Over the past decades M&A has become an indispensable element of corporate strategy. Yet, given the large amounts of capital involved, one single mistake can have very destructive consequences. This means that financial skills are critical for executives who are directly or indirectly involved in the decision-making process, argues Professor Matti Suominen, who teaches the Valuation program at the Amsterdam Institute of Finance.
“In today’s world, it’s something like a ‘winner-takes-all’ market.”
Professor Matti Suominen, Aalto University School of Business
“In today’s world it’s something like a “winner-takes-all” market. Because of the emergence of digital management tools, organizations can today become very large while still operating efficiently. To get more economies of scale, many companies are regularly doing acquisitions. If some companies choose not to participate in M&A, they run the risk that the others who do engage in M&A and gain economies of scale, will soon be able to outprice them in the product market”, Suominen observes.
Bankers and sellers
Properly evaluating a deal is not easy. Many of the players involved have incentives of their own that will not always align with the best interest of the company. “You have bankers wishing that you do deals because it allows them to collect fees. This might lead them to forecast higher potential for synergies than they would otherwise do. And in any deal there’s always the seller who knows the company inside out. When they see that the time to sell is right, they are happy to sell you an overpriced company.”
Other considerations
Also within organizations themselves, other considerations than purely financial ones can come into play. Suominen once heard about a company where the head of M&A had been in the job for six years, but had not been able to complete a deal in that timeframe. “He wanted to move on with his career, but realized that one of the questions that was likely to pop up in a job interview was how many M&As he has done. Since he did not do a single one, he found it necessary to convince the whole organization that it should do a deal. The M&A department then cooked up numbers and presented these to top management as attractive M&A opportunities. Top management has to be able to screen that and say ‘hold on, I can tell that this investment is not going to work out well’.”
“If you buy a company for ten billion Euros and you overpay ten percent, you’re already losing a billion euros, which is enormous.”
Huge consequences
The consequences of these decisions can be huge, Suominen points out. “If you buy a company for ten billion Euros and you overpay ten percent, you’re already losing a billion euros, which is enormous. The largest European companies are easily operating at a scale which can lead to decisions that are massively value destroying.
3G licenses a terrible investment
Similar dynamics that influence M&A decisions are also in play when companies are making decisions about other large capital investments. Suominen recalls the billions of Euros of misguided investments in 3G licenses in Germany that European telecom companies did early this century. The government sold these licenses to build networks for mobile data through auctions. “Some of the companies that ended up buying those licenses lost most of their value. One saw their share price come down more than ninety percent. So they lost almost everything in this one terrible investment decision. One of the executives involved admitted to me that they never calculated the net present value of that investment. They just relied on other techniques.”
Inflated numbers
Suominen remembers another example at a large paper producer. “I talked with the head of strategy. He told me that the reason they often ended up making unsuccessful investments in production facilities was because division heads of that organization wanted to expand their own activities. So they kind of inflated their numbers. In response the headquarters developed skills to try to better assess whether the forecasts were realistic.”
Basic financial skills
It does not mean that every executive needs to have the financial acumen of a CFO, Suominen clarifies. But to have control where money is allocated in the organization, basic financial skills are important in today’s business world.“In this market you cannot survive without M&A. There is scientific evidence showing that companies get better over time doing M&A. The more deals they do, the better they become. But be it a wind farm, an airplane, a massive IT system, whatever investment you’re doing, you need financial skills to evaluate it. For executives, a good starting point for the development of these skills is in an academic setting”, Suominen concludes.
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