Investor Communications: New Rules for M&A Success

"Sure, there are some synergies here. I don't know where they are yet. To say that now would be an idiot's game." Barry Diller at the announcement of QVC's proposed acquisition of CBS, 1994.

Conventional wisdom has it that the great merger wave that began in the 1990s is over. Indeed, compared with the blizzard of deals announced between 1998 and 2000, merger activity has declined sharply. But by historical standards, mergers and acquisitions are still the primary tool of corporate strategy. What has changed dramatically is the M&A climate.

With the steep declines in the S&P, and particularly the Nasdaq market, the available currency for deals has dropped significantly. Mistakes that were covered up by a rising market are now visible for all to see. Perhaps most important, company directors now understand that they will be held accountable by shareholders, especially for "bet the company" decisions.

This new spotlight on officers and directors is great news for investors, because two decades of research on M&A performance confirm that CEOs often give investors good reason to sell shares on announcement of a major transaction. Too often, M&A communications expose a lack of preparation by senior management, and investors react accordingly. This early reaction of investors is, in fact, an excellent indication of eventual success or failure of the deal. While much has been written about the secrets of successful transactions, little has been said about the communications required to encourage investors to purchase - rather than sell - an acquirer's shares after a deal is announced.

Dealmakers and students of deal-making alike have treated M&A communications as an afterthought. This is a huge mistake, for several reasons. First, well-conceived M&A communications during due diligence can serve as a litmus test for the prospective acquirer in thinking through whether the transaction is a good idea in the first place, and whether it will give investors more reasons to buy than to sell. Another reason is that investors performing their own due diligence use the information contained in press releases, investor presentations, conference calls and interviews. Also, employees, customers and other vital constituencies scrutinize communications materials for signals on how the deal will affect them.

As the Enron scandal vividly demonstrated, shareholders are not nameless and faceless, but are often a company's own employees. So when a deal is met with a drop in the acquirer's share price of 5 percent, 10 percent or more, not only do employees - the folks who will have to make the deal work - lose a significant portion of their pension assets, but morale suffers accordingly, even before the critical task of deal integration begins.

Consequently, communications strategy can make the difference between success and failure on everything from securing shareholder approval to meshing the cultures of two distinct organizations.

The M&A Communications Process
Slick press releases and conference calls can't save a bad deal, but a poorly conceived communications strategy can - and usually will - kill one that may make good strategic sense. Over the last several years, many of the biggest unsuccessful deals, as measured by post-announcement return to shareholders, have performed poorly in large part because the acquirers didn't tell their story adequately. Well-publicized examples include Hewlett-Packard Co.'s acquisition of Compaq Corp., Conseco Inc.'s acquisition of Green Tree Financial Corp. and Newell Co.'s takeover of Rubbermaid Inc. In contrast, PepsiCo Inc.'s acquisition of The Quaker Oats Co. (see sidebar) and Reed Elsevier Plc's acquisition of Harcourt General Inc. succeeded largely because, in each case, the acquirer explained to investors the rationale behind its respective deal - carefully, honestly and succinctly.

As many companies have discovered, it's hard to put the genie back in the bottle once a deal gets a bad reception. A new study by The Boston Consulting Group of 302 large transactions found that share prices declined 64 percent of the time and rose 36 percent of the time following the announcement; the average return for acquirers following the announcement was minus 4 percent. These initial reactions were highly indicative of future returns. Moreover, in the year following announcement, acquirers whose deals were met initially with a negative investor reaction, and continued to be perceived negatively, posted an average return of minus 25 percent; whereas acquirers whose deals initially received, and continued to receive, a favorable response, re-turned an average of 33 percent - a difference of 58 percentage points!

Get started early. Long before transactions are even brought to their board, company executives must put themselves in their investors' shoes. Communications experts should be brought in as early as possible to understand the transaction and strategic benefits so that they can begin crafting the communications package. Think of a merger rollout as akin to a political campaign - complete with detailed schedules, timetables, risk factors and plans for responding to opponents.

Discuss in detail: deal assumptions, expected cost savings, worst-case scenarios and the timetable for execution. The merger partners must think long and hard about their message and the forum for delivering it to their key constituencies: shareholders, analysts, bankers, employees, media and customers - and frequently, unions, regulators, government officials, strategic partners and rating agencies.

Moreover, these materials should explain, clearly and logically, why the transaction's business case is accretive and value enhancing. If the deal is dilutive in the short term, but makes "strategic" sense long-term, there had better be compelling economics for profitable growth. Constituencies - particularly investors and employees - must be convinced that the company is capable of delivering on its promises and that they will be better off if the deal is completed.

Prepare an exhaustive question and answer document to respond, in advance, to potential critics. The press release, the investor presentation, letters to various constituencies and other documents will emerge from that exercise. The Q&A document will attempt to ask and respond to all the tough questions that investors, analysts and the media will likely ask on the morning of the announcement. If the deal team can't convincingly answer the 40 or so questions crafted by the communications team - that will not augur well for the transaction.

