Beyond Traditional Due Diligence for Mergers an Acquisitions in the 21st Century
Harvey, Michael, Price, Michael P., Lusch, Robert F., Review of Business
Too many mergers and acquisitions result in failure, which may be due to an inadequacy of the traditional due-diligence process as well as the limited breadth and duration of the process. Consequently, there are three important phases of due diligence: prior to, during and after acquisition. The due-diligence team for all three phases should include the same individuals. Phases one and three are addressed here; phase two has been examined previously.
Mergers and acquisitions (M&As) are accepted strategic options in a competitively aggressive post-industrial economy. In the past three years and after four years of decline, there has been a dramatic increase in M&A activity in the U.S. Merger volume in the first quarter of 1995 alone totaled $73.2 billion, up 36% from the record highs of 1994. On April 1, 1996 alone, 44 mergers were announced totaling $30 billion. Some of the major ones were: SBC Communications and Pacific Telesis, Aetna Life & Casualty and U.S. Healthcare, Allegheny Ludlum Corp. and Teledyne, Inc., Furnishings International, Inc. and Masco Corp., DSP Group, Inc. and Scitex Corp., Cooper Cameron Corp. and Ingram Cactus Co., Hiberina Corp., and San Bernard Bank & Trust, Fresh Juice Co. and Ultimate Juice Co. M&A activity will continue to grow rapidly due to (1) the availability of acquisition capital, (2) the relatively low cost of that capital, (3) the maturing of many industry and product life cycles, (4) the increased number of foreign firms seeking acquisitions in the U.S. and (5) a growing appetite of U.S. companies for expansion in the international marketplace.
The new wave of M&A activity concerns some of the acquiring companies and their financial intermediaries. The "hangover" of the mid-1980s M&A binge has many potential acquirers concerned about undetected liabilities that precipitated some of the failed M&A activities of the 1980s. The specter of environmental liabilities being passed on to the acquirer and the source of funding has heightened this weariness. Increased regulation in the banking industry underlines the importance of conducting effective due diligence prior to any M&A.
Many of the deals of the 1980s are coming apart as fast as they were put together. It is estimated that $100 billion of spin-offs have occurred since 1991 with an additional $77 billion pending, and new proposed deacquisitions are being announced almost weekly. Spin-offs are frequently viewed as overt indications of the failed spree of leveraged acquisitions during the latter half of the prior decade. Many companies are having difficulty reaching the performance expectations used to justify the acquisitions in the first place.
Experts have begun to re-examine the traditional due-diligence process of the past several decades to determine how to enhance its value. The complexity of M&A transactions, the financial instruments used in the transactions and increased government regulation have stimulated a renewed interest in due diligence. The expense of conducting a comprehensive due-diligence process is dwarfed by the costs associated with a failed merger or acquisition. Thus, it is important to explore how the due-diligence process can be used to enhance the probability of a successful merger or acquisition.
The Traditional View of Due Diligence
Many highly visible M&A deals of the 1980s, which produced sobering results, were undertaken with cursory or limited due diligence. The current probability of a successful "corporate marriage" through acquisition or merger is only about 50%. The American Management Association estimates that of the 7,500 annual mergers and acquisitions:
* Nearly 25% of these transactions confronted declining productivity within 12 months.
* Nearly one of every six companies established through merger or acquisition lost market share.
* One of every four had significant management turnover creating management instability. …