Every corporate director knows the importance of M&A in the grand scheme of enterprise. With some 40,000 significant transactions announced annually, M&A is hard to ignore. Yet there are persistent risks that directors need to understand and mitigate through insightful questions and the dialogue that ensues.
- Risk: Not all bets will pay off—at least not right away. Buying a company means placing a bet on the future. Given the level of unpredictability involved, there is some chance that the merger will fail to achieve its goals and/or fail to return incremental value to shareholders. It is commonly cited that “80 percent of all mergers fail” to add value; however, this percentage is an exaggeration. Event studies that compare transactions over time present a more realistic picture by showing that incremental financial value is not assured. For example, a study conducted by Kingston Duffie, publisher of the digital magazine Braid, indicates that companies actually lost 4.8 percent of their value when they spent at least five percent of their market capitalization on M&A during the 18-month period between October 2014 and March 2016. The interactive graphic included in the study shows differentiated performance during the period—high for Stamps.com Inc., medium for Starwood Hotels & Resorts Worldwide Inc., and low for EV Energy Partners. Your company could experience returns like any one of these.
Question for Directors: If this merger ends up having a slightly negative result for our shareholders, what are the compelling strategic reasons to do this deal? When do we believe that deal synergies will materialize?
- Risk: As a director, you could be named in a lawsuit—especially if you are voting on the sale of a company. In 2015, lawsuits were brought in 87.7 percent of completed takeovers. Although most cases settle, some do go to trial. In a trial setting there are four main standards for judging director conduct in the sale of the company, ranging from lenient to stringent:
- The business judgment rule (trusting the decision as long as directors have no conflicts of interest and are reasonably well informed).
- The Unocal standard (protecting anti-takeover moves only if a threat is real).
- The Revlon standard (requiring an auction process once a company is in play).
- Entire fairness (requiring both a fair price and a fair process).
In addition, when a company has promised its shareholders the right to have the company appraised, the court itself can impose its own valuation. In the original Dell go-private transaction, the court retroactively forced the company to pay aggrieved stockholders what the court deemed to be a missing increment to their premium.
Question for Directors: How can we find assurance that sale is in the best interest of the company and its owners, and that we have chosen an optimal price? How can we ensure that there is a litigation-ready record of our deliberations in this regard?
- Risk: You could lose your board seat. According to a study by Kevin W. McLaughlin and Chinmoy Ghosh of the University of Connecticut, there is a higher rate of retention for directors from the acquiring firm (83 percent) following a merger, with the most likely survivors being individuals who serve on more than one outside board. Only about one-third of directors from the target board (34 percent of the inside directors and 29 percent of the outside directors) continue to serve after the merger.
This October, when Dell Inc. and EMC Corp. officially merge (assuming full regulatory clearance following their recent shareholder approval), many who serve on the EMC board may not be on the post-merger Dell board, including retiring EMC Chair-CEO Joe Tucci. When the merger was first announced last October, a spokesman for Elliott Management Corp. stated in a press release, “Elliott strongly supports this deal. As large stockholders, we have enjoyed a productive and collaborative dialogue with Joe Tucci and EMC’s Board and management. We are confident that this Board has worked tirelessly to evaluate all paths for the company and that today’s transaction represents the best outcome for stockholders.”
Saying goodbye to some or all of these incumbents this fall will seem to be an ironic outcome for creating value. And yet that is how it must be. Fiduciaries are not self-serving, but rather they serve on behalf of shareholders to promote the best interests of the company. As such, they need to be ready to move on when that is the best outcome for the corporation. Still, it is disruptive (and not always creatively so) to be a trusted voice of wisdom for the future one day, and mere history the next.
Question for Directors: If we sell this company and our board must merge or disband, who among us will be most useful in steering the combined company in the next chapter?
These are not easy questions. But by asking them, directors can help their companies beat the tough M&A odds.
For more insights, see Director Essentials: Strengthening M&A Oversight, and Governance Challenges 2016: M&A Oversight—two new publications available without charge to all NACD members. See also “Does the Deal Fit the Strategy?” in Metropolitan Corporate Counsel, and “Project M&A” in Financier Worldwide.