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What's the big deal? The great urge to merge is taking managers' attention away from the basics

Sun, 31st Jul 2005

LIKE IT or not, companies increasingly inhabit a deal economy. Put baser motives like ego and self-aggrandisement to one side impatience, competition for investor attention and the globalising world economy are reasons why many chief executives these days feel compelled to pay as much attention to mergers, acquisitions and divestments as to products, services and customers.

With investors breathing down their necks, many CEOs find organic growth too snail-like to impress - particularly where turnarounds are concerned. Couple investors' shrinking attention span with the need to react quickly to changing conditions, add in ready access to global capital and the attractive targets (and hungry rivals) emerging in new economies such as India and China, and it's hardly surprising transactions are the newest field of strategic competition.

Last year, says a new report from Ernst & Young, corporate transactions totalled more than $1.5 trillion in deal value, $700m of that in Europe. No less than 88 per cent of European and 96 per cent of US companies studied were planning a merger or acquisition in the next two years, and only slightly fewer had divestment projects in the pipeline. Transactions of all kinds, sums up the report, 'are an ever-increasing part of the way corporations do business, expand, and adapt to changing circumstances'.

In turn, the growing strategic importance of the deal has consequences for the way firms are managed. In the past, transactions would have been handled by the finance director or chief financial officer (CFO). Today, as a result of the Sarbanes-Oxley Act and ever-beadier investor scrutiny, the finance department is increasingly tied up with compliance and reporting. A separate specialist function, sometimes reporting to the finance director but more often directly to the CEO, is growing up to handle the transaction side of strategy: the corporate dealmaker (there's even a new magazine of that name) or chief development officer (CDO)

The corporate development function had its origins in the internet era, when every company in search of a business model was desperately looking to make alliances and deals. Now that feeding frenzy has died down, the emerging function is striving to articulate a role, and the attributes needed to carry it out, for a world in which transactions have become as much part of mainstream strategy as a new-product launch or branding. Indeed, charting the evolving CDO role is what the EY report - 'Corporate Development Office European Study Findings 2005' - is all about.

The overriding concern noted by EY is the need for greater professionalism. Externally, the imperative is to face up to mounting competition for the best deals from increasingly aggressive and streetwise private-equity (PE) funds. PE is not only ubiquitous - there are now more than 7,000 groups active worldwide, EY reckons - it also enjoys some inbuilt advantages. With their lower cost of capital, shorter time horizons, and greater dealmaking experience (that is all they do), PE funds can often pay more and react faster than company rivals.

None of this is lost on canny venture capitalists and other investors, who are becoming adept at playing off PE funds, trade buyers and even initial public offerings against each other to push sale prices higher. Last year PE funds accounted for 15 per cent of global mergers and acquisitions activity, rising to 22 per cent in the UK and 37 per cent in Germany.

Eventually, like all bandwagons, the PE phenomenon will hit the buffers, either overreaching itself like the corporate raiders of the 1980s or competing its own advantage away. But for the moment, competition from this source is steadily intensifying. At a recent CDO gathering in London, half the participants admitted losing a deal to private-equity rivals in the past year.

Meanwhile, an ominous new precedent is the SunGard deal, in which three large PE groups are combining to take the US IT security firm private for a total of more than $11bn. Dave Read, global vice chair of transaction advisory services at EY, notes that as PE firms start to hunt in packs they are even more formidable competitors: 'They have access to large quantities of reasonably priced capital, can move quickly and don't generally have to worry about the difficulties of integrating businesses. Transactions are their core skills.'

But it's not enough for corporate dealmakers to match private-equity counterparts for speed and opportunism. Investors are putting increasing pressure on companies to improve on the estimated 70 per cent of mergers and takeovers that fail to live up to projections: as well as doing deals, corporate dealmakers need to make them work.

Badly targeted and badly executed transactions can have a dramatic effect on corporate performance, Read points out. 'CDOs are taking greater end-to-end responsibility for transactions and their outcomes,' he says. 'Not only are CDOs today responsible for originating, assessing and managing deals, they are also becoming more involved in integration, corporate strategy and risk management. In effect, CDOs are the new CEOs of transactions.'

The pressures on the role are compounded by the need to look abroad for growth opportunities. While most of Europe (especially) is stuck in the economic doldrums, emerging economies led by China and India are expanding too exuberantly to be ignored. Some CDOs also contrast favourably the increasing ease of doing business in such countries with growing regulatory, compliance and liability issues at home. For many large companies, dipping a toe in foreign waters is a matter of when, not if - with all the legal and cultural baggage that entails.

Businesses have always felt the need to reshape their portfolios from time to time. What is different now is the need to do so at speed, worldwide and in competition not just with traditional industry rivals but with well capitalised finance groups worldwide. In short, the ability to do deals well is becoming a source of strategic advantage, just as inability is a strategic handicap.

But although 'corporate development' will involve some management innovation - managing virtual teams, measuring transaction success, developing working relations with the board and other stakeholders - ultimately it won't do to get carried too far away from the basics. Most deals still fall down because no one has thought who will manage the merged operation or how the success of an entity in one context can be fully preserved in another. As one CDO quoted by the EY report noted wistfully: 'Financial capital is easier to deploy than human capital.'

The Observer, 31 July 2005


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