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“Success” in M&A is not so different from “success” achieved by value-style investing and created by the perfection of an analysis discipline that allows good judgment. The winners follow it over and over, and never deviate from the discipline. An aim of this book is to bring M&A analysis discipline to the forefront, in much the same way that Benjamin Graham and David Dodd did for securities analysis and Warren Buffett put into practice.

Even though success in M&A is uncertain, research and practice suggest the outlines of its key drivers. The perspective developed in this book is that success is driven by both the structure of the M&A opportunity one faces, as well as the conduct by which one pursues it. This venerable² model is useful for sorting out the determinants of success in M&A. Exhibit 1.1 summarizes the direction of influence: Structure drives conduct and outcomes; and conduct shapes structure³ and drives outcomes. This has intuitive appeal when you consider the simple idea that where you wind up is a matter of the resources, opportunities, and constraints you began with, and of what you did along the way. The random strokes of good or bad luck also have an influence; therefore, your conduct of M&A needs to anticipate the possibility of both.

The structure of the M&A situation is like the setup of a game, the resources (the sports equipment you have), opportunities (the team you recruit), and constraints (the rules) under which you operate. In M&A, the elements of structure include:

EXHIBIT 1.1 A Model of the Drivers of Outcomes

*“SWOT” stands for strengths, weaknesses, opportunities, and threats. The use of SWOT analysis to develop strategy is discussed in Chapter 6.

 Economics of the opportunity. This is simply the distribution of costs and revenues that determine cash flows, and ultimately net present values of investment. The “economics” also refers to the financial impact of the transaction on the buyer and target shareholders. From the buyer’s standpoint, the financial impact consists of the potential value to be created (as measured by net present value) as well as the effects of deal financing. Synergies are a key driver of the economic impact of the deal. Valuation analysis is the cluster of tools that enables one to assess the likelihood of the deal to create value. Best practitioners in M&A are rigorous analysts of the economics of an opportunity. In short, “economics” embraces the factors determining the financial risk and return of a deal. Chapters 9 through 17 outline the economic analysis of M&A opportunities; Chapters 18 through 24 present an economic lens through which to assess the design of transactions.

 Strategy. The recognition of a strategic threat or opportunity in the firm’s competitive arena motivates most deals. The industry positions of the buyer and target are important determinants of the attractiveness of a deal. The firm may want to engage in M&A activity to acquire special capabilities and to improve its strategic position. Strategy is not only a direct driver of deal success, but also a driver of the economics, organization, and reputational structure of the deal. Successful acquirers are critical analysts of the strategic positions of the buyer and the target. Chapters 4 through 7 explore the strategic perspective and present several tools with which to assess the position of a firm and the strategic attractiveness of a deal.

  Organization. The buyer and the target come to the deal with organizations that are unique in terms of their structure, leadership, and culture. The ability of two organizations to mesh has a huge influence on the ability of the new firm to realize merger synergies and strategic benefits. Failure to integrate well can torpedo a deal that, on paper, looked like a winner. Thus, best practice acquirers devote serious attention to the organizational profiles of the two firms, and to the postmerger integration challenge. Chapters 24, 36, and 37 assess the influence of social issues and the challenges of postmerger integration.

 “Brand.” The reputation and influence of the buyer and target go largely unrecognized in conventional assessments of M&A, yet practitioners consider these to be a key influence on the conduct of the M&A effort. Economists think of the brand in terms of “signaling,” the ability of a firm to distinguish itself from other firms. Signals can have a large influence on prices and even the ability to close a deal. But for them to have much effect, they must be costly or difficult, and unambiguous. Brand names are signals of quality or other special attributes. Brands and signals have special influence where interaction with customers or counterparties is repeated over time. Best practitioners seek to create and preserve brand value, and to understand the sources of the counterparty’s brand. Worth noting is that in M&A personal brand is also important: The aura of a CEO, financial adviser, or operating manager has been known to advance or stall a deal. Chapters 30 through 33 explore some of the implications of reputation in M&A.

