4 The biggest merger disaster

The benefits of mergers and acquisitions (M&A) include:

  • Diversification of products and services
  • Factory capacity increase
  • Larger market share
  • Leverage operational expertise and research and development (R&D)
  • Reduce financial risk

If the merger goes well, the value of the new company should appreciate, as investors are expected to achieve synergies, saving costs and/or increasing revenue for the new entity.

However, after the transaction was completed, executives faced major obstacles time and time again. Cultural conflicts and territorial wars will hinder the correct implementation of the plan after integration. Different systems and processes, dilution of the company’s brand, overestimation of synergies, and lack of understanding of the target company’s business can all occur, destroying shareholder value and lowering the company’s stock price after the transaction. This article introduces some examples of transaction failures in recent history.

Key points

  • A merger or acquisition is when two companies join forces to take advantage of synergies.
  • For example, due to expected reduced financial risks, product and service diversification, and greater market share, the combined company will be better than both companies.
  • It is difficult to merge the two companies because they have different cultures, operating settings, etc.
  • If management cannot find a clear way to unite the two companies, then the merger will fail.

New York Central and Pennsylvania Railroad

In 1968, the New York Central Railroad and the Pennsylvania Railroad merged to form the Pennsylvania Central Railroad Company, becoming the sixth largest company in the United States. But only two years later, the company shocked Wall Street by filing for bankruptcy protection, becoming the largest corporate bankruptcy in American history at the time.

Railways are the industry’s deadly opponents, and their history can be traced back to the early to mid 19th century. The management promoted the merger in order to adapt to the unfavorable trends in the industry. This was a desperate attempt.

Railroads operating outside the northeastern United States generally enjoy a stable long-distance transportation business for bulk commodities, but the densely populated northeast has concentrated heavy industries and various waterway transportation points, and income sources are more diversified. Local railways serve daily commuters, long-distance passengers, express freight services and bulk freight services. These products provide shorter distance transportation and bring more unpredictable and riskier cash flow to the Northeast Railway.

Over the past ten years, the problem has been increasing, as more and more consumers and companies have begun to prefer to use the newly built wide-lane highway driving and trucking respectively. Short-distance transportation also involves more people and employees (thus incurring higher labor costs), and strict government regulation limits the ability of railway companies to adjust the rates charged to shippers and passengers, making the combined cost reductions seem to have an impact The only way to the bottom line is positive. Of course, the resulting decline in services will only exacerbate the loss of customers.

Penn Central regards the classic case of cost cutting as the “only way out” in restricted industries, but this is not the only factor that led to its demise. Other problems include poor vision and long-term planning on behalf of the company’s management and board of directors, overly optimistic expectations for positive changes after the merger, cultural conflicts, regionalism, and poor execution of plans to integrate the company’s different processes and systems.

Quaker Oats and Snapple

Quaker Oats successfully managed the popular Gatorade beverage and believed it could do the same for Snapple’s popular bottled tea and juice. In 1994, even though Wall Street warned that the company had paid $1 billion too much, the company bought Snapple for $1.7 billion. In addition to overpaying, management also violated a basic rule of mergers and acquisitions: make sure you know how to run the company and bring specific value-added skills and expertise to the operation.

In just 27 months, Quaker Oats sold Snapple to a holding company for only US$300 million, or the company lost US$1.6 million every day when it owned Snapple. By the time the divestiture occurred, Snapple’s revenue was approximately US$500 million, which was lower than the US$700 million when the acquisition occurred.

When completing an M&A transaction, it is often beneficial to include language to ensure that the current management stays in the company for a period of time to ensure a smooth transition and integration, as they are familiar with the business. This contributes to the success of M&A transactions.

The management of Quaker Oats believes it can use its relationship with supermarkets and large retailers; however, approximately half of Snapple’s sales come from smaller channels such as convenience stores, gas stations and related independent distributors. The acquisition management also explored Snapple’s advertising. Different cultures brought a catastrophic marketing campaign to Snapple, and these marketing campaigns were supported by managers who did not adapt to the sensitivity of its brand. Snapple’s previously popular advertisements were downplayed by sending inappropriate marketing signals to customers.

Although these challenges confuse Quaker Oats, huge rivals Coca-Cola (KO) and Pepsi-Cola (PEP) have launched a series of new competitive products that cannibalize Snapple’s positioning in the beverage market.

Curiously, there is a positive aspect of this failed transaction (as most failed transactions): the acquirer was able to offset its capital gains elsewhere with the losses from the bad transaction. In this case, due to the losses caused by the acquisition of Snapple, Quaker Oats was able to recover the US$250 million in capital gains tax paid in the previous transaction. However, this still leaves a considerable portion of the value of the equity destroyed.

