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. Last Updated: 07/27/2016

Motives for Acquisition and Key Success Factors

As M&A is gaining popularity with Russian businesses, questions regarding its effectiveness are becoming critical for business owners. What are the motives behind acquisitions? How successful are they? What determines the success?

By far, not all companies involved in acquisitions have "a well-thought strategy" and action plan for creating value. In our experience, business owners name four basic motives for M&As: accelerate business growth, gain scale and consolidate, protect business against risks, use momentum to trade. In pursuing these objectives, companies do not necessarily create economic value. There are at least three areas where they struggle: selecting the right motives for M&A; evaluating M&A attractiveness in the context of a broader range of options; and checking strategy against key success factors.

Value-creation should be at the heart of M&A decisions. To create value in M&A transaction, the buyer must ensure that the price paid to the seller does not exceed its value to the buyer. To achieve it, the buyer should either pay for the asset less than its stand-alone value or capture synergies in access of the premium. Why don't companies follow the value-creating approach? There are several reasons:

• "Winner's curse" -- a buyer pays too much in a competitive bidding process.

• "Escalation of momentum" -- a buyer tries to justify the time, energy and resources invested in the deal.

• "Strategic reasons" -- a buyer is convinced of the strategic reasons regardless of what "the numbers say."

• "Implementation failure" -- a buyer underestimates the difficulties involved in integrating the firms.

• "Estimate error" -- a buyer makes wrong assumptions about the target or its industry.

Since "value" is a relative notion, M&A decisions should be weighed against other options. Because M&A opportunities require quick action, companies don't always have time to evaluate these options. Thus, in non-core acquisitions the following issues are overlooked: 1) problems in core businesses hidden through cross-subsidization; 2) non-core business losing competitiveness; 3) lack of resources required for growth.

One manufacturing company faced with low margins and topped production capacity, decided to acquire warehouses. Its goal was to improve profitability by charging below-the-market storage rates, and to build forward stocks for high seasons. As a result, the expenses were not reduced significantly. ROIC dropped considerably because of an increased asset base and working capital. Core business lacked capital needed to grow. Alternatively, the company could have considered other options. Because of pressure in M&A decision, the company had no time to understand the issues and evaluate other options.

The success of any M&A strategy hinges on the ability to implement it.

If an acquirer plans to create value through sale to a multinational competitor, the following factors should be taken into account: compliance with the multinational's business standards, strategic location of production sites, large capacity plants, high speed of consolidation, and exit flexibility. Brand may or may not be important.

If an acquirer's goal is to become a dominant player in the industry, he should pay attention to his ability to restructure a target, improve cash flow, retain key employees, build brand, and chose the right pace of acquisitions.

One company acquired cheap worn-out assets in hope to shortly resell them to a strategic investor who, it knew, was planning consolidation. As a result, the investor changed its strategy and the company was stuck with the assets generating negative cash flow. It used debt to cover the financial hole and then divested the assets at a loss. Often, to walk away from a transaction is the best option of all.