There is little evidence that M&A actually works, says professor Killian McCarthy.
In the bustling world of finance and corporate strategy, mergers and acquisitions (M&A) often take centre stage as the pinnacle of growth and expansion strategies. Yet, lurking behind the façade of optimism and potential lies a harsh reality: the overwhelming failure rate of these deals.
In an interview with the Dutch M&A Magazine, Killian McCarthy, Associate Professor at Radboud University, a seasoned quantitative researcher specializing in M&A, delves into the depths of data-driven insights that challenge the conventional narrative surrounding these high-stakes transactions.
Professor McCarthy has been active in M&A-research for the past fifteen years. His quantitative research in which he compares thousands of transactions strongly suggest that the vast majority of deals, up to 79 percent in his experience, fail to deliver any value. McCarthy's warning for business leaders therefore is: “be very cautious before you engage in an M&A deal. Lots of value is destroyed.”
Helicopter view
Drawing from seminal studies and his own extensive research, Professor McCarthy paints a picture of the M&A landscape that will most likely not be greeted with much enthusiasm by the M&A Community. He highlights a seminal study from The Journal of Finance, the most prestigious journal in finance, revealing that for every dollar invested in billion-dollar deals in the 1990s, shareholders lost 2.31 dollars — a paradoxical outcome for endeavours that commandeer immense resources and intellectual prowess. “The paper was called Wealth Destruction on a Massive Scale", says McCarthy. “That's how the number one journal in finance describes mergers and acquisitions. And they showed that the net effect of all the M&As in the 2000s was to wipe 240 billion of the stock market. It's insane.”
But when he talks to advisors, they don't seem to recognize this. “They all think that every deal is a success, but that is not what you see in the data.”
Only 7 percent of synergies is realized
Looking more closely at these failure rates, it seems to be in the realization of revenue synergies things often do go sour. “Acquisitions are typically pursued to either increase revenues or cut costs", says McCarthy. According to him, 86 percent are aimed at the former. But, "the data shows that, on average, only 7 percent of the synergy forecasts for revenue increases are achieved, compared to about 60 percent of cost cutting synergies.”
Despite the low success rates observed in the data, managers and advisors often remain optimistic about their acquisition prospects. “There is a tendency to believe that their case will be the exception rather than the rule", according to McCarthy. “I have observed that the numbers are made to fit the acquisition objectives rather than the other way around. So, it doesn't surprise me that this doesn't work out. You can't grow a business like that.”
Smaller deals are less risky
The little good news that there is, is that the research is concerned mostly with large transactions done by listed companies. In the mid-market, things are likely different as McCarthy expects these entrepreneurs to be much more sceptical about doing M&A deals and that scepticism is not always there at the higher corporate levels. Another challenge for the big corporates is the enormous complexity of such an endeavour. “If Philips is buying a Chinese target, it is much more of a task to integrate that and create value. The bigger companies do worse deals and the closer the companies get to each other in terms of size, the worse it gets as well.”
It's not just about the numbers
Soft factors, such as cultural integration and mismanagement, are blamed for about 65 percent of the failures. “One of the things I've noticed over the years is that everybody in M&A seems to think that it's just a matter of getting the numbers right", says McCarthy. “But when you look at the data, it's simply not true. The human side, the integration side and the relationship side, those are really the important parts.”
Deal advisers usually participate until the contract is signed and then they disappear, but it is at that moment that the value has to be realized. “I always use a soccer analogy here", says McCarthy. “The economics and finance for me are being able to run and kick a ball, which will get you up to day zero of the deal. The goal scoring, realizing the synergies, happens thereafter and that is quite often the point when businesses stop paying attention.”
Alternatives to M&A deals
Given the high likelihood of failure and the relatively low realization of forecasted benefits, Professor McCarthy questions the rationale behind pursuing acquisitions. He suggests that the odds of success may be better in other investment avenues. “I have studied M&A for 15 years now and the odds are that everything is stacked up against the acquirer. And then I always wonder to myself, you know, if the purpose of the acquisition is to acquire specific resources, is there not smarter and cheaper ways to do that that are much less risky? And then I think of things like strategic alliances or corporate venturing as alternatives. But they seem to be much less on the agenda for whatever reason.”
Indeed, studies suggest that strategic alliances boast a significantly lower failure rate compared to mergers, while also requiring considerably fewer financial resources. Despite this evidence, the dominance of M&A departments within corporations persists, raising questions about the reluctance to embrace more cooperative approaches. “I kind of see M&A as the nuclear option", says McCarthy. “If there is really no other way, than do it, but I doubt very much that this should be the default mode.”
