Two big mergers were announced yesterday. Southwest Airlines is buying AirTran, and Unilever is acquiring Alberto-Culver. Odds are at least one of them will be a flop. The standard estimate -- well documented in studies and in experience -- is that three out of four mergers "fail" in the sense that their benefits fall short of what the deal-makers assured themselves (and employees and shareholders) would happen.
Let's set up an office pool: Which do you think has the best chance of succeeding and why? My general observation is that the worst deals happen when conditions seem best. That would be, first, in boom times. When everyone's living high on the hog, a pig in a poke looks good -- for a while. In a boom, the business development department gets a deal over its hurdle rate by projecting continued growth. The shrewdest sellers know that, which is why they unload assets at the top. The death of Eddie Fisher on September 22 is, perhaps, a reminder of this phenomenon. For the Casanova crooner -- whose five wives included Debbie Reynolds, Elizabeth Taylor, and Connie Stevens -- seduction was just too easy and relationships were just too hard.
These aren't boom times -- d'oh -- but M&A is heating up for a second reason. The corporate eye has gone wandering not because everything looks beautiful but because a lot of things look cheap. Especially money: They're practically giving away greenbacks. The Fed is aiming to keep the Federal Funds rate -- which is what banks charge each other for loans -- at a quarter of a percentage point. Your savings account is paying notional interest. The prime rate's 3.25%. In August, IBM borrowed $1.5 billion with bonds that carry just a 1% coupon. The cost of capital doesn't get any lower. Deals that were expensive a few years ago look eminently do-able today.
What's not to like? Plenty, of course. The fundamental question in any merger is -- or should be -- whether the business being sold will perform better for the new owner than for the old. (I'll grant one sad exception: An all-but-dead business from which an acquiring ghoul can to harvest a few viable organs.)
That means M&A should be about capabilities. A deal:
- Should bring you a company that plays roughly the same game you do. If you're a low-cost provider, don't go buying luxury brands.
- Should add to your sweet spot when it comes to capabilities. I don't know how many times I've seen executives acquire a company because "It brings us skills we don't have" -- only to discover that these are skills they can't use.
- Should bring products and customers that complement your core business. With demand still dicey, this is no time to add to the complexity of your business.
"The cost of capital is approximately zero. But what should you buy? The kinds of companies that will increase your IQ." Especially, she said, look for something that fits who you are but can also be a seedbed for innovation.
In sum, something's smart when it increases your capacity to get smarter.