In fact, asking tough questions may force the deal team to think about issues they may not have considered: Where will layoffs take place? What plants will be closed? What is the timetable? What are the revenue implications? Who will manage the process? What assumptions are made for the transaction to succeed?

Managers should avoid buzzwords like "convergence" and "synergies," which, together with an excessive acquisition premium, send a clear message to investors: Sell. "Words like 'strategic' scare the daylights out of investors," says Tobias Levkovich, managing director at Salomon Smith Barney.

Where the Rubber Meets the Road
M&A communication must signal that senior management understands fully what it is proposing and promising. Acquirers must be able to satisfactorily answer three questions:

1. Do you have a credible story, with clear targets, that can be communicated, accomplished and monitored, over time, by the acquirer and investors?

The story - the strategic logic - must address why the company can beat existing expectations, as reflected in the pre-announcement share price, and do so in ways not easily replicated by competitors. This logic must be accompanied by reasonable operating targets that can easily be understood and monitored. Forecasting overly optimistic gains from would-be "synergies" without explaining how or when they will be realized sends a red flag to investors. It's better to say nothing than to make predictions that can't be achieved. When management fails this first crucial test, it comes across as seriously misguided.

For example, Conseco attempted to make a case that its acquisition of Green Tree Financial was "strategic" by asserting that Green Tree had a successful track record and that the deal was not driven by cost savings. In contrast, when The Mead Corp. and Westvaco Corp. announced their merger, they itemized $325 million in cost savings, released a timetable for achieving the savings, and during the regulatory period, each company posted frequent updates on its Web site.

Then too, experienced acquirers can run afoul of investors by predicting benefits for one type of deal based on the success of other, completely different transactions. For example, prior to Newell's announcement of its $5.6 billion acquisition of Rubbermaid, Newell had a successful 30-year track record in making small, single-product acquisitions. Trouble was, the Rubbermaid deal was 50 times larger, on average, and vastly more complex than any of its earlier transactions. The result: On announcement, Newell shareholders lost $1 billion - precisely the amount of the acquisition premium - and its shares plunged by one half in the first year of the merger.

2. Does your story remove uncertainty and give direction to the organization so that employees can effectively deliver? Uncertainty is one of the unavoidable facts of life in M&A. But major M&A announcements that inject unnecessary uncertainty are extremely disruptive, and compound the already disruptive effects of post-merger integration. Such announcements will not only cause employees to question the deal's logic, but will also prompt many of them to aggressively consider other career options.

The new management team and key reporting relationships must be in place when the deal is announced to avoid a leadership vacuum that can jeopardize the integration of the two companies. Facility closings that require major relocations and headcount reductions must be carefully communicated. Employees must be told quickly and honestly how they will be affected.

In September 2001, when H-P announced plans to acquire Compaq, the companies said that they'd achieve $2.5 billion in cost savings, largely by cutting 15,000 employees over a two-year period - which was over and above the combined reductions of about 11,000 employees that had already been announced by the two companies. This did not go over well with employees, in addition to creating a headhunter's paradise. The uncertainties implied therein contributed to the 19 percent drop in H-P shares on announcement, and a continued decline, as the highly publicized battle between H-P and H-P heir Walter Hewlett heated up in the press.

In contrast, when Reed Elsevier announced its $6.5 billion acquisition of Harcourt General in October 2000, its investor presentation clearly spelled out the strategic rationale, a-long with plans for selling or integrating each of Harcourt's business units. Reed Elsevier effectively shaped investor and employee expectations for the new organization, and shareholders responded by bidding up its share price by 10 percent on announcement.

Acquisitions often involve the payment of a significant premium to the shareholders of the selling company. Unfortunately, the message communicated to investors does not always square with the performance required to justify the price. Even when management offers credible answers to the preceding two questions, investors will mark down the acquirer's share price to reflect the deal's "true value" if the synergy numbers do not justify the premium.

Nothing is more likely to cause investors to sell their shares than a deal that cannot justify the value being given to another company's shareholders. Failure of the acquirer to provide critical information might cause it to lose even more value than the premium because of the signals this sends to investors - that the company might be trying to cover up other internal problems.

Besides creating unnecessary uncertainties, the H-P announcement failed this key test as well. Although H-P projected cost savings of $2.5 billion, it said these synergies would not be fully realized for two years, during which time combined revenues would also decline by as much as 10 percent.

Not only will a negative market reaction jeopardize the success of the merger, but it will also distract managers from ongoing business activities. After Conseco got a chilly reception to its plan to acquire Green Tree, Conseco's CEO Steve Hilbert declared that the company would not make other acquisitions while it digested Green Tree - in effect, shutting down the growth strategy that had led to 15 years of superior shareholder returns and causing dramatic declines in its share price.

The theme that emerges in poor investor communications - and in deals that are unlikely to be good for investors - is a distrust of investors. This distrust is generally associated with the failure by senior management to reconcile the performance that is being promised with the benefits that realistically can be achieved.

