Cross-Border Acquisitions: How Can PE Be So Successful?
Mergers and acquisitions are as much marriages as they are business transactions. In addition to the proposals, announcements, champagne, and paperwork, there tend to be genuine differences that must be resolved before the two parties become one. Whether those differences are mismatched furniture or ERP systems, integration will usually be a challenging process, further compounded by cultural differences. We see this time and time again in the M&A news, but it seems that private equity funds manage to defy this rather consistently. PE investment theses often include taking a firm to larger markets (in search of top line revenue growth) or making further acquisitions to strengthen the initial buy. So, what makes PE Firms routinely successful in acquiring businesses that traditional M&A says will be problematic?
A 2017 study by Deloitte found that today’s managers are engaging in cross-border acquisitions at higher rates, and this additional experience is aiding their success. However, executives listed economic policy uncertainty and cultural differences as key difficulties, which primarily determine the outcome, positive or negative. While these difficulties affect any M&A transaction to varying extents, it’s evident that these factors will play larger roles in cross-border deals, as the business environment may be drastically different. Companies often experience this when expanding into other major regions, like from the US to Asia, or from Asia to the European Union. Furthermore, academic research indicates that investors react negatively to acquiring firms engaging in a cross-border transaction (Moller & Schlingemann 2006). However, investors react positively to Private Equity firms and PE-backed firms engaging in cross-border acquisitions (Humphery-Jenner et al. 2016). Let’s examine some of the factors influencing these different reactions.
Investors trust private equity firms’ extensive experience in making acquisitions. This can be considered intuitive, as a private equity firm does not behave like a corporation when in the M&A market. Most corporations focus on their core business and, when needed, enter the M&A market. Some companies, like Tyson Foods or Cisco, are continually acquiring companies over time, and so have some reputation for acquisition success or failure. PE firms, on the other hand, are only in the business of acquiring firms, improving their operations, and selling them at a profit (in theory). Since M&A is their core business and stated expertise, investors view private equity acquisitions as positive announcements, particularly in poor information environments (Humphery-Jenner et al. 2016). Investors believe that the PE firm knows far more about the acquisition than they do, with some of this knowledge stemming from a network of contacts in and around the target company. Essentially, investors believe the PE firm to have conducted the best due diligence prior to the acquisition, amounting to what is effectively an insider’s view of the target. This perceived view, as well as their observed experience in making cross-border acquisitions, helps to explain the positive post-announcement reactions.
PE firms are also known for improving their acquisitions’ operating performance through a variety of measures, such as optimizing workforces (layoffs, automation, outsourcing, etc.), updating company infrastructure, and other techniques. While the research is mixed on whether there are net employment gains or losses post-acquisition, there is substantial evidence to support that businesses become more efficient post-acquisition. What’s more, a 2015 study by Drs. Bloom, Sadun, and Reenen found that, in addition to better operating performance, PE-backed company managers report greater autonomy across most functional areas. This argues that PE-backed acquisitions may have better working conditions than before they were PE-backed, which could be key to explaining PE cross-border performance.
Corporate culture is the combination of many factors: management styles, workday details, perks, compensation, etc. Mergers and acquisitions, particularly cross-border transactions, tend to exacerbate cultural differences between the parties. This can often make the target company’s employees feel they are being ‘swallowed’, as the buyer attempts to incorporate the acquisition into its own company culture (Sikora 2005). A PE firm doesn’t typically ‘swallow’ a target, as investments are usually in the short-term (5-7 years), and so these firms must have a full complement of managers. However, a negative change in working conditions could force away the managers and employees that drove the target’s valuation in the first place, causing substantial harm to a PE investment thesis. The Bloom et al. study suggests that by improving working conditions, PE firms smooth the differences between “acquirer culture” and “target culture”, thus increasing the likelihood of success, even in a cross-border acquisition.
Due to the differing natures of their core business, private equity firms have several distinct advantages over corporations when it comes to cross-border acquisitions. However, these acquisitions are still plagued by the usual problems of PE, which are, generally speaking, highly leveraged deals, tight coupling between solvency and financial outcome improvement, and assumptions made within the investment thesis not coming to fruition. This doesn’t mean that corporations cannot take away lessons in how to acquire firms though, as the extensive due diligence throughout the process and an acute attention to company cultures can be practiced by any acquirer. The above should be considered ‘best practices’, and may narrow the performance gap between corporations and private equity.
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