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Tag Archives: merger of equals

How can two world-renowned business leaders commit first-time-beginner mistakes ?

Told you so …

Some critics, journalists and experts from all walks of life relish in pointing out how accurately they had predicted a business failure many months before it occurred.  One year exactly after Publicis and Omnicom announced their plan to merge, I don’t take much pride in having spelt out at the time what would happen to their phantasm of becoming the world’s largest marketing services company:  John Wren and Maurice Levy’s proposed scheme contained all the misconceptions and glaring mistakes one can possibly make in a merger or acquisition.  A real beginners’ job.  It is actually quite shocking to see two internationally respected businessmen totally ignoring some of the basic rules they could have found in the introduction of “Mergers and Acquisitions for Dummies”, which is easily available from Amazon alongside my own “Perfect M&As – The Art of Business Integration”.

Visualising the end game

Before and After : Publicis's Maurice Levy, all smiles as the merger project was announced.
Before and After : Publicis’s Maurice Levy, all smiles as the merger project was announced.

The Publicis-Omnicom proposed deal did not rest on a compelling business case, and in the absence of a clear and credible statement of the benefits the merger will

provide, one cannot expect to have the drive and motivation to overcome the many hurdles and challenges that need to be resolved as two organisations blend to become one.  Who is the individual that will set the tone? What will the resulting merged company look and feel like considering the two companies each have a strong but very different culture?   How well will Wren and Levy agree on key decisions?  The answer to this last point became blatantly obvious: not being able to agree on the nomination of the CFO is just so basic one struggles to understand how Messrs Wren and Levy allowed themselves to reveal with such enthusiasm and optimism a plan for which the first elementary steps had not even been thought through.

By Omnicom’s chief executive’s own admission : “There was no clear finish line in sight”.  How is it conceivable that such senior and supposedly experienced business leaders could ignore the most basic prerequisites of a successful business integration?

Preparation, preparation, preparation

Maurice Levy has to recognize the glaring shortfalls of the Publicis - Omnicom merger plan
Maurice Levy has to recognize the glaring shortfalls of the Publicis – Omnicom merger plan

It will take a good autopsy of this failed merger to reveal how much (or how little) advice the two companies had requested and received and considered prior to announcing their merger plan to the world.  Was there really that little due diligence prior to the announcement, or did the two businessmen simply ignore any warning signs they might have been given? Were they blinded by the prospect and thrill of becoming the world’s number one agency, bigger, better and bolder than Sir Martin Sorrell’s WPP? When Publicis and Omnicom announced their intention to merge, my article referred to “The obsession with size”.  Was this finally just about two over-inflated egos, or was there truly a cogent business rationale which failed to materialise?

How is it that nobody had anticipated that tax considerations would invalidate the complex structure on which the proposed combined company was due to be set-up?  Last year, in writing “shareholders vote by raising their hand, but clients can vote with their feet”,  I was wondering how forcing fierce global rivals such as Coca-Cola/Pepsi, Nestlé/Mars or Microsoft/Google to deal with one combined agency would not run into regulatory problems or result in some of those key clients seeking other options.  Now it transpires that amidst the difficulties to keep the merger on track, talent and client retention also became a big challenge: is that at all surprising?

Maintaining focus

Any book or “how to” manual on M&A will tell you that one of the big challenges during the merger process is to manage the dual focus of keeping day-to-day business on track whilst maintaining the integration drive.  Publicis already had a few problems of its own to resolve prior to the merger announcement, and attempting a complex merger in that state is like covering rust with glossy paint that will not take long to peel off.  In the absence of clear succession plans in Publicis Maurice Levy had already postponed his retirement before the merger proposal was on his radar screen, so by what miracle would the key pieces of the puzzle all fall beautifully into place in a combined Publicis-Omnicom organisation if Publicis could not figure out how to organise itself as a stand-alone entity?

