&A has a very chequered history, most notably for the acquiring company and their increasingly detached institutional (short-term, indifferent) and retail (long-term, disenfranchised) investors.

An eminent authority in the field of M&A, Patrick Gaughan, has identified three broad disciplines that define the subject arena:

      1. Economics.
      2. Corporate finance.
      3. Law.

We add our own three dimensions in the discussion which follows, making six components in total:

      1. Business environment dynamics.
      2. Global business strategy options.
      3. Inter-organizational management capabilities for effective and efficient post-acquisition integration.

Categorising M&A motivations

The following lists indicate the broad range of motivations relating to M&A activity in global business strategy.

      • Operating Synergies:
        • Economies of scale in production and operations.
        • Economies of scope: leverage global supply chain, e.g. P&G/Gillette; BP/Castrol; Unilever/The Dollar Shave Club; leverage global R&D, e.g. Glaxo Wellcome/SmithKline Beecham (GlaxoSmithKline or GSK).
        • Bargaining power over suppliers, e.g. raw materials, IT systems procurement.
        • Bargaining power over buyers, for example, FMCG companies versus powerful global retailers (see Chapter Twelve, A Stakeholder Perspective on Global Business Strategy for a detailed discussion of this scenario).
      • Financial Synergy: reduce combined companies’ cost-of-capital; reduce the cost of borrowing; balance cash flows in product/market portfolios as discussed in Chapter Five, Analysing Global Markets and the Intelligent Company; finance new emerging markets development.
      • Diversification: (see section Applying the Profitable Growth Framework for Risk Mitigation in Chapter Five):
        • New value proposition/current markets.
        • New value proposition/new markets.
        • Current value proposition/new markets.
        • Combinations of any of the above.
      • Market Power: obtain higher end-user prices (but beware the anti-trust/consumer interest argument); leverage economies to reduce price so as to penetrate the market further (but beware the anti-trust/predatory pricing argument).
      • Strategic Realignment: see the discussion relating to the ‘Profitable Growth Framework’ in Chapter Five.
      • Technological Change: keep pace with rapid change in a company’s business environment, either to exploit emerging categories or to negate potential business environment threats. Recent examples include Google/YouTube; Facebook/Instagram/WhatsApp; Amazon/Whole Foods/Ring.
      • Regulatory and Political Change: lobby for market definition, e.g. Disney; Qualcomm.
      • Hubris: managerial pride (see Chapter Ten, Theories of Organizational Behaviour and Strategic Management and Chapter Eleven, A Strategic Perspective on Managing Change for a broad-ranging discussion of behavioural theories of the firm).
      • Buying Undervalued Assets: use Q-Ratio to identify: “the ratio of a company’s assets (as measured by the market value of its outstanding stock and debt) divided by the replacement cost of the company’s assets (book value)” – ft.com/lexicon.
      • Exploit Mismanagement: this can relate to many of the other M&A motivations; typically exploited by private equity groups.
      • Managerialism: the belief in the rational judgement and professionalism of management, for example, executives with MBAs must always be right!
      • Tax Considerations: Exploit cross-country corporate tax differentials, e.g. RELX (formerly Anglo-Dutch company Reed Elsevier).

Do M&As create or destroy enterprise value?

The following lists address the role of M&A in global business strategy from an investment perspective,  i.e. a view which will almost always have one fundamental concern: enterprise value:

      • Global M&A activity is intended to create:
        • A greater combined enterprise value than the two firms could achieve if they operated on their own, a synergy arising from a number of sources including asset leverage. A good example of this is the coming together of P&G and Gillette. P&G had a huge range of product brand categories (in most of which they were market leaders) but a relatively limited global market reach in terms of the number of countries they operated in; Gillette, meanwhile, had a very limited product range but had extensive distribution in virtually every country in the world. Combining the companies gave P&G ‘overnight’ (it’s never so simple!) multiple markets access through leveraging Gillette’s global supply chain, a genuine value-added for investors in both companies. (As an aside, at certain points in time Gillette’s corporate portfolio included an odd hotchpotch of global brands including Braun and The Parker Pen Company, a function of earlier M&A activity).
        • A greater value than the two firms could achieve working together in another way, e.g. through a licensing arrangement, joint venture or strategic alliance (see below and also the discussion relating to Markets or Hierarchies in Chapter Ten, Theories of Organizational Behaviour and Strategic Management).
      • The ‘extra’ value created via M&A activity is often derived from ‘synergies’ arising from a new combination of resources and capabilities or a consolidation of duplicated assets and/or functions, e.g. R&D, HRM etc. (Many reports of major mergers are accompanied by speculation of how many jobs are likely to be lost, the most common category being back-office functions and roles). But, as we demonstrated in Chapter Five, anticipated synergies are extremely difficult to realize…
      • Access new markets, e.g. Disney’s acquisition of Marvel Studies: one movie, the all-black cast Black Panther, was a huge success in multiple African countries, markets which Disney had historically struggled to penetrate.

How does M&A potentially destroy enterprise value?

