Why M&A?

M&A's record for helping companies is mixed. Studies show that a significant proportion of M&A transactions ultimately destroy value for the acquirer. Oftentimes there is competitive bidding for a target company, which can push the acquisition price beyond what is economically rational. Information asymmetry sometimes means that acquirers don't know what they have bought until after the deal is closed. Realizing the cost and revenue synergies assumed during the financial modeling of the acquisition can be much more difficult to realize in reality.

However, despite these risks and mixed results, some companies have an excellent track record of using M&A to add value. Small companies, that might have withered if they had relied on organic growth alone, have used M&A to become successful behemoths. The key to success is a disciplined process.

Naturally, a company is more likely to be a successful acquirer if it has accumulated some experience in acquiring and integrating companies. For example, as the banking industry started consolidating, Bank of America acquired an extensive list of banks to become one of the largest banks in the United States. Citibank did the same with credit cards. Through experience these companies developed consistent disciplined approaches to finding targets, evaluating them, forecasting synergies, modeling, due diligence, negotiations and then integration.

It is advisable for a company to gain experience in smaller acquisitions before attempting larger deals. Any acquisition, small or large, requires an enormous amount of preparation: periodically scanning competitors who might become available, gaining competitive intelligence on those targets, modeling potential synergies, and being ready with a potential purchase offer when a competitor is distressed. An acquirer with too little experience, too anxious to do a deal, who relies too much on their investment banker, and throws caution to the wind, may end up with a money losing catastrophe.

So, in our example, what does it mean to have a disciplined approach? It is easy to believe that a disciplined person — CEO, CFO, or other business leader — will be disciplined when it comes doing an M&A deal, but it is much more difficult in an actual competitive bid for a company. The company is bidding against its archrival. The timeline is short, there are secret meetings, rumors in the market, and the pressure is intense. This acquisition might save the company from oblivion. It might be the capstone of a CEO's career. Risk taking, courage, ego, pride, and envy get mixed up in a tight timeline with endless meetings and calls, and sometimes not enough sleep. Discipline and rationality might be in short supply. Like many things in life and business, the immediate winner may become the loser over time, if the acquisition fails to achieve its goals.

At the heart of it all is a quantitative financial model with data and assumptions of varying degrees of reasonableness. If the data and the assumptions are fairly accurate, there is a good chance that the company's bid will be the basis for a good acquisition. If the assumptions are bad, if the model is bad, the bid becomes a roll of the dice. This book is about a disciplined modeling process.

What is this financial model we are talking about? Very simply, it is the spreadsheet that models the merger of two companies, measuring the savings and costs of combining them, plus the cost of paying for the acquisition itself. At a high level it is simple, but in the details it can be incredibly complex.