Numerous studies have shown that roughly two out of three corporate acquisitions fail, as measured by the performance of the stock of the acquiring company. What if those odds could be flipped? What if it were possible to succeed two times out of three and just fail a third of the time?

Our research suggests this is possible. A 20-person team that spent two years investigating 2,500 major corporate failures from the past 25 years found that almost half stemmed from ill-conceived strategies that should never have been pursued. Applying the lessons derived from that research can help executives dodge problems and reshape strategies in ways that greatly increase the chances of success.

The issue is timely because there’s likely to be an awful lot of acquiring over the next few years. That’s because the sort of lull in activity that currently exists has historically been followed by a burst of M&A activity. The severity of the recession may, in fact, mean deal activity will be far greater this time around. The crisis is creating scads of targets, many of which never would have been in play before. And many companies that are available for purchase are especially attractive because they haven’t had time to really deteriorate; they just need a shot of liquidity, and they’ll be good to go again.

But the possible downside is enormous, too. Just ask Bank of America about its $50 billion acquisition of Merrill Lynch. Or ask private-equity fund Bay Harbour Management about its decision to buy the Steve & Barry’s retail clothing chain out of bankruptcy proceedings for $168 million last year, only to announce three months later that it would liquidate the chain. Based on our research, we identified both those deals as flawed at the time they were announced, but it was too late for BofA and for Bay Harbour. (For more on our thoughts on these and other deals, see our blog at blog.billiondollarlessons.com)

The time to get things right is now, not when the deal pipeline starts to fill. That’s because our research found that, once a deal is in the works, it’s hard to stop, even when it’s a bad idea. Companies need to agree ahead of time on the sorts of quality checks and process safeguards that will let them strengthen weak ideas and stop bad ones. In other words, executives can take advantage of the current lull to make sure that, when the deals start flowing again, they can have those two in three odds, not the one in three that have historically prevailed.

In this paper, we’ll lay out a quality assurance process that we call the Strategic Stress Test. Companies should be putting this process in place now, because good deals will make heroes of the acquiring companies and their senior executives while bad deals will sink others.

Download Full Article:

A recent big example is Oshkosh Truck’s announcement in October that it would buy JLG Industries Inc. for $3 billion. The companies said they see a strategic fit, but look at their businesses. Oshkosh makes fire, military, concrete and garbage trucks. JLG makes equipment that lifts people and heavy materials several stories into the air. What do those businesses have in common?

The one example the companies cite is that Oshkosh’s fire trucks with ladders might be able to use JLG technology to lift firemen into the air faster and more safely. It’s hard to imagine that there are major improvements to be made there. We’re all for keeping firemen safe, but our bet is that the equipment already works quickly and safely. In any case, no other Oshkosh equipment needs to lift anything several stories into the air, so JLG’s core technology can’t help beyond the one type of fire truck. It’s possible the two companies can share some technology for transmissions, axles, etc., but that’s hardly enough to justify a major deal.

Oshkosh seems to be falling victim to one of the most common mistakes that can doom synergy strategies: Oshkosh is seeing synergies that don’t exist in the minds of customers. Japanese consumer electronics companies made this mistake in the late ‘80s and early ‘90s, when they decided that they would buy movie studios. The companies seized on a computer-industry analogy and decided they wanted to own “software” to run on their “hardware.” The analogy misunderstood the computer industry; while hardware and software are certainly both necessary, almost no company is a success in both parts of the industry. More importantly, the consumer electronics companies kidded themselves about how customers think. Sony, for instance, wasn’t going to be able to convince a customer to go to a movie made by Sony just because she owned a Sony TV. Nor would a customer rent a Sony video just because he owned a Sony VCR. Meanwhile, because Sony’s “hardware” people didn’t understand the peculiarities of movie business “software,” they lost their shirts. Sony bought Columbia Pictures in 1989 for $3.4 billion. In 1994, Sony took a $2.7 billion writeoff on the purchase and reported a $510 million operating loss at Columbia, meaning the value of its investment had almost entirely disappeared. 

Oshkosh also seems to be making another common mistake, overestimating the value of scale. Oshkosh said the purchase will mean that the combined companies will now buy roughly $1 billion of steel a year. That is surely a big increase for Oshkosh, but the figure means Oshkosh-JLG will account for less than half of one percent of the world’s steel consumption. How much pricing power does that give Oshkosh?

Without synergies or economies of scale to justify the acquisition, Oshkosh is basically just betting that JLG is worth more than shareholders thought it was–quite a bit more, in fact; Oshkosh agreed to pay 40% more than the price of JLG stock on the date the purchase was announced. Maybe that’s a good bet. But maybe it isn’t.

Oshkosh notes that JLG will be its 15th acquisition since 1996, and companies that make frequent acquisitions can sometimes get to be good at them. What Oshkosh doesn’t note is that its acquisitive decade began right after the company made a series of divestitures to clean up problems that followed a prior string of purchases. In addition, JLG is far larger than any prior purchase by Oshkosh, so the fact that others have worked out doesn’t necessarily say much about the prospects for the JLG deal. 

Sounds to us like Oshkosh may be headed for a crackup.