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Thought Leaders: David Harding, Bain & Company, on HR's Role in Mergers

David Harding is a partner in Bain & Company in their Boston Office. He joined the Global Business Consulting firm in 1983 and is a leader in the area of Corporate Strategy and Organizational Effectiveness. His client work has included large multi-national corporations with extensive domestic and international operations. David frequently counsels chief executives and their boards of directors on growth strategies and the role of deal making in creating and sustaining shareholder value. He is an expert in M&A, Due Diligence and Post-Merger Integration and most recently co-authored Mastering the Merger, a detailed and thoughtful analysis that explores common presumptions about business mergers and explores why more than two-thirds of the major M&A deals fail to create shareholder value. David has published several articles in the Harvard Business Review, the Wall Street Journal, the Wall Street Journal Europe, and has been quoted in numerous publications including Fortune Magazine, Business Week, Time Magazine, M&A Magazine, and Mergers and Acquisitions Report. He has also appeared on Business Week TV and CNBC's Kudlow and Kramer show and CNBC's The Closing Bell.

Topic: Mastering the Merger: HR's Role 
 

RD: I want to focus on HR's role in Mastering the Merger, but we need to set the stage. Your book focuses on four critical decisions that make or break a deal and you talk about the paradox of deals. Tell us about the paradox and the four critical decisions and why they are so critical.

DH: We have to think about them in the context of the problem that we are trying to solve. The problem is a paradox and the paradox is that most companies find it difficult to pull off large mergers. The advice they get all of the time is stick to your knitting, stay close to your core and do what you do best. That is terrific advice if you are Michael Dell running Dell Computer or you are Best Buy or JetBlue, where there are opportunities to grow the core.

For a lot of others, growth is really hard to come by. They find that they need to look outside of their cores for adjacencies, businesses that they can buy and build out from their core. It is almost impossible to build a world-class company today without doing deals that help with the growth. But, when you try to do deals, the track record has not been particularly good.

As part of our research for the book, we looked at a sampling of almost 800 large deals. We tried to grade them to see whether or not they created value for their shareholders. What we found was that over half of the deals destroyed shareholder value in the first year after the deal was consummated. What we mean by destroying shareholder value is that the stock price of the acquiring company actually dropped in both relative terms and real terms versus their market index in the year after the fact. What is interesting to note is that many of these executives actually felt good about the deals that they were doing.

Part of this gets to why do you do deals in the first place. The measurement that we are using is stock price returns and yet companies do deals for a whole bunch of different reasons, not the least of which is that they are looking at their own growth expectations versus the expectations that Wall Street has.

Historically, growth rates of earnings are very close to the growth rate of the overall economy. If you go back historically, the GDP has grown at about 5% annually and the S&P 500 has grown at just about the same rate. Yet, if you look at the implied growth rate in stock prices today, the market is looking for something like two and a half times what we can realistically expect the economy to grow at. The pressure to grow is intense.

Companies come back to, 'how do I find growth?' 'How do I find a way to put my business on the winning track?' Yet again, we get so much advice that says don't do deals. The answer to this paradox is something that we spent an awful lot of time thinking about. We asked ourselves if we were thinking about the question the wrong way. While 800 big deals seem like a lot of activity, the reality is the vast majority of M&A activity that takes place in the market place is composed of small deals. Of those deals that are publicly disclosed, almost 80% are for less than $100-million. By definition, all of the undisclosed deals are going to be smaller than that. Probably, 95-99% of all deal activity is of the smaller kind. We decided that rather than trying to grade big deals, we should be looking at the performance of companies who do a lot of deals versus companies that do few deals. We looked at 15 years of data for 1,700 companies and sorted them by how many deals they did. We then looked at their ability to earn their cost of capital. What we found is that the more acquisitive a company is, the better their return for shareholders is. This was true in the United States, Europe and Japan. The number of deals a company had to do in order to be acquisitive was not a huge number. It averaged about one a year. There is clearly something going on here in terms of experience.

With that data in mind we decided to cut the data another way. When we took the 1,700 company database and we cut it again, we found that the highest returns accrued to companies that did small deals. The larger the deals got, the poorer the return profiles were.

What we've found is that companies who are good at doing smaller deals earn the right to do bigger deals. We aren't saying don't do big deals. We are saying start small and build your organizational capability to do deals, and then you can go forward and do the larger deals.

The worst place to be is doing large episodic one off deals, the one big transformational deal  those are often deals that put the company on the road to ruin.

Also, companies who were inactive (did no deals) over the period studied were also destroying shareholder value and not earning their cost of capital.

RD: What is your take on Southwest Airlines? They have not acquired anyone, yet have grown significantly.

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Mr. DiGeorgio is the principal of Richard M. DiGeorgio & Associates, a management consulting firm. He is a change management consultant, leadership trainer and coach. His firm is a network of quality consulting firms, who have worked in numerous industries and at all levels of Fortune 500 companies.

Mr. DiGeorgio has twenty-nine years of experience as an executive and change consultant with three Fortune 500 firms, eighteen of those years were spent at Mobil Oil. His last assignment was as an internal change consultant on assignment to Project Horizon, Mobil Oil's effort to improve its effectiveness in building capital projects and save $500M a year. 
 

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