 Law. The matrix of laws and regulations in the business environment constrain the actions of the buyer and target firms and of specific players such as CEOs, directors, accountants, analysts, and insiders. The businessperson must ask, “What is our legal exposure in this situation and how can we manage it?” Chapters 26 through 29 explore the structural influence of laws and regulations in M&A.

 Ethics. In the professional literature on M&A, very little has been written about ethical dilemmas. Yet practitioners struggle through these virtually daily. Chapter 2 argues that the best practitioners consciously address the ethical dimension in deal development and assiduously avoid taint that might accrue from an ethical lapse.

To focus only on structure is to be a determinist: “If X is the condition, Y is the outcome.” Yet to be a determinist is to settle for a limited view of the world. Causality might be more complicated than initially believed, as the followers of Karl Marx and Sigmund Freud discovered. Human behavior is uncertain. This uncertainty muddies the causal effects of structure. For instance, a machine can hit a tennis ball over the net with great predictability. Humans, on the other hand, are less predictable—differences in skill, strength, and strategy can force opponents to make bets about the behavior of each other. Such is also the case in M&A, a game in which one’s conduct has a large influence on outcomes. Conduct intervenes in the pursuit of good outcomes anytime one must make a strategic choice or adopt tactics for behavior. In short, best practice requires that we augment the deterministic focus on structure with a probabilistic focus on conduct, in areas such as the following:

  Search for partners. Chapter 6 argues that the search for acquisition targets is one part structured research and another part serendipity: In the modern jargon, good discovery relies on networking, which itself relies on social skills that are not readily given to deterministic description.

 Due diligence. This is the structured search for risk. Here again, we have a discovery process that depends on both organized inquiry and agile thinking. Chapter 8 argues that due diligence is least successful when reduced to rote fact checking. Instead, the right way to discover hidden risks is to research curious details, anomalies, inconsistencies, and discontinuities—all under tight time pressure and efforts by the seller to put a gloss on things. Here, the uncertainty of conduct arises from the investigator’s stamina, care, and capacity for critical thinking.

 Negotiation and bidding. The probabilistic influence of psychology and self-discipline appear most vividly in settings where M&A parties grapple with one another. Chapter 30 reviews research that shows that attitudes, appetites, and negotiation tactics have a large influence on deal prices and terms. Chapter 31 shows that auctions and deal frenzy can prompt a bidder to make an offer beyond the rational maximum—this results in the “winner’s curse.” Chapters 32 and 33 emphasize that hostile takeovers are games in which psychology and beliefs about competitors have huge influences on the step-by-step movements of the competitors.

 Dealing with laws, regulations, and the judicial system. Laws and regulations may seem like constraints on actions, though to the artful practitioner they may raise new opportunities and/or mitigate threats. Lobbying regulators and legislators and appealing to the courts for relief are means by which the practitioner might actually shape the structure of the M&A situation. Chapters 26 through 29, 32, and 33 survey the dimensions in which laws, regulations, and the courts may affect M&A conduct.

 Deal design. Chapters 18 and 25 frame the deal design effort as a search for trade-offs that can accumulate to a winning outcome for both buyer and target, the so-called win-win deal. This search is yet another discovery process, more like a dance than an engineering problem. And as dancers know, it takes skill and coordination to come to an end with graceful bow and applause rather than stumbles and embarrassed gasps.

 Postmerger integration. William Blake once said, “Execution is the chariot of genius.” No matter how good the deal design, implementing the merger integration is where the hypothesized deal benefits are won or lost. Choosing the right integration strategy is a matter of judgment; implementing it well is a matter of managerial skill. Chapter 36 argues that acquisitions trigger fear and anxiety among employees in the target firm and that these emotions can torpedo efforts to realize benefits from the deal.