Predictably, the uncertainty and lack of unity of vision that rapidly emerged after the merger announcement proved a huge distraction to the business.  Now the engagement is over, and the bruised fiancée is licking her wounds.  Publicis’s shares have dropped 16% since the beginning of the year, wiping off EUR 1.8 billion of the company’s value, with a drop in net income and further margin erosion,  whilst Omnicom announces a healthy rise in revenue.

After such a poor performance, Maurice Levy had better return to his desk and thrash out a coherent succession plan to restore clarity within Publicis, as many shareholders will feel he has reached the end of his shelf-life.

 

Two European giants with global reach

Holcim and Lafarge, confident of making the (b)right choice in cementing their future together
Holcim and Lafarge, confident of making the (b)right choice in cementing their future

For a change, this month’s mega-merger announcement does not involve American or Asian heavyweight players, but rather two giants in “old Europe”.  It is not about social media, high-tech or software, and will instead rock an industry which has none of that glitz and glamour  : cement.

Having flirted together but failed to reach a deal 18 months ago, the world’s two biggest cement producers (by value) are set to blend, in what is described as a merger of equals (after all, cement is cement …) as Holcim intends to acquire Lafarge and become a global giant with an annual turnover of 32 billion Euros.

A feast for the anti-trust regulators

Once combined, Holcim and Lafarge would have operations in 90 countries.  This would not be the first time an industry’s two largest players are allowed to merge after letting go of some assets, as did Guinness and GrandMet in 1997 to form Diageo, but the approval of that merger required some seven months of deliberations by regulators across the world.

Holcim and Lafarge expect to be under scrutiny in at least 15 countries.  This is unlikely to be a casual routinely exercise, because the cement industry has a long history of collusion and price fixing, acting as a cartel in many countries, and both Holcim and Lafarge are among the cement producers being probed under an investigation launched by the European Commission in 2010 which is still open.  In that context, important concessions will need to be made to the regulators if the deal wants to have the remotest chance of closing by the beginning of 2015 as Holcim and Lafarge predicted in their announcement.

Those sacrifices are already part of the merger scenario; a Lafarge spokesperson confirmed that up to 15% of the new group’s assets might be divested to secure the anti-trust authorities approval of the deal.   Two-thirds of those disposals are likely to occur in Western Europe where the overlap between the two merging companies is the most significant.  Compared to shutting down plants, selling production plants to competitors avoids massive lay-offs and also reinforces competition on the market: this is evidently something that will be perceived as positive by European authorities.

However, Western Europe is the area where cement over-capacity is at its worst and the market’s growth prospects are dull.  In that context, the pair’s disposals might only fetch a very low price, and if that divestment programme does not generate the projected 5 billion Euros, the business case of the merger could be quite seriously affected.

An ambitious business case

Some of the rationale for the Holcim-Lafarge merger makes eminent sense, but other components of the business case will require a real tour de force to be achieved.  The merger announcement failed to cause much excitement on the markets, even though the share price rise both Holcim and Larfarge have experienced – oscillating mostly between 5 and 12% – reveals a degree of interest from investors.

Holcim-1Cement is bulky, heavy and of low value relative to its weight. The market catchment area for any given production plant is therefore quite limited as transport costs rapidly outweigh economies of scale.  The positive side of this is that cement is one sector in which mature economies are not likely to be invaded by Chinese production, even if China now accounts for more than half of the world’s cement consumption.  A producer’s geographical spread is therefore a key factor.  In that sense, Holcim and Lafarge complement each other particularly well in the fast growing economies, as the former is strong in Latin America and Asia whilst the latter is well positioned in Africa and the Middle East.  The pair believe that the lower risk and business fluctuations resulting from better geographical spread will reduce their borrowing costs, thereby generating annual savings of some 200 million Euros.

Holcim and Lafarge believe they can save an annual 1.4 billion Euros three years after merging, which together with to the above-mentioned saving in financing costs would include 340 million on procurement and 250 million on sales costs, to mention just the key savings areas.  If they can manage that it will be quite a remarkable achievement considering their heavy involvement in France and Germany, two notoriously inflexible labour markets in which change can be slow and costly to implement.

