What you don't know about the intangibles of M&A deals

You have worked hard to buy over a company; you have to work harder now to avoid seeing its value disappear.

2012 could be remembered as the year when mergers and acquisitions (M&A) made a comeback following a lull post-2008 Financial Crisis. The TCC Asset-led US$13.5 billion acquisition of Singapore’s Fraser & Neave (F&N) dominated headlines in South-East Asia, following Dutch beer maker Heineken’s bid for F&N-controlled Asia Pacific Breweries. It was one of the largest ever deals in the region, and made up part of the US$426 billion Asian M&A market for 2012.

According to management consulting firm, Hay Group, M&A deals are being struck more quickly now than ever before. The results, however, are not always positive: regionally, dealmakers saw an average decline of 38 percent in the value of their acquisitions’ “intangible assets” over a two-year period from 2010 to 2012. Applied to 2012 deals, those companies would have lost over US$100 billion in value by 2014.

The Hay Group describes these “intangible assets” as a company’s organisational capital (company culture; communication), relational capital (client loyalty; brand value), and human capital (leadership; employee engagement; development and management).

“Things like leadership skills, employees, brand management, governance and others all need engagement to remain active,” explains Andreas Raharso, Director of Hay Group’s R&D Centre for Strategy Execution. “Otherwise, this capital becomes inert.”

Inert capital versus active capital

Raharso likens a company’s active capital to sunlight and water to a potted plant i.e. things that keep it healthy. In the same way that sunlight and water keep the plant verdant, intangible assets that remain active after the merger is crucial to the company maintaining its pre-merger value. Unfortunately, this concept is not always completely appreciated by acquiring companies in M&A deals.

“This is really no fault of theirs. It’s more so rooted in the established principles of accounting,” Raharso told Perspectives@SMU. “It isn’t like a gold bar, because no matter what I do with this gold bar, it still holds its value. The basic assumption here is that this asset is active as its starting point. The problem with intangible capital is that this isn’t true.”

Intangible assets could also be understood as the difference between a company’s book value and its market capitalisation. For example, Apple had around US$200 billion in assets but was worth more than three times that when its stock price hit US$700 last year. Given that Apple’s stock has since fallen below $500, one might say its intangible assets – its organisational, relational, and human capital – have become less active.
Keeping intangible assets active

To avoid intangible assets of a target company reverting to their default inert state, acquiring companies need to consider if both companies are compatible in four areas, which the Hay Group calls “drivers”:

- Candour

- Courageous follow through

- Calculated risks, and

- Compatible response

The latter two drivers describe the situation at the organisational level, whether both companies have a culture of risk-taking, and are quick in making decisions. A good example is BenQ’s acquisition of Siemens, which foundered because the former’s informal and entrepreneurial culture clashed with 100-year old Siemens’ formal ways of adhering to strict procedures.

Courageous follow through describes senior management’s willingness to tackle difficult issues during the merger process. Among other things, this might involve discontinuation of one party’s product line, or perhaps even significant layoffs. It is at this point where Candour emerges as the most critical of the four drivers.

“If you had to focus on one of the drivers, then it may be best to focus on candour, because candour is the critical factor that will lead to trust,” Raharso says. “In the M&A life cycle, especially during the post-merger integration phase, lost trust is the number one reason that deals collapse or fail to create value.”

Raharso continues, “Employees need to be assured that the deal is in their best interest. If rumours proliferate and fears begin to spread about job security, they will jump ship and the company will lose value – not to its balance sheet, but to its portfolio of intangible capital.”

Costs of mismanaging intangible assets

The Hay Group estimates that 60 percent of an organisation’s earnings before interest, tax, depreciation and amortisation (EBITDA) and 77 percent of stock price movement can be attributed to intangible capital being in its active form. However, 70 percent of the executives that they spoke to expressed their belief that it is “just too difficult” to obtain intelligence on a target company’s intangibles.

“As a result, the driving focus for many leaders is on the mandatory aspects of integrating finance and IT infrastructures,” suggests David Derain, Global Managing Director of business solutions and global M&A practice at Hay Group.

“As corporations in Asia-Pacific continue to make forays abroad, a comprehensive understanding of intangible capital and its drivers need to become the cornerstone of their outbound strategy. Only then will their aspirations of being truly global, truly world class businesses be realised.”

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AUTHOR: SMU Staff

SOURCE: https://www.smu.edu.sg/perspectives/2013/06/26/intangibles-ma-deals#.UdpqaKzlbJ8