 Leadership and communication. As adept public speakers know, it is not merely what you say, but also how you say it, that counts. Differences in expression are some of the most subtle and powerful ways in which conduct can intervene in the realization of outcomes. Communication issues permeate the deal process. This book addresses them in numerous areas, including ethics (Chapter 2), deal search (Chapter 7), due diligence (Chapter 8), accounting (Chapter 16), social issues (Chapter 24), disclosure to markets (Chapter 27), negotiation (Chapter 30), auctions (Chapter 31), hostile takeovers (Chapters 32 and 33), the presentation of proposals (Chapter 35), postmerger integration (Chapter 36), and the leadership of the deal process (Chapter 37).

 Managing the deal development process. A special perspective of this book is an emphasis on the importance of good process as one of the key drivers of good outcomes. Best practitioners make deal management into a strategic capability. Process lends discipline to one’s thinking, fights the psychological trap of deal frenzy, and helps to motivate the creative search for solutions to thorny problems. How one might structure good M&A process is the subject of discussion in chapters on deal search (7), due diligence (8), valuation (9), deal development (25), negotiation (30), communication (35), and best practice (38).

The final element of the structure-conduct-outcomes framework is outcomes, the whole point of the M&A effort. Quite simply, this could be measured in terms of the fulfillment of one’s intentions for doing the deal. The thoughtful practitioner will benchmark the deal’s outcomes against at least seven measures:

1 Creation of market value. As Chapter 9 suggests, one needs to think like an investor, which means harnessing the perspective of the providers of capital. The creation of market value is measured straightforwardly by the change in share values, net of changes in the stock market.

2 Financial stability. Some of the saddest M&A deals are those that, rather than making the buyer stronger, actually destabilize it. In most of these cases, the buyer overreaches its financial capacity. Financial stability can be measured by changes in debt ratings, default risk, or other measures of financial capacity outlined in Chapters 13 and 20.

3 Improved strategic position. Many M&A transactions are motivated by a strategic purpose that seeks to improve the firm’s competitive position, acquire new capabilities, improve agility, or obtain resources that are vital to future prosperity. Chapter 6 sketches these considerations. Also, many deals respond directly to turbulent forces in the firm’s environment—these are surveyed in Chapters 4 and 5.

4 Organizational strength. Knitting together two firms is especially challenging from an organizational perspective. Most CEOs would agree with the old slogan “People are our most important asset.” Chapters 36 and 37 survey what this might mean in practice. In essence, one could measure organizational strength in terms of depth of talent and leadership, effectiveness of business processes, and the transmission of culture and values.

5 Enhanced “brand.” The deal should improve the reputation of the acquirer and its deal architects. Usually, the realization of these other aims will do just that. But one can imagine deals that depend on acrimony, subterfuge, and win-lose mentality—in a world of repeated play, the executive must consider how these qualities might affect one’s M&A success in future deals.

6 Observance of the letter and spirit of ethical norms and laws. You can gain financial, organizational, and strategic objectives in M&A, but in ways that violate norms such as equity, duty, honesty, and lawful observance. After the corporate scandals of recent years, any assessment of outcomes would be incomplete without consideration of laws (Chapters 25 through 29) and ethics (Chapter 2).

7 Improved process. The process orientation of this book emphasizes the importance of learning from each deal. As illustrated in Chapter 37, good practitioners try to capture the lessons of each deal in an effort to accumulate an improvement of practice for the next time around. This is the way a firm turns mere skills into truly strategic capabilities.

Exhibit 1.2 summarizes the success framework for M&A. It suggests that one must first assess the structure of the business environment and deal opportunity. The structure will suggest the outlines of a deal design. Next, the thoughtful practitioner must tailor a deal development process and conduct the process in ways that achieve an attractive outcome. In other words, Exhibit 1.2 summarizes a way for practitioners to organize and execute good deal development. Think of Exhibit 1.2 as a bull’s-eye target, useful for practicing your aim at various points in the merger process. The balance of this book adds the details.