How to avoid common Merger & Acquisition pitfalls

Nov 21 2019 Financial Management

Whilst the collapse of Thomas Cook came as shock to many, it can arguably be traced back to a merger which happened more than a decade ago. What went wrong and what steps can you take to ensure a successful merger?

Collapse of Thomas Cook

The immediate answer as to why Thomas Cook failed after 178 years in business is that it was unable to secure £200m bailout money from its bankers. But a sudden crash of a once iconic brand doesn’t come out the blue – its problems started more than a decade ago with its ill-fated decision to merge with travel brand MyTravel in 2007. Despite the merger promising to save Thomas Cook’s money as well as increase its reach into Europe by becoming part of a giant travel brand, it was merging with a company that hadn’t actually made a profit more than once in six years.

The result of the merger for Thomas Cook was the acquisition of debts. The merger didn’t result in the increased profits it had hoped and in the first half of 2019 Thomas Cook Group wrote-off more than £1.1 billion in goodwill relating to MyTravel’s UK business. This catapulted Thomas Cook Group into a heavy interim loss as it sought to cope with a high debt burden (since 2012 it paid £1.2 billion in interest and finance costs) and a difficult trading environment. This ultimately resulted in Thomas Cook Group being unable to convince lenders to provide the funding necessary to keep it afloat.

So how can your business avoid similar M&A problems?

Ask the right questions

It’s easy for senior executives to get so enamoured with a particular acquisition that it ends up getting pushed through the finance department without sufficient due diligence. Even if there is due diligence, the right questions may not be asked or there is not enough focus on what risks the deal poses to the acquiring company.

Tip 1. It’s your job to force management to slow down a bit and to ask the tough questions: “What is our strategy?” (the strategy of your company not just the strategy behind the deal in question) and “Do the deal’s objectives, e.g. to boost market share or try to break into new markets, align with that strategy?”.

Tip 2. The acquirer should always ask, “Why are they selling?”. Understanding the motivation for the sale should give you insight into what the key risk factors will be. What was the last quarterly earnings report? What are they saying in the blogosphere about the product? Maybe the seller had a bad product release that hasn’t shown up in the numbers yet.

Tip 3. Although due diligence checklists can run into hundreds of pages, there are likely to only be about five to eight key risk issues in any particular deal. Focus your due diligence on these areas.

Evaluate your financial stability

Cash is more important than profit so before embarking on merger or acquisition, check that your company has enough liquidity to make and sustain such an investment.

Tip 1. Prepare a likely and worst-case scenario cash flow forecast for at least two years after the merger or acquisition, to identify any times when there could be a funding shortfall. If your company is taking on significant debt to fund the merger, ensure you include the future interest payments in your cash flow.

Tip 2. Where there are shortfalls, consider whether the company would be able to obtain finance to cover these, particularly if it already has a significant amount of debt.

Thomas Cook’s merger in 2007 didn’t result in the profits it had hoped for and saddled the firm with huge debts. Avoid similar issues by focusing your due diligence on five to eight key risk areas. Ensure that you will be able to obtain funding for any post-merger cash shortfalls.

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