Does the “value magic” reside in transforming the industry?

Beyond the promise of operational and financing savings, two components of the rationale for the Holcim-Lafarge merger are quite hypothetical at this stage but are potentially the most significant generators of economic value in the longer term.

Firstly, it takes a real mammoth to fight the growing competition in some of the world’s rapidly growing markets, such as China where Anhui Conch became the world’s largest cement maker last year (by volume, not by value), or Mexico’s Cemex, currently the world’s Nr 6 but growing on the fast lane to overtake its rivals.

Secondly, and this is the more exciting aspect of the merger, the pair’s combined marketing nous and R&D capability has the potential to revolutionise the market with the launch of innovative products which would transform the image of the industry, until now only too similar to the physical attributes of the product : rigid, grey and dusty …  Maybe cement can really be more than cement: Lafarge in particular has developed products whose improved specifications justify higher pricing and elevate cement above its current commodity status, such as fast drying cement or even cement which can set under water.  Variations in tone, texture and appearance are also on the cards, and with this comes the potential  – and the expectation as far as Holcim and Lafarge are concerned –  to play an active role in the evolution of architectural design and advise architects in their choices of these innovative materials.

Lafarges-Roberta-Plant-Calera-UsaConceptually and intellectually, this is quite an appealing and exciting challenge, but it is difficult to imagine such transformation within the next three to five years in two companies which until now have relied mostly on size and hegemony (and some times price-fixing when the going became too tough) rather than being agile and capable of re-inventing themselves by adding a service veneer over their heavy industry core.

Another fascinating business case commences for future business school students.  Let’s watch the next moves and allow three to five years before the jury delivers its verdict. We may be in for a good surprise.

Two ways of looking at the same thing

On 24th September, the world’s largest chip manufacturing equipment maker U.S. based Applied Materials (AMAT) announced its intention to merge with world number three Tokyo Electron, resulting in a company which will be twice the size of its next rival.

computer-chips

AMAT’s executive chairman Mike Splinter commented on CNBC that he believed “the regulators will look closely at this deal” but concluded that he is “confident it will get approved”.  Not so according to the same CNBC’s Jim Cramer who declared “This deal will not go through.  It will absolutely not go through”. There is only one absolute certainty: one of these two gentlemen is right!

Market dominance: the helicopter view vs. the microscope

In his categorical prediction, Jim Cramer also refers to some of the U.S. Regulators’ recent decision, particularly their opposition to mega mergers in the airline industry (see American Airlines – US Airways article on this blog site), which follows years of relative leniency during which industry consolidation was seen as a necessary evil to remain competitive in global markets.  The question, really,  is to define the point at which a company becomes so competitive that it effectively crushes its rivals and erects barriers to the entry of newcomers.  In other words: market dominance.

Opponents to the merger will be quick to point out that the resulting merged company would achieve a worldwide market share of over 25% of all chip manufacturing equipment, whereas the number 2 would struggle to maintain 13%, particularly as AMAT’s executive chairman states that beyond generating costs savings, the merger would enable the combined entity to gain a few points in market share.

AMAT and Tokyo Electron will therefore need to “educate” all the regulatory bodies consulted in this matter to demonstrate that although there is some overlap in their products, most of them actually complement each other in the end-to-end process of chip manufacturing, because that process involves a number of different tasks performed by different machines.  Seen from that angle (if they can persuade the regulators to adopt that view), the merger closes gaps and does not result in a simple addition of the two players’ current market shares.

The outcome of a debate between helicopter view and deep-dive into the segmentation of a market is quite uncertain.  Back in 1997 when Guinness and Grand Met merged to become Diageo, competitors and customers were argued that owning Gordon’s, Tanqueray, Booths and Bombay Sapphire would give Diageo complete dominance of the gin market.  Diageo, on the other hand, contended that those brands’ market shares should be considered within the broader context of white spirits (which include vodka, white rum, cachaça), so that even by including Smirnoff vodka into that calculation, Diageo would only be a relatively modest player in an enormous market.  In that instance, the Regulators did not quite buy into Diageo’s argumentation, forced the group to dispose of Bombay Sapphire, and whilst looking at the white spirits category as a whole, also forced Diageo to sell rum-based brand Malibu.

