No single board is completely ready for future governance
Mergers & Acquisitions in the boardroom
“Can you actually do acquisitions when you don’t have organic growth? The answer is yes, you absolutely can. Acquisition can be a superior strategy”, says Peter Bakker, president of the World Business Council for Sustainable Development (WBCSD).
Annual Boardroom Breakfast - May 19, 2017
In his time as CFO (5 years) and CEO (10 years) at TNT, he witnessed no less than 47 M&A’s. “Big deals are tricky though: they only work in mature markets that are growing slowly. In high-tech, fast-moving markets, the return on big deals is minus 12%. The best strategy is to make programmatic and small deals that create a portfolio, with 2.8% incremental return, apart from other reasons to consider M&A, such as synergy, consolidation, access to markets or transformation of technology or business models.”
Terminal value is a dream
In M&A, there’s a fundamental difference between being the hunter or the hunted, says Bakker. His perception of the M&A process reflects a CEO’s point of view: “If you’re an alpha male, you think of yourself as a hunter: you cannot imagine being hunted. So you create a strategy and decide which part of that strategy you can build for yourself, and how much you want to buy. You make that a distinct part of the conversation with the Supervisory Board. Depending on how many accidents the company experienced in the past, that conversation will be difficult or easy. The Supervisory Board will want to talk about the risks of the M&A strategy. Your answer will be to do a DCF calculation. But Discounted Cash Flow Models are completely ineffective. In their M&A strategy, most companies will attribute 75% or more of their value to what is called the terminal value.
Terminal value is defined as infinite growth of the cash flow in the last projection year, as established in your assumptions. In the real world, however, infinite growth simply doesn’t exist; in most cases terminal value is a mere dream. Management will translate the strategy in a target list. Finally you get to do the deal. Then the hard work of integration begins. Hopefully, the Supervisory Boards have improved over the last five years, because in my experience they are not involved sufficiently in integration. Very few acquisitions get tracked as individual output. In my opinion, CFOs need to be forced to deliver the numbers.”
“There are very few companies, if any, who have a strategy for being attacked or consolidated.”
Forced in the game
With a strong US dollar, we have recently seen American investors being keen on relatively cheap European assets. Last February, Kraft Heinz was chasing Dutch/British Unilever. The acquisition battle over AkzoNobel is taking place in court right now. Bakker: “There are very few companies, if any, who have a strategy for being attacked or consolidated. Nowadays we make up arguments based on concepts like ‘Dutch pride’ and ‘crown jewels’, but these are not real arguments. There is a lot of talk about defense mechanisms against Anglo-Saxon attackers, but there’s really only one mechanism: shareholder value. Price. Occasionally you can scare them away, but mostly you’re forced to participate in their game.
One other defense is the EU: that’s a monster that Americans in particular don’t understand. Sometimes you can buy yourself time to think about an offer, but you should have been prepared in the first place. What companies should do more often is to use their stakeholders, just like Unilever did when they were under attack by Kraft Heinz. Unilever also had a strong story, backing of other stakeholders and a good track record. The final plan from Unilever, that was a hardcore capitalist response: double the margins, grow the revenue, sell the spread business. One thing to note however is that in all cases transparency on the arguments used in response to a bid, is often insufficient.”
Climate change is the biggest risk
Mark Carney, chairman of the financial stability board, stated in his speech ‘Tragedy of the Horizon’ that the risk horizon of the financial system is one to three years, but that climate change is the biggest risk out there. Bakker agrees: “The Taskforce for Climate-related Financial Disclosure came up with three recommendations. Every company must disclose its emissions in standardized comparable data. Every company must disclose the processes it has in place to manage climate risks at the level of the Supervisory Board, the office of the CEO and the operating level. And every company must prepare a strategy for what will happen to their business model in a two-degree world: the maximally allowed rise of temperature, as established in the Paris agreement.
Globally, we have 23 more years in which to emit CO2, and then we have to switch everything off. You need to have a strategy to deal with that reality, and the Supervisory Board needs to sign it off. The G20 will discuss this report in July, and the results will be included in corporate governance codes around the world, so my advise to members of Supervisory Bboards is, to get educated and prepared to deal with this important subject.”
“Leadership is way more important than Discounted Cash Flow Models.”
“I think no single board is completely ready for future governance”, concludes Bakker. “50% of the cost of driving a truck is the truck driver behind the wheel. Self-driving trucks are 3 to 5 years away. I used to work in a company with 60,000 drivers. They might all lose their jobs. If today you buy a company that you think is going to give you a lot of synergies, for instance because you can combine two loads on a single truck and get rid of half your drivers, you should be aware that that solution will not work anymore. The future is coming so quickly now, and the assumptions in the DCF are changing so rapidly, that boards need to read up and get ensure they are on top of the new trends and risks. History is an OK guide, but cannot be the only one.
If you think about M&A, my experience is there are three key things for a Supervisory Board to be mindful of:
(1) The key relationship to monitor is the one between the chairman and the CEO, particularly when the pressure around a deal or bid is going up,
(2) Leadership of integrations after the deal is way more important than Discounted Cash Flow Models before the deal. Who is going to pull the wagon and round up the business, and what are the milestones that person needs to deliver?
(3) Don’t rely on external advisors and investment bankers too much, they are all incentivized for companies to be in deal-mode and transactions. Supervisory Boards should make up their own mind.”
Peter Bakker’s remarks on transparency and the still dominant alpha male culture in businesses appeared to ring a bell with the audience at the Boardroom Breakfast in the Cobra Museum. While discussing five statements, opinions were divided on the level of transparency during M&A negotiations. “M&A is fundamental to strategy, so the whole board should be present to give their long-term vision,” as one participant put it.
Depending on the size of a company, most were in favor of a separate M&A committee within the Supervisory Board, provided that the other board members were being kept informed. The audience felt that should be doable: “As soon as you’re working on a deal, you can make a selection from the Supervisory Board to form a committee. Any good chairman can do that in an afternoon.”
And the chairman himself should definitely be part of such a committee. This committee could play a role in preparing the company for a (hostile) take-over. Without such preparations, the game that can develop between a CEO and a chairman poses a potential risk. The deal-driven alpha male culture needs to change dramatically; the public demands accountability. On the other hand, it’s clear that M&A is a delicate process. You don’t want the whole world to co-negotiate. Finding the right balance is key.
Around the Boardroom program
The Boardroom Breakfast is part of the CFO Program and Supervisory Board Program, under the umbrella of the Around the Boardroom Program of Deloitte The Netherlands. More information about these programs can be found at www.deloitte.nl/AtB.