Lack of knowledge among directors can lead to major value destruction in M&A deals and investments.
In recent decades, M&A has become a central part of the strategy of many companies. Because large amounts of capital are involved, a single mistake can have very serious consequences. Financial skills are therefore crucial for the directors involved in the decision-making process, argues Professor Matti Suominen. He is the lecturer of the Valuation program at the Amsterdam Institute of Finance.
“Today the principle of 'winner-takes-all' applies in business,” says Suominen. The rise of digital management tools enables organizations to become very large while still operating efficiently. Acquisitions are a good way to achieve scale. This means that companies that choose not to do an M&A run the risk of missing out on economies of scale, which puts pressure on their competitive position.
Bankers and salespeople
However, making a good decision in a deal is not easy, Suominen warns. The parties involved often have interests that do not coincide with the interests of the company. "For example, bankers want you to do a deal because they make money from it. This can lead them to estimate the potential cost savings higher than they otherwise would. In addition, with every deal there is always a salesperson who knows the company inside and out. If he sees that it is the right time for him to sell, he will without hesitation sell you an overpriced company."
Other considerations
Motivations other than purely financial ones can also play a role within organizations themselves. Suominen talks about a company with a head of M&A who had been working there for six years. Despite his long service, he did not do a single deal. "He wanted to move on with his career, but realized that in a job interview he would likely be asked how many M&A deals he had done. Since the answer was zero, he concluded that it was necessary to convince the entire organization that it was time to do a deal. The M&A department then came up with figures and presented an attractive M&A opportunity to management. They must then be able to look at it and say: 'Wait a minute, I foresee this investment isn't going to turn out well.'"
Huge consequences
The consequences of these types of decisions can be major, Suominen continues. "If you buy a company for ten billion euros and pay ten percent too much, you will already lose a billion. That is enormous. The largest European companies quickly operate on a scale where decisions can destroy a lot of value."
3G licenses: a disastrous investment
The same dynamics that are visible in M&A processes also play a role when companies have to decide on other major investments. Suominen refers to the billions of euros that European telecom companies spent on 3G licenses in Germany at the beginning of this century. The government sold these licenses for mobile data networks through auctions. "Some companies that bought licenses subsequently lost most of their value. One company saw its share price drop by more than ninety percent. In short, they lost almost everything from one disastrous investment decision. One of the directors involved later admitted that the net present value of that investment had never been calculated. They had simply relied on other, alternative valuation techniques."
Inflated numbers
Suominen gives another example. At a major paper manufacturer, investments in production facilities often failed. "This was because the division leaders of the organization wanted to expand their own activities. They inflated their figures to do so. To cope with this, the head office developed skills to better assess whether the forecasts given were realistic."
Basic financial skills
Does this mean that every executive must have the financial knowledge of a CFO? Certainly not, Suominen clarifies. But in modern business, basic financial skills are very important to have and maintain control over where the money flows in the organization.
"You cannot survive in this market without M&A. It has been scientifically proven that companies get better at it the more deals they do. But whether it concerns a wind farm, an aircraft, a large-scale IT system, or any other investment , you need financial skills to be able to weigh them up. For administrators, an academic learning environment is a good starting point for the development of these skills," Suominen concludes.
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