AOL and Time Warner

AOL Time Warner’s merger may be the most prominent merger failure in history. Warner Communications merged with Time Corporation in 1990. In 2001, AOL acquired Time Warner with a huge merger of US$165 billion; the largest corporate merger to date. Respected executives of both companies are trying to take advantage of the convergence of mass media and the Internet.

However, shortly after the large-scale merger, the Internet bubble burst, causing the company’s AOL division to shrink in value. In 2002, the company reported a staggering loss of US$99 billion, the largest annual net loss ever reported, due to the write-off of AOL’s goodwill.

Around this time, the competition for revenue from Internet search-based advertising was heating up. Due to financial constraints within the company, AOL missed these and other opportunities, such as the advent of higher bandwidth connections. At the time, AOL was the leader in dial-up Internet; therefore, as high-speed broadband connections became the trend of the future, the company sought out Time Warner’s cable division. However, as dial-up users declined, Time Warner insisted on using its Road Runner Internet service provider instead of marketing AOL.

With its integrated channels and business units, the merged company did not implement the integrated content of mass media and the Internet. In addition, AOL executives realized that their expertise in the Internet field has not translated into the ability to operate a media group with 90,000 employees. Finally, Time Warner’s politicization and site protection culture make it more difficult to achieve the expected synergies. In 2003, amid internal hostility and external embarrassment, the company removed “AOL” from its name and changed its name to Time Warner.

AOL was acquired by Verizon in 2015 for $4.4 billion.

Sprint and Nextel communication

In August 2005, Sprint acquired a majority stake in Nextel Communications for $35 billion in stock. The combination of the two becomes the third largest telecommunications provider, second only to AT&T (T) and Verizon (VZ). Before the merger, Sprint catered to the traditional consumer market, providing long-distance and local phone connections and wireless products. Nextel has a large number of companies, infrastructure employees, and followers in the transportation and logistics markets, mainly due to the news and calling capabilities of its mobile phones. By reaching each other’s customer base, both companies hope to achieve growth by cross-selling their products and services.

Soon after the merger, a large number of Nextel executives and middle managers left the company, citing cultural differences and incompatibility. Sprint is bureaucratic; Nextel is more entrepreneurial. Nextel focuses on customer issues; Sprint has a notorious reputation for customer service and has experienced the highest customer churn rate in the industry. In such a commercialized business, the company failed to realize this critical success factor and lost market share. In addition, the macroeconomic downturn has caused customers to have higher expectations of the US dollar.

If the merger or acquisition fails, it may be catastrophic, leading to large-scale layoffs, negative impact on brand reputation, decline in brand loyalty, loss of revenue, increased costs, and sometimes even permanent closure of the company.

Cultural issues exacerbate integration issues between various business functions. Nextel employees often need to seek approval from Sprint superiors when implementing corrective actions. Lack of trust and harmony means that many of these actions have not been approved or implemented correctly. At the beginning of the merger, the two companies maintained separate headquarters, which made coordination between the executives of the two camps more difficult.

The managers and employees of Sprint Nextel turned their attention and resources to the attempt to make the merger successful in the face of operational and competitive challenges. The technological dynamics of wireless and Internet connectivity require smooth integration between the two businesses and excellent execution in rapid changes. Nextel is too big and too different from the successful combination of Sprint.

Sprint sees intense competitive pressure from AT&T (which acquired Cingular), Verizon (VZ) and Apple (AAPL)’s popular iPhone. With the reduction of operating cash and high capital expenditure requirements, the company adopted cost-cutting measures and laid off employees. In 2008, due to impairment of goodwill, it wrote off a staggering $30 billion in one-time expenses, and its stock was rated as junk. The merger at a price of $35 billion did not pay off.

Bottom line

When considering the transaction, the managers of both companies should list all the obstacles to achieving shareholder value after the transaction is completed. These include:

  • A cultural conflict between two entities usually means that employees will not implement the integrated plan.
  • Since redundant functions often lead to layoffs, frightened employees will take action to protect their jobs, rather than helping employers “realize synergy.”
  • In addition, differences in systems and processes can make business mergers difficult and often painful after the merger.

The managers of the two entities need to communicate appropriately and gradually support the integrated milestones. They also need to adapt to the target company’s brand and customer base. If management is seen as indifferent and does not care about customer needs, the new company risks losing customers.

Finally, the executives of the acquiring company should avoid paying excessive fees for the target company. Investment bankers (commissioned work) and internal transaction proponents have been working on a prospective transaction for several months, and they usually push the transaction “just to complete the task.” Although their efforts should be recognized, if the transaction is ultimately meaningless and/or the purchase price paid by management exceeds the expected return of the transaction, it will be unfair to the investors of the acquiring group.

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