Exploitation or exploration?
Consolidation is always the main driver within M&A because companies have the feeling that they have to keep on growing and expanding or their competitor will beat them. Does that make sense for Professor Killian McCarthy? He emphasizes that while consolidation is often touted as a primary motive for M&A transactions, its efficacy from an innovation standpoint is questionable. Citing examples like the rise and fall of Blockbuster in the face of industry evolution, McCarthy challenges the notion that consolidation guarantees long-term success. “When the industry was done, the industry was done, it was time to move on", he notes. McCarthy cautions against viewing M&A solely as a consolidating tool, stressing the importance of discerning when consolidation may be beneficial and when it risks becoming outdated due to rapidly evolving technologies and markets.
Moreover, McCarthy's research sheds light on the critical juncture where M&A transactions are deemed failures. Through a focus on innovation outputs, he reveals that a staggering 79 percent of acquisitions fail to yield improvements or even result in a decline in innovation. This leads him to advocate for a more balanced approach to corporate strategy, where divestitures play a significant role alongside acquisitions. By strategically divesting underperforming assets, firms can reallocate resources, foster innovation, and adapt to changing market dynamics more effectively.
McCarthy: “M&A can be a good tool for cutting costs and consolidating. It's good for exploiting what you're good at when there's almost no risk. Cost-cutting deals are the least risky because you know in advance what you're getting into. But exploring new technologies is a huge risk. The more risk you add to a deal, the more you go from the 60 percent synergy realization to the 7 percent synergy realization mentioned earlier. At the moment, I think corporates overuse M&A and they use it like a blunt hammer. They use it for everything whereas they should only use it for certain types of actions. 86 percent of mergers and acquisitions are aimed at exploring growth and that's where I think it goes really wrong. For exploring, you should be using corporate venture, strategic alliances and joint ventures, not acquisitions.”
Corporate acquirers, be very skeptical!
As a famous example of an acquisition gone bad, Professor McCarthy often uses the infamous Daimler Chrysler case, highlighting how a seemingly promising acquisition led to a decade of financial hemorrhaging and eventual divestment. McCarthy: “So Daimler announces the acquisition and then it bleeds cash for a decade until it sells. Then it has to pay an investment company to take Chrysler of its hands just to stop the bleeding. All the while, Daimler was struggling on the stock market and it could itself have become an acquisiton target. And that’s the point. It's not just a once-off bad decision that costs money. It can open up a decade of problems, take create existential threats on the firm.”
With a stark warning against the overuse of M&A as a strategic tool, McCarthy emphasizes the importance of skepticism and thorough evaluation before engaging in such endeavors. “So, my first advice is: always remain very skeptical. I think there almost needs to be somebody in the room who keeps shouting: ‘only 7 percent of this will be achieved on average’. Keep in mind that the models from most of the advisors are driven by the finance and accounting models, but they are not going to realize the forecasted value.”
His second piece of advice is to consider alternatives. “Ask yourself, do you need to own this target? Is this the only way to get what you want? Is there not a cheaper option? If you've got a 20 percent probability of succeeding, are you willing to take that risk? We see that 65 percent of acquisitions are divested within 5 years as failures. And when it comes to that, you have to hire expensive advisors again to do the carve-outs for you and you won't get the price you paid back then. So, it's a huge and depressing cycle with very little positivity in it”, McCarthy concludes. "It doesn't make a lot of sense to me in terms of the number of deals that are done, the amount of money that is wasted and the value that is destroyed.”
Conclusion
M&A, once hailed as the epitome of corporate strategy, may often serve as a costly distraction rather than a catalyst for success. That is the sobering conclusion from Professor McCarthy's extensive research of more than 500,000 deals. Despite the allure of consolidation and market dominance, McCarthy urges a nuanced approach — one that prioritizes strategic clarity, risk assessment, and alternative pathways to growth.
In the tumultuous world of corporate finance, McCarthy's voice serves as a beacon of scepticism, challenging entrenched beliefs and advocating for a more discerning approach to M&A. As stakeholders grapple with the complexities of strategic decision-making, his insights offer a sobering reminder: in the pursuit of growth, prudence must prevail over exuberance, and data-driven analysis should illuminate the path forward.
Read also: The three biggest pitfalls in a post-merger integration
