Acquisition Advice: Big deal or good deal?

HP is one of a multitude of companies that has overpaid on acquisitions, and like those other companies, it cannot claim that it lacked outside advice and guidance. In fact, HP paid $30.1 million in advisory fees to Perella Weinberg and Barclay’s Capital for guidance on how much to pay for Autonomy and whether the deal made sense. So why did they not spot the accounting manipulation or recognize that synergy would be elusive? In general, why, if acquiring firms pay so much for "expert" advice, do so many deals go bad?

Conflicting roles: The answer can be seen in an imperfect analogy. Asking an investment banker whether a deal makes sense is analogous to asking a plastic surgeon whether there is anything wrong with your face. After all, if either party says “No”, they have no business to transact and no revenues to generate. Allowing the dealmaker (the investment banker) to also be the deal analyst (provide advice on whether the deal is a good deal) is a recipe for bad deals and we have no shortage of those. The solution is simple in the abstract but transitioning to it may be difficult. The deal making has to be separated from the deal analysis. Put differently, investment bankers should do what they do best, which is to manage the mechanics of the deal, and be paid for the service. There should be a third party, with absolutely no stake in the deal's success or failure, whose job it is to assess the deal to see if it makes sense, with compensation provided just for that service. Why has this common sense change not happened yet? First, as I noted in my last post, many acquiring companies want affirmation of decisions that they have already made (to acquire), rather than good advice. Second, the same entity (say, Goldman Sachs or Morgan Stanley) cannot slip back and forth between being a deal maker on one deal and a deal analyst on another, since there will be a shared and collusive interest then in shirking the deal analyst role. You would need credible entities whose primary business is valuation/appraisal and not deal making.

The deal table: In many businesses, companies measure their success based upon market share and revenues. M&A bankers are no different and their success is often measured by where they fall in the deal table rankings. Here, for instance, is the latest deal table from Bloomberg, listing the top bankers for M&A globally, in 2011 and 2012.

Note that the rankings are based upon the dollar value of deals done, and that there are no extra columns for good deals and bad deals. Consequently, a banker who does a $11 billion bad deal will be ranked more highly than one who does a $4 billion good deal. There are three implications that follow.

1. When a big deal surfaces, bankers line up to be part of that deal, willing to bear almost any cost to get involved. 
2. The bigger the deal, the worse the advice you are likely to get; the conflict of interest that we mentioned earlier gets magnified as the deal gets larger. 
3. Individual bankers will be judged on their capacity to get deals done and not on the quality of their deal advice or valuation expertise. Thus, it is not surprising that the biggest stars in the M&A firmament are the dealmakers. In fact, it is interesting that Perella Weinberg is listed as one of HP”s advisors on the Autonomy deal. Joe Perella, co-founder of the firm has a long history in the acquisition business that goes back almost four decades to his position as co-head of M&A at First Boston in the 1970s. He left the firm, with the other co-hear of the First Boston M&A team, (Bid 'em up) Bruce Wasserstein, to create Wasserstein Perella, a lead player in the some of the biggest acquisitions of the 1980s. He returned to head M&A at Morgan Stanley for a few years before leaving again to found Perella Weinberg. Through all the years, it seems to me that the singular skill that he possesses is not his capacity to value target companies but that he can get any deal done. 

So what can we do to change this focus on deal making? We do have to begin by changing the way we compensate bankers in deals but we also have to follow up on deals. I would like to see some entity generate deal tables that track the largest deals from five years ago and report how much those deals have made (or lost) for stockholders in the acquiring firms. It would be interesting to see the list of the top 10 bankers in terms of value creating and value destructive deals.

Compensation: The third factor that contributes to the deterioration of deal advice is the way in which the deal advisors get compensated for their services. In most deals, the deal advisors get paid for getting the deal done and there is no accountability for deal performance. Neither Perella Weinberg nor Barclay’s Capital will have to return any of the advisory fees that they received for the HP/Autonomy deal, even though the advice that was offered was atrocious. I think that there is a solution, even within the existing system. Rather than tie the entire fee to getting the deal done, a significant portion should be contingent on post-merger performance. Thus, if the acquiring firm’s stock price or profitability fails to beat the peer group’s stock price performance or profitability in the years (two, three or five) that follow, the bankers will either not get a large portion of their fee or be forced to return a proportion of the fees that they have already been paid. Bankers will complain that this puts them at the mercy of  macroeconomic shifts and mismanagement of the post-merger integration, but those are variables that they should be considering when assessing whether a deal should get done.

In closing, though, acquiring firms are quick to blame bankers for bad advice. As I noted in my last post, I think that the ultimate blame has to lie with the top managers of the acquiring firms. No acquirer  is ever forced to do an acquisition at the wrong price and if they chose to do so, they should be held responsible.


The Acquisition Series
HP's deal from hell: The mark-it-up and write-it-down two step
Acquisition Archives: Winners and Losers
Acquisition Hubris: Over confident CEOs and Compliant Boards
Acquisition Advice: Big deal or good deal?
Acquisition Accounting I: Accretive (Dilutive) Deals can be bad (good) deals
Acquisition Accounting II: Goodwill, more plug than asset

Acquisition Alchemy: Creating value from deals