A good "story" is just the beginning. As evidence from the recent wave of mergers convincingly demonstrates, investors will eventually see through a flimsy story if acquirers don't deliver. The decision to merge or acquire is very often a bet-the-company decision, and it's a bet that any company aspiring to superior performance cannot afford to lose.

When done right, M&A can be a legitimate means of achieving superior growth and performance. A well-conceived communications strategy is a vital key in the due diligence part of that process.

Getting It Right: PepsiCo's Acquisition Of Quaker Oats
While many companies bungle their M&A communications, those that get it right stand to reap big rewards for their shareholders - starting on the day of the announcement and over time. A good example is PepsiCo Inc.'s formal announcement of its $13.4 billion acquisition of The Quaker Oats Co. in December 2001.

PepsiCo had to overcome significant communications problems before that deal could be consummated. Reports had been floating in the market for weeks about a not-so-private auction of Quaker, with The Coca-Cola Co. and Groupe Danone as the other suitors. After PepsiCo offered to pay a 20 percent premium for Quaker, it exercised unusual discipline by not raising its bid, even in the face of competing offers. PepsiCo's announcement was received very positively by investors - its shares rose over 6 percent in the days after the announcement and have continued to outperform the shares of its peers over time.

PepsiCo got off to a good start with a detailed press release and investor presentation, supported by a lengthy analyst/investor call and a web cast. It also sent letters to employees, customers and bottlers to address the concerns of these various constituencies. Not only did PepsiCo promise that the transaction would be accretive to earnings in the first full year after closing, it went so far as to express expected results in terms of return on invested capital (ROIC), saying it would increase by 600 basis points over five years. While sophisticated investors understand this language, it is rarely seen in merger press releases. Additional detailed materials outlining the deal's synergies were also available on the company Web site.

PepsiCo's investor presentation had three key hallmarks: 1) clear, understandable "base" cases; 2) trackable and defendable synergy targets; and 3) a credible management team already in place.

1. Establishment of the base cases. At the outset, PepsiCo spelled out to investors what the company had already promised concerning revenue, operating profit (EBIT), EPS and ROIC growth. Thus, the case for improvements - the synergies - could then be clearly expressed as increases in profitable growth.

2. Trackable and defendable synergy forecasts. PepsiCo described in detail where it realistically expected synergies, differentiating these expected gains from those it anticipated but did not include in the investor model. The investor presentation compared the revenue, EBIT, EPS and ROIC growth rates it expected for the integrated company with PepsiCo and Quaker as stand-alone entities. The presentation described but didn't include any assumptions about the benefits of selling Quaker Oats' Gatorade beverage line through the Pepsi network. Rather, emphasis was given to the benefits that Gatorade brought to PepsiCo's Tropicana business.

The presentation erred on the side of modest cost savings assumptions. A total of $230 million of synergies was identified and expressed in terms of their respective contributions to operating profit: $45 million from increased Tropicana revenues; $34 million from Quaker snacks sold through the Frito-Lay system; $60 million from procurement savings; $65 million from cost savings derived from selling, general and administration expense, logistics and hot fill (beverage temperature when packaged) manufacturing; and $26 million saved by eliminating corporate redundancies.

It was clear what investors and employees could expect in every major part of the business. They could easily see how the deal would produce improvements in operating profit, more efficient use of capital and reductions in tax rates - more than justifying the modest 20 percent acquisition premium of about $2.2 billion.

3. Clarity of leadership and reporting relationships. PepsiCo announced that Steve Reinemund would become the new chairman and CEO, Indra Nooyi would be-come president and retain her CFO responsibilities, and Roger Enrico and Bob Morrison (former CEO of Quaker) would become vice chairmen and report to Reinemund.

The management team articulated clearly how it planned to integrate Quaker Oats and all of its brands into Pepsi and how capabilities from both companies would be leveraged to achieve additional growth. Moreover, Roger Enrico, Pepsi's outgoing chairman, stressed frequently that management used conservative estimates for cost savings and revenue synergies. Despite senior-level management changes at the top of the company, virtually every constituency understood how it would be affected by the transaction.

The December conference call announcing the deal generated a positive initial perception that persisted because of the process that followed the deal closing on Aug. 2, 2002. At that time, PepsiCo released, in EXCEL format, the restated financial statements for the combination and reviewed all the changes that had occurred since the original presentation. It also hosted a full-day investor conference reviewing the synergies and growth opportunities. Because of the clarity PepsiCo achieved during the closing process, the company actually increased the value of anticipated synergies to $400 million from $230 million.

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ABOUT THE AUTHORS

MARK L. SIROWER leads the Mergers and Acquisitions practice at The Boston Consulting Group and is a Visiting Professor of M&A at NYU's Stern School of Business. He is author of The Synergy Trap: How Companies Lose the Acquisition Game (Free Press, 1997, 2000).

STEVE LIPIN is Senior Partner at Brunswick Group, a financial communications firm specializing in mergers. Previously, as the M&A reporter at The Wall Street Journal, he was nominated for a Pulitzer Prize. Both authors are based in New York.