Deal or no deal?

Mergers are usually dangerous for shareholders, but here are five ways to assess if you want to be part of the purchase

By Andrew Willis
Globe Investor Magazine, Feb. 21, 2008
Illustration by Jeremy Traum

A Canadian company makes a splashy thrust into the American market with a multibillion-dollar acquisition. Within months, the high-profile U.S. CEO walks, marketing budgets are slashed, and there's upheaval in the ranks as long-time employees are shuffled into new premises. It sounds like a recipe for disaster, except the buyer in question was Manulife Financial Corp., and the acquisition was the $15-billion purchase of Boston-based John Hancock in 2004, widely regarded as one of the best-executed M&As in financial services history.

Yes, former Hancock chief David D'Alessandro departed quickly. But it later became clear that Canadian counterpart Dominic D'Alessandro (no relation) was a better operator. Manulife inspired and united Hancock employees by shifting them from three buildings to one iconic, new waterfront office tower all under the Hancock name.

History has shown that takeovers generally hurt stock prices more than they help them. Yet Manulife's share price has doubled since it acquired Hancock, and investors who were scared off by the noise missed out on a jewel of a stock. There's a valuable lesson here for those who are too quick to conclude that a merger or acquisition is in trouble. We offer a checklist that will help you cut through the confusion.

1. When was the deal done?

A simple reason for the ruin of many a promising M&A is that the purchase was made at the top of the valuation cycle, meaning that the acquiring company may be paying a grossly inflated price for a mediocre business. The biggest M&A craze the world has ever seen was driven by private equity buyers, but even these pros can get caught overpaying.

"The problem with the private equity boom isn't that quality companies went for high valuations. The problem is a lot of average and even weak companies likely got sold at expensive valuations," says Ontario Teachers' Pension Plan vice-president Lee Sienna, who is a senior member of the fund's private equity team. "Paying a premium for a weak company is what comes back to haunt you." The lesson: The last deals done in a boom market are often the worst ones. If a company buys a second-tier company at a valuation that's out of line with similar deals in the past, shareholders won't be happy.

2. What is the buyer's track record?

This is an obvious question the investor needs to ask. In other words, does the acquirer have a history of delivering cost savings? Nearly every takeover deal promises synergies that will fatten the bottom line. But, that doesn't always happen.

One notable exception is Agrium, the Calgary-based fertilizer company. Chief executive Mike Wilson made a small splash in 2006 by winning a bitterly contested, $528-million hostile takeover of seed retailer Royster-Clark. He made a bigger impression by delivering twice the promised synergies.

Agrium's stock has doubled since the takeover, and this track record should give comfort as investors contemplate whether they should back the company's recent $2.2-billion friendly acquisition of rival United Agri Products and its 1,100 U.S. sales reps. Wilson has promised $115 million in annual savings from the UAP merger.

Companies that have notched up a number of successful acquisitions generally employ managers who specialize in in-tegrating newly acquired businesses, keeping other senior executives focused on day-to-day operations. This kind of spe-cialization exists at Cisco Systems Inc., the technology giant based in San Jose, California, that has swallowed 115 com-panies since 1993. Using dedicated M&A teams and a well-established acquisition plan, Cisco Systems is adept at weav-ing new people and ideas into its 63,500-employee work force.

3. Does the CEO have scars?

Senior executives sometimes shy away from making tough decisions on staff cuts and operations because they're worried about damaging morale. Harsh as it no doubt sounds, if employees are being fired, it's probably a good sign for share-holders.

CEOs who have successfully integrated a rival company have the scars to show from it. One such veteran is Toronto-Dominion Bank CEO Ed Clark, who filled thick binders with the lessons he learned when integrating his old firm, Canada Trust, with TD. Clark still grimaces when he talks about the merger and the Canada Trust colleagues of many years standing whom he had to let go. "People joke that Canada Trust did a reverse takeover of TD, yet we let go more than 60% of Canada Trust management," says Clark. For shareholders who have seen their TD shares double in price, how-ever, the deal was an unqualified success.

4. How many execs were canned?

If the CEO of the target company leaves, that's normal. Good leaders are used to calling the shots on strategy, so they probably won't be satisfied running divisions. On the other hand, cross-fertilization of other senior managers shows that the target company is being successfully integrated.

"Within the first year of a merger, it is important that a large number of people in management groups of both compa-nies receive substantial promotions across the lines-that is, from one of the former companies to the other," says Rick Johnson, founder of Florida-based consulting firm CEO Strategist LLC. "The goal is to convince managers in both compa-nies that the merger offers them personal opportunities."

5. What's in it for the merged firm?

Anticipating a successful merger isn't just about the numbers; it's also about good business sense. Management guru Pe-ter Drucker insists it's just as important to look at what the acquiring company contributes to the target as it is to look at what the target brings to the buyer. That's one of the reasons the John Hancock acquisition was so successful for Manu-life-the American firm inherited systems, savings and retirement products, as well as a cost discipline that it had been lacking.

The bottom line is that diversification for the sake of diversification rarely works, says Johnson. "Two businesses must have either markets or technology in common...as well as a common language. Without such a core of unity, diversification-especially by acquisition-never works."