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 / Fourth Quarter 2002 / Issue 29(originally published by Booz & Company)


Why Deal Makers Go Astray

What fatal flaw is shared by many of today’s corporate fallen angels, from WorldCom Inc. to Tyco International Ltd. to media conglomerates like Vivendi Universal? At one time, each was a darling of Wall Street and the business press for its daring strategy of growth, largely by acquisition. Now the CEOs who led the charge are gone and the companies are beset with huge debt, accounting questions, tumbling stock prices, bankruptcies, and even criminal investigations. A single shared attribute led them astray: the deal maker’s hubris.

Growth doesn’t come easy. CEOs are under great pressure to produce results. To make a quick impact, many of them have articulated inspiring but impracticable visions, and have tried to achieve them by using acquisitions to juice up top-line growth. These leaders are deal junkies whose competencies include discovering clever ways of getting their deals done. Tyco’s taxation expertise, for example, allowed its executives to outbid a rival to acquire the home-security firm ADT Ltd. through a complicated reverse merger that effectively relocated Tyco headquarters to Bermuda. Deal makers like these spend a lot of time cultivating relationships with key investment bankers and securities analysts, and have huge public relations machines, all in order to keep their stock prices artificially high. This garners glowing headlines, with CEOs heralded as godlike figures. But have they really created sustainable value?

More often than not, they haven’t. Companies that pursue a growth-by-acquisition strategy commonly ignore the complex reality of adding operational value to the acquired companies. They see both revenue growth by acquisition and margin expansion by cost cutting as one-time events — believing the mergers, alone, equal success. Time after time, such companies fall apart when they don’t earn back the merger premiums they paid, when they fall victim to crushing debt loads, or when their promises of revenue growth through operational synergies prove incorrect. Additionally, performance pressures create a temptation to skirt the rules of accounting and governance.

To be sure, acquisitions are an important part of a growth strategy. Corporations that balance acquisitions with organic growth, focus on the top and bottom lines, and use acquisitions to accelerate growth have had very positive long-term outcomes. This approach underlies the General Electric Capital Corporation’s legendary growth. GE Capital has superb acquisition integration skills and uses integration teams drawn from multiple functions. A team’s early actions are to identify and retain the best people in the acquired company, reach out to customers, and integrate growth-oriented assets such as the sales force — all of which must be done in 120 days. From the start, GE Capital works hard to cultivate its management discipline and values.

Contrast that with Tyco’s growth-by-acquisition strategy in the late 1990s. Tyco used deals to power top-line growth and slashed costs to demonstrate profitability improvement for the short term. But it was not sustainable. Tyco bought companies that had little growth potential in the first place; it promised growth rates of 20 percent per year while buying businesses that were growing 5 percent per year. It simply cut costs and moved on to the next deal.

Then there are the new breed of deal makers — those who don’t focus on cost cutting. Instead, they attempt to buy revenue growth through the convergence of disparate companies. Some media conglomerates were built this way. For example, Vivendi claimed that delivering content from Universal Studios and its myriad publishing groups through Canal+ and its other distribution channels would boost the conglomerate’s revenues. But when the economy buckled, the fissures between the businesses became obvious. Now the Vivendi dream seems over, and some other media conglomerates are struggling under large debt loads, leaving their convergence promises unfulfilled.

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