David's Blog

Mergers and Acquisitions: Le Mariage ou Le Divorce

12th February, 2015

In Jane Austen’s time a well brought up young lady was expected to achieve a good marriage, be attached to a partner from a decent background with enough capital to provide for them both, plus children, plus a suitable number of servants. There was no question of the wife taking up gainful employment. Although she was not officially owned by her husband, she effectively became his property. These marriages were not mergers, they were acquisitions.

In the movie “Back to School” starring the very large American comedian, Rodney Dangerfield, (a movie I am not ashamed to say that I have watched several times) the Economics Professor unemotionally proposes marriage to the English Professor by suggesting that they engage in a merger: they are equals in intellect and each has his/her own skills and interests. ‘Merger’ is not a bad description.

So what is a commercial merger? Acquisition? It’s as well to understand the difference and implications especially since the flood tide of such deals in insurance is already flowing. I guess it’s fair to suggest that the similarity between Jane Austen’s generation and the likes of Ren Re/Platinum, XL/Catlin and Axis/Partner Re is that they all involve people, even to the extent of breach of promise. In the case of Axis/Partner Re the decision by one party or the other to withdraw from the proposed transaction would involve a penalty of $250 million.

All of these companies have CEOs (one) and Managing Directors (several to many) and Senior Executives and Managers. There is invariably a line structure and there should be a strong corporate culture. There is no reason why one company’s corporate structure should be identical to another. In the new entity there can only be one CEO and one corporate culture. Can there really be a merger?

In the year 2000 The Economist ran a six weeks series of case studies of mergers, most of which had occurred at least two years before the articles so that lessons could safely be drawn. None of the case studies was in the Titanic league of merger disasters on the scale of AT & T’s 1991 purchase of NCR. None had gone entirely smoothly either. The Economist suggested that, as important as the need for clear vision and due diligence before a merger, is a clear strategy after it. “As every employee knows, mergers tend to mean job losses. No sooner is the announcement out than the most marketable and valuable members of staff send out their resumés. Unless they learn quickly that the deal will give them opportunities rather than pay-offs they will be gone, often taking a big chunk of shareholder value with them.”

The mergers that worked relatively well were those where managers had a sensible strategy and set about implementing it straightaway. As in every walk of business, luck and economic background play a big part. Merging in an upswing is easier to do.

Above all personal chemistry matters every bit as much in mergers as it does in marriage. It matters most at the top. No company can have two bosses for long, so one boss must accept a lesser role with good grace. Without leadership from the top, a company that is being bought can all so often feel like a defeated army in an occupied land and will wage guerrilla warfare against the deal.

The fact that mergers so often fail is not of itself a reason for companies to avoid them altogether, but it does mean that merging is never going to be a simple solution to a company’s problems. It also suggests that it would be a good idea before they book their weddings if managers boned up on the experiences of those who have gone before.

The insurance industry repeats the same mistakes with mergers and acquisitions again and again. There are few successes but many failures. Andrew Doman, insurance partner at management consultants McKinsey’s, explained many years ago that most mergers in the insurance industry added little or no value, and in any case they have been a distraction to managers. Mergers often are concentrated in periods when insurers are losing money but where stock markets are high. On average both short and medium term mergers and acquisitions in insurance have created little value.

Last November the New Yorker published an article written by James Surowiecki entitled ‘Le Divorce’. It’s worth quoting from that article as follows:

“For most of this year (2014) corporate America exhibited a full blown case of merger mania. Deals worth more than a trillion dollars were announced but there is also something odd going on: the urge to merge has been accompanied by an urge to purge. According to S&P the number of spin-offs announced by the end of October was nearly 30% higher than the number for the whole of 2013.

No-one’s upset about the u-turns because breakups, unlike mergers, have a solid track record. Studies have found that spun-off stocks have consistently beaten the market by a wide margin. Breaking up has advantages, especially if one part of your company is growing faster than the rest or is significantly more profitable. In some cases spin-offs are the final verdict on mergers that should never have happened in the first place. The brute fact is that most mergers don’t work. ‘More value is destroyed by acquisitions than by any other single action taken by companies.’ Furthermore, a study of some thirty-seven hundred acquisitions between 1990 and 2007 found that big mergers were less likely to improve the bottom line than small ones. ‘Getting cultures to fit together, getting people to stay on board, merging IT systems and back offices: all these things are really hard.’ If we’re seeing a boom in corporate divorce, it’s in part because the past decade gave us so many bad marriages.

Still, it’s unlikely that corporate America will lose its penchant for getting hitched. Between Wall Street’s desire to keep the pipeline stoked and the unshakable conviction of CEOs that they can beat the odds the trend towards consolidation is sure to continue.”

So far as Lloyd's is concerned, our view is that there is still scope for rationalisation of the quoted sector. This now consists of Amlin, Beazley, BRIT, Hiscox, Novae and Randall & Quilter. There are also entities which remain independent of outside shareholders or trade investors. We like the idea that these companies should be able to maintain their separate identities within potential mergers so that investors can recognise the individual performance of those entities and that such performance can be separately rewarded.

We also believe that there is scope for rationalisation of facilities, such as back office management/claims service/compliance. Such rationalisation would lower the cost burden that threatens to undermine the long term return on capital in a Lloyd's environment which is so dominated by regulation whether productive (as with the Franchise Board) or compliant (as with FCA or PRA influence).

We believe that such mergers will best come about when individual entities recognise the advantages to be gained by putting together their businesses in the way described rather than being cajoled or forced into them by outside influences. It may take a little longer this way, but the best structures will eventually result.

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