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Not Every Marriage Works

Getting the merger deal signed is just one step in a processBIZ SPOTLIGHT – Mergers & Acquisitions

Combining two businesses through a merger or acquisition doesn’t necessarily lead to scenes of Brady Bunch happiness. The operating styles of the two enterprises may fail to mesh. The deal, expected to raise shareholder value, may fail to do so—a disappointment that occurs more than half the time.

Whether the union emulates the long-running bliss portrayed by Florence Henderson and Robert Reed or collapses into a Hatfield-McCoy-style bloodbath may depend upon the outlook and the preparation the parties bring to the relationship.

Despite the business community’s passion for mergers, the odds seem stacked against them creating stronger, more lucrative entities. Seventy percent of mergers failed to achieve their predicted revenue growth, according to a post-deal survey done in 2002 by New York City management-consultant McKinsey & Co. Furthermore, the survey showed that cost reductions had been overestimated by at least 25 percent in one quarter of the mergers. Other studies from accounting firms and academics cite merger-failure rates running from 50 percent to as high as 80 percent.

Problems tend to arise as management feels its way around the newly combined company. For one thing, those lofty promises of shared authority may not hold up. “Very seldom is there a marriage of equals in the real world,” says John Hempstead, managing director of Hempstead & Co. in Haddonfield, a business-valuation consultant. “They talked about it with Chrysler and Daimler-Benz, but of course it wasn’t a marriage of equals. The Daimler people ended up controlling the company and it’s almost always that way.”

And some mergers simply turn out to not have made sense. The AOL Time Warner merger that closed in 2001 is widely considered to be one of the biggest turkeys in recent history. Great expectations swirled when high-flying online-service provider America Online—which shortened its name to AOL in April 2006—bought Time Warner, the world’s largest media company. But as things developed, the new company could not figure out how to best integrate AOL’s soon-flagging dominance as an Internet portal with Time Warner’s extensive library of movie, television and publishing content.

Then the dot-com bubble burst. AOL’s value fell from a high of $226 billion to $20 billion. Additionally, as more consumers got comfortable with the Internet they abandoned AOL in hordes. In 2003, the erstwhile AOL Time Warner dropped AOL from its name and de-emphasized the division’s role in the company.

While in most cases the buyer will dominate the new entity, finding some harmony may improve chances for growth. “The No. 1 thing is to make sure there are synergies that the two organizations can exploit together more than they can exploit on their own,” says William Hagaman, accountant and shareholder in charge at the New Brunswick offices of WithumSmith Brown. Hagaman specializes in advising clients in mergers and acquisitions. “You also want to make sure that there is some commonality in the culture so the new organization isn’t going through a complete culture shock.”

Aside from bringing the two teams together, management must deal with any skeletons that might tumble out of its newly acquired closets. “There’s always things after the closing that you wish you had known before,” says Hempstead. “Sellers normally try to paint a rosy picture and sometimes they don’t trouble themselves to fully disclose everything that might be wrong with the company.” For example, a seller might hide the fact that a key client just ended its contract or that there are problems in the manufacture of a major product.

Hagaman says deep investigation of a potential merger partner is vital to future success. “Proper due diligence should uncover any major issues that you are going to run into…,” he says. “You really don’t know the nitty-gritty of the company you are creating until you do a bit of due diligence. Even then you are not going to have 100 percent knowledge, but at least you will feel you have uncovered all the major issues.”

Trouble with the books became apparent soon after Cendant in Parsippany was formed in the 1997 merger of CUC International in Stamford, Conn., and HFS in Parsippany. CUC offered services like handling vacation time-shares and direct marketing. HFS was a franchisor of hotels, residential real estate agencies and car-rental companies. The new company, Cendant, found itself accused of fraud in reporting sales numbers.

It turned out that CUC’s management had pumped up its revenue figures by about $500 million over three years. Cendant lost about $14 billion in market capitalization as shareholders dumped stock in reaction to the scandal. In 1998, Cendant sold its software division to Vivendi Universal for $1 billion in a belt-tightening move.

Cendant, like some other roll-up plays, has since dismantled itself. The firm, which at one time included Coldwell Banker real estate, Ramada International Hotels & Resorts, rental agencies Avis and Budget and online travel booker Orbitz, in 2005 decided to boost shareholder value by breaking up. Cendant split into Realogy real estate, Travelport travel, Wyndham Worldwide hospitality and Avis Budget Group.

Ultimately, success can take some time to gauge. “It’s hard to evaluate after year one,” says Hagaman. “But some time in the middle of year two you should begin to get some traction and generate the rate of return you are looking for.” Potential partners should remember the actual gains from a merger might be less than hoped for. “I think you have to make sure you set reasonable expectations,” says Hagaman. “Pricing carries significant weight. Pricing sets expectations for the buyer on a going-forward basis. The more they pay for a company, the larger the expectation is for profitability or growth in market.”

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