      • Starting with the evidence, empirical research indicates a high failure rate of M&As ranging between 50–80%; why so?
      • As noted by Professor Doz and his colleagues at the prestigious French business school Insead, there simply might not be an ideally suitable acquisition target and therefore any hoped-for strategic alignment is poor, and the new combined entity underperforms.
      • Acquired assets are excessively expensive:
        • Acquisition premiums (the actual price paid minus the estimated ‘real’ value of the target) are paid and transaction costs including legal, banking and consultants’ fees are frequently underestimated.
        • There is always a difficulty in valuing the target, leading to overpayment, challenging the veracity of the Q ratio.
        • Overpayment is more likely if the takeover is ‘hostile’.
        • Overpayment is highly likely if a bidding war between two or more suitors emerges, for example, the bidding-up of the share price offered for Sky during 2018.
        • The acquirer’s reputation is damaged if the deal is ultimately not completed.
      • The ‘Winner’s Curse’, wherein the bidding process pushes the acquisition cost to such a high level that the originally anticipated synergies and efficiencies could never be realised.
      • An obsession with not losing the deal leads to management ego triumphing over rational choice (see below).

Panaceas and pitfalls in global business strategy by M&A

There are three broad categories of problems typically encountered with growth via acquisition:

      1. They are seen as ‘quick fix’ solutions to complex strategic challenges.
      2. Excessive bid-premiums are demanded, contested but ultimately paid by craving acquirers.
      3. Post-acquisition integration.

Each of these is now considered in more detail.

Chasing the Holy Grail: Quick fix solutions to address complex strategic challenges
In many cases, M&As are no more than a quick fix solution to recover from previous ‘strategic sloppiness’ (bad strategy). Acquisitions are also perceived to be an easy way of entering new markets and/or acquiring technologies. In practice, however, strategic problems are long term in nature and are rarely solved by quick-fix solutions, particularly when the following two problem categories are taken into account.

Excessive bid premiums demanded, contested but paid
A second major problem with acquisition strategies is that firms pay too much for the target. Bidding wars are common and stock market speculators are quick to ‘talk up’ the value of companies. As previously noted, fuelling the escalating cost is that bidding firms are reluctant to lose ‘face’ once they have made their intentions clear, i.e. acquisitions can be considered as much a behavioural process as a rational economic strategy. Time will tell whether ‘unicorn’ acquisitions by Facebook (Instagram/WhatsApp), Alphabet (YouTube), Amazon (Ring) ultimately pay dividends and the likely truth is that we’ll never know given the opaqueness of accounting practices in this complex arena (Gaughan, 2018).

The bid-premium problem has been particularly acute in the UK and the US where the liquidity of equity markets combines with an institutional investor base to create an extremely short-termist climate. By contrast, Japanese strategies, in the main, have tended to focus on stretching core competencies and leveraging established technological and marketing assets as they have developed their global market presence. Tellingly, when Japanese companies have pursued the acquisition route to international expansion there have been some spectacular failures, as there have been with German companies, most notably BMW (Rover) and Daimler-Benz (Chrysler).

From a strategic management perspective, the key issue associated with the ‘pay too much’ syndrome is that funds for core activities such as product development and advertising are often substantially reduced as senior management perceive such investments as ‘discretionary costs’, i.e. as candidates for quick-fix cutbacks. As previously noted, companies often claim that the resources needed for high price acquisitions will be financed from subsequent synergies arising. Indeed, many acquisitions have cost-cutting agendas as their central rationale. Despite this, the synergies and cost-cutting potential rarely fulfil their pre-acquisition expectations, not least because of the final problem category associated with growth via acquisition.

Post-acquisition integration: Challenge and opportunity
A broad set of post-acquisition integration issues plague acquisitive growth strategies. Different cultures, different systems, different remuneration policies, powerful unions and different legal structures are just some examples of the challenges which have to be addressed once an acquisition has been completed. The problem becomes acute with international acquisitions and also when large companies acquire smaller entrepreneurial firms. Furthermore, key staff are often lost, a major concern in knowledge-based industries such as publishing, software, advertising, legal and so on.

Major changes are often required to integrate two previously independent organizations. Change is difficult enough to manage within an organization, let alone between organizations as we will demonstrate in Chapter Eleven, A Strategic Perspective on Managing Change. The time required – and the associated costs – for integration are often grossly underestimated, thus compounding the ‘pay too much’ syndrome. Post-acquisition integration tasks are among the most complex of management challenges and very often firms have little or no experience of having dealt with them.

As mentioned above, when acquisitions do take place the research evidence suggests that the post-acquisition integration process often fails to achieve its over-inflated intended objectives. Prof. Doz of Insead argues that three competencies are essential for the successful integration and management of merged companies:

      1. Bidirectionality, i.e. the willingness of both parties to share capabilities and competencies, avoiding the imposition of a ‘one-best-way’ approach by the acquiring firm.
      2. Maintaining a balance between learning and efficiency, i.e. exploiting potential synergies but giving the acquired company the autonomy and scope to deal with its own business environment.
      3. Fostering a sense of mutual interest and flexibility: “To create the most value, both the acquired and the acquiring companies must usually learn to work together, i.e. both must adapt”.