Supplier vs. customer power

It would be wrong, however, to compare the Regulators’ conditional acceptance of the Diageo merger and refusal of the American Airlines – US Airways merger to the proposal which is being put forward by AMAT and Tokyo Electron.  The regulators’ main focus is the impact on the end-consumer rather than what happens upstream in the value chain.  Allowing a consolidated supplier to dictate prices in an unchallenged manner to an atomized set of customers inflates prices and is therefore detrimental to the end-consumer.  But AMAT and Tokyo Electron’s main customers are a industry giants such as Intel Corporation, Samsung Electronics or Taiwan Semiconductor Manufacturing Company: the very companies that have continuously exerted extreme pressure on their suppliers to reduce their costs whilst at the same time requiring the development of ever increasingly sophisticated equipment to match the exponential complexity and miniaturisation of micro-processor chips.

Seen from that angle, the Regulators might view the AMAT – Tokyo Electron merger as restoring the balance between a supplier and its dominant customers rather than upsetting the balance within the pool of suppliers.  Even if that merger allows the future company to gain a few points in terms of gross margin, this will be achieved through savings and improved efficiencies rather than through increases in selling prices which will be contained by the group’s giant customers.  It is therefore unlikely to cause a perceptible impact on the end consumer price of a large screen TV, tablet, smartphone or laptop computer.

As a final consideration, the consolidation of R&D capability could ultimately benefit the end-consumer by allowing an acceleration of the pace at which the performance of microprocessors improves.

So all things considered, if AMAT and Tokyo Electron construct a cogent argumentation, it is quite possible they will get their way.  That certainly seems to be the view of both companies’ shareholders, judging by the stock market reaction to the merger announcement.

Konichiwa ?  Ugh, not that well actually!

The biggest hurdle ahead for AMAT and Tokyo Electron will probably not be the regulators’ verdict, but what will ensue.  Whilst Tokyo Electron may well be considered as one of Japan’s most “westernised” companies, it is not a Japanese subsidiary of a western company and this is important, because the combined business culture and ways of working will need to be redefined.

Already now, both sides are trying to emit the right sound-bytes in an attempt to pave a smooth way towards a harmonious integration; but anyone with some experience of post-merger integrations can see through that smoke-screen.  “A merger of equals” is the official version, though it will in fact be a 68% AMAT / 32% Tokyo Electron balance.  To restore some sense of equilibrium, AMAT’s recently appointed CEO will move to Tokyo and run the combined business from there.  It remains to be seen whether the Japanese language has an equivalent for the idiom of “the tail wagging the dog”.

More significant even than the challenge presented by the business culture integration is the fact that both AMAT and Tokyo Electron are operating in a highly cyclical and very tough market.  AMAT’s net income fell to $168 million in its most recent quarterly results, compared to $218 million the previous year.  In Japan, things do not look rosy either as the semiconductor industry is living through difficult times, with important players filing for bankruptcy or being bailed out by the Japanese government, leading to diminished demand for Tokyo Electron’s products in their key home market.

The relative uncertainty and more importantly the likely duration of the regulatory process may cause some instability in both companies at a time when they need to focus on surviving through these difficult times, and the integration that lies ahead will be a huge distraction.

And the end result is …

If the AMAT – Tokyo Electron merger goes ahead  – which I think is likely, contrary to Jim Cramer’s confident statement –  the price of our smartphones, tablets, large screen TVs and laptops will not jump, but that merger may have a domino effect in the industry, as the world’s number two ASML will seek alliances and acquisitions to avoid being dwarfed.

Consolidation is the almost inevitable evolution of a maturing industry.