Kieran Levis.com

17 December 2009

My last post dwelt on two particularly disastrous mergers. These are not of course typical, but the short answer must surely be yes: mergers and acquisitions are nearly always dangerous, since the outcome is always uncertain and the risks enormous. Most result in much poorer performance than was promised at the time, but when the two companies are from different industries, the chances of success are roughly comparable to those of invading another country and being welcomed as a liberator.

Ironically, one of the few successful approaches (mainly to hostile acquisitions rather than agreed mergers) is the rapacious one of spotting underperforming companies and rapidly restructuring them – stripping out costs, selling off assets and laying off lots of people. This tends not to get a good press, though the threat of it undoubtedly keeps many companies on their toes. A very different approach was Cisco’s in the 1990s, when acquisitions became as important, and as glamorous, a strand in its strategy as how it used the Internet.

The networking market was growing explosively, with new technologies appearing every week. Cisco couldn’t hope to master these by conventional R&D, so it systematically acquired promising small companies and absorbed them, their products, and above all their people, as a way of extending its capabilities and broadening its product portfolio. Between 1993 and 2000, Cisco bought 73 companies, using its own stock as a currency more attractive than cash: its price was rising even faster than sales, which were growing at an astounding 50% per annum.

Cisco reckoned it had turned acquisitions into a business process, a core capability. A team of eventually 60 people worked full-time on it, screening possible targets, evaluating their prospects and capabilities, negotiating in detail and, most importantly, ensuring that key people were quickly integrated and motivated. The day after the deal was done, everyone would have new job titles and business cards, there would be Cisco signs outside the building, Cisco coffee in the percolators, and T-shirts with “I’ve been assimilated” on them.

Inevitably, the Cyborg of Silicon Valley succumbed to hubris and got careless. In 1999 it bought Monterey Networks for $517 million, but within a few days its owners had left, and Cisco subsequently closed it down, having decided that Monterey’s fiber-optic technology was “ahead of its time”. In the same month, after only three days of negotiations, it paid an astounding $6.9 billion for Cerent Corporation. If the goal was to acquire its 287 employees, this valued each of them at $24 million.

These were crazy times: for a few weeks in 2000 Cisco was valued at $550 billion, higher than any other company in the world. Even though the Internet bust that soon followed slashed its market cap to $100 billion and meant no sales growth at all for several years, Cisco survived and most elements in its breakneck growth strategy were vindicated. It had by far the most comprehensive product range in the industry and it remains the automatic networking standard for most business customers.

Acquiring new capabilities is imperative for all businesses in rapidly changing markets, but doing it this systematically and on such a scale is a trick very few could hope to pull off. Cisco could only afford it financially because of astronomic growth and valuations, the like of which we will surely never see again. It remains to be seen whether its more recent acquisitions and moves into ‘market adjacencies’ are turning it into what some pundits call a Supercorp that ‘coordinates and cultivates’ rather than commands and controls. Others fear it could be becoming over-extended.

Cisco deserves considerable credit for the attention it has long paid to extending organisational capabilities. Thinking hard about how firms would fit in also paid off in most cases. Most inveterate acquirers give little thought to whether they even have the capabilities to run their new toys, let alone to how to make the combined entity something more than the sum of its parts. All too many buyers veer between waffle about ill-defined synergies and a relentless focus on financial detail whose precision sometimes turns out to be as spurious as the synergies.

The most scathing recent critics of ill-conceived M&A are the authors of The Curse of the Mogul. Knee, Greenwald and Seave argue that the main reason that large media companies have performed so badly in the last twenty years is that they’re obsessed with growth by acquisition and very bad at doing it. Ego plays a much bigger part than business logic and they almost invariably overbid because they cannot bear to ‘lose’. Consequently, the bigger these companies have got the less profitable they have become.

The authors suggest that M&A is only successful when it cuts costs by eliminating duplicated infrastructure, the bidding is not competitive, or if the buyer gets lucky by discovering an undervalued asset. (Disney had no idea when it bought Cap Cities that ESPN would become such a goldmine.)

I would suggest three minimum conditions:

1. The buyer thoroughly understands the company, and not just its accounts – its capabilities, culture, markets, competitors and people.

2. It knows how it would add value to what it is buying.

3. It can define how the combined company would be worth more than the two separately – and avoid anticipating that in the price it pays.

You’d think these were fairly modest requirements, but what are the chances of the next large-scale merger abiding by them?