In practice, such lofty ideals are rarely met. Firms pursuing acquisition policies tend to adopt one method of integration, regardless of the specific objectives relating to the acquisition concerned. For example, acquisitions are often managed as ‘absorptions’ – full rationalisation – when a partnership approach to the creation of value through leveraging combined assets would be more appropriate.

Such problems become acute when large firms acquire the skills and knowledge of small entrepreneurial companies and subsume them within the more stifling bureaucratic role culture of the larger organization, in the process destroying the innovativeness they have acquired. A classic example of this which this author experienced from the inside, but as an outsider, was the acquisition of the flexible, customer-focused lubricants category leader Castrol by the monolithic and ‘mechanistic’ BP (see Chapter Seven, A Practical Framework for Global Business Strategy Success, for background).

On the positive side, a major part of the logic behind BP’s acquisition was not just to acquire the Castrol brand, a global category leader, but also to procure Castrol’s world-renowned brand management capabilities. Only time will tell if the minnow will survive in some symbiotic sense with its monolithic master or be otherwise consumed.

While there are some clear successes of growth by M&A (e.g. P&G/Gillette, Disney/Marvel) many have failed to provide the ‘ex-post’ gains promised in the ‘ex-ante’ propaganda. It could be that, in a strategic sense, ‘hard’ restructuring through M&A is just too difficult for many firms, a notable problem emanating from the complexities of integrating diverse cultural groupings, two classic examples being BMW’s disastrous acquisition of Britain’s Rover Group and the abject failure of the Daimler-Benz/Chrysler ‘merger’ where the marriage was over barely before the honeymoon ended; and the divorce was very messy.

In a final proofreading before submitting the initial version of this manuscript – 1st May 2018 – the Financial Times carried the following headline on its front page: ‘Bonanza day of deals hits $120bn as pace of M&A breaks records (Platt and Massoudi, 2018, 1st May). The reporters cited companies being emboldened by global economic growth, high stock prices (used to purchase the assets) and the continued availability of cheap borrowing to explain this phenomenon. Since the latter factor is a direct function of central bank quantitative-easing – effectively printing cash – a Marxist interpretation would likely state this to be a transfer of national wealth to private and unworthy hands. But that’s a subject for a different book; and a different author!

Concluding remarks

In this chapter, we have acknowledged the importance of M&A in global business strategy but we also drew attention to the paradox rooted in its simplicity and complexity. Acquisition is a simple strategy: in a nutshell, don’t build market position, buy it. Complexity arises in post-acquisition integration and, from a different perspective, explaining to angry investors where the enterprise value disappeared to!

There are winners in M&A activity, of course, most notably the shareholders of the acquired company. On this topic, the most common question this author is asked is: ‘what is the difference between a merger and an acquisition?’ Or, ‘which company acquired which?’ In response we can revert to complex discussions rooted in financial theory or tell the truth: it depends on who you ask. This is neither flippant nor facetious: many Castrol managers to this day genuinely believe that Castrol acquired BP. And their managers, in turn, don’t denude them of the fallacy.

‘Network solutions’ such as JVs and SAs can potentially help to overcome many of the problems that tend to undermine successful outcomes from M&As and, indeed, they account for a much larger, ongoing dimension of international business economic activity. The world’s number one brand Apple, for example, derives much of its enterprise value from the sweat and toil of its contract manufacturer strategic alliance partner Foxconn; Coca-Cola relies heavily on its business partners – independent ‘bottlers’ -for its income in what is probably the world’s biggest single Licensing arrangement. A significant percentage of BP-branded petrol stations worldwide are operated by Franchisees; ditto Marriot hotels, McDonald’s restaurants, Starbuck coffeehouses and the global mechanic’s favourite, Snap-on workshop tools.

Well-managed strategic alliances which bring together complementary assets and competencies (e.g. Snap-on and its franchisees which combines global presence with local market capabilities) typically have a more enduring lifespan than equity-based joint ventures such as that between Philips and LG in display technologies which brought substitutable assets and diverging parent company ambitions: as the old Chinese proverb explains, same bed, different dreams.

 

Recommended resources for further inquiry

For readers interested in exploring the wide-ranging issues associated with M&As in more detail the author’s recommended textbook, based upon the multiple criteria presented in the ‘Introduction to the Global Business Strategy Blog’ and extracted here, is Gaughan (2018), Mergers, Acquisitions and Corporate Restructurings. It does come with a ‘health warning’ that the book is quite technical in places, not surprising given the multiple complexities associated with acquisitive strategies, some of which we have discussed in this chapter.

For deeper insights into the pros and cons of strategic alliances in global business strategy see The Global Business Strategy Album post Does cooperation trump competition? Assessing alliances in global business strategy.

 

Outside Fortress Europe Excerpt References

Gaughan, P. A. (2018). Mergers, Acquisitions, and Corporate Restructuring (7 ed.). London: John Wiley & Sons.
Platt, E., & Fontanella-Khan. (2018, 22 March). Global M&A sprints past $1tn mark in record time after series of megadeals. Financial Times, p. 13.
Platt, E., & Massoudi, A. (2018, 1 May). Bonanza day of deals hits $120bn as pace of M&A breaks records. Financial Times, p. 1.

 

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