Examining mergers and acquisitions.(From the Editor)

In place of a typical editor's message, this issue begins a series of articles appearing in this space that analyze merger and acquisition (M&A) activity in the hotel industry. Domestic and international M&As have become important tools in the lodging industry as a major means for companies to grow in size and to go international. While mergers may have taken a pause in the current environment, Exhibit 1 shows the annual number and annual market value of target stocks for worldwide lodging acquisitions completed or pending as of late in 2008. The data sample, supplied by Securities Data Corporation (SDC), includes M&As of both public and private companies in which at least one of the companies involved operates in the lodging industry. In 2000, a total of 333 mergers or acquisitions occurred around the world in which the acquirer or the target was involved in the hotel industry. The aggregate value of the targets was about $32 billion. Even though M&A activity dropped in 2001, it began to pick up again in 2002. By 2004, the value of the targets was $51 billion. In 2007, there were 435 hotel related worldwide mergers or acquisitions in which the total value of the targets was $109.7 billion. As of August 20, 2008, 176 M&A deals were announced, and the targets have been valued at $17.6 billion. Of the 176 pending or completed M&A announcements in 2008, about 29 percent involved international transactions. It is evident that international M&A activity is significant. The market value of the targets involved in an international transaction represented 46.4 percent of the total market value of the targets year to date.

Managers sell M&As to owners or shareholders and institutional investors with such claims as economies of scale and synergy, resulting in a reduction of expenses and a lower cost of capital (Fee and Thomas 2004). In theory, this is true, but in reality, there are frictions and implementation problems such as clashes of corporate cultures and leadership problems. As a result, the financial reality may be quite different from the theoretical expectations. Even though managers claim that the value of the firm will increase, historically for the overall market, the financial reality has been somewhat disappointing. Although many benefits of M&As are stressed when a deal is announced, research studies on M&As have reported relatively high rates of failure (see, for example, Jensen and Ruback 1983; Gregg, Brickley, and Netter 1988; The Economist 1999; and Marks and Mirvis 2001).

Despite all the research about M&As, unanswered questions remain regarding how to reap the potential benefits of the transactions identified by managers. According to a recent study (Carr et al. 2004), more than two-thirds of M&A deals fail to create shareholder value. In particular, many studies show that the greatest danger comes when the two companies attempt to combine operations. Through interviews with acquirers, the Carr group concluded that the following factors are important for adding value: identify where to prioritize integration, quickly integrate the financial opportunities that inspired the deal, put cultural integration high on the agenda, and keep most of the employees' efforts on the base business (Carr et al. 2004). Integration is difficult, but if it is executed thoughtfully, it can magnify a deal's chances of success. If handled poorly, failure to integrate is a major cause of failure. In fact, there is a growing recognition that "all value creation takes place after the acquisition" (Haspeslagh and Jemison 1991), during the postmerger integration stage.

In this issue, I present a brief description of the M&A process. In the next issue, I cover the impact of the degree of relatedness on the integration stage. The degree of relatedness and industry structure were identified by other researchers as factors that may influence the integration stage of the M&A process. As a result, they may affect the acquiring firm's ability to attain the benefits associated with the transaction. In upcoming issues, I will analyze the impact of the degree of relatedness on the financial performance of both the target and acquiring firms at the time of the merger announcement in the global lodging industry. This will allow us to determine whether the financial market continues to view consolidation as value-enhancing in the lodging industry. The approach taken here involves evaluating the stock market's reaction to merger announcements. This analysis is performed for both acquirers and targets. Last, I will present a summary of the factors that are useful for managers to consider when evaluating M&A transactions.

The M&A Process

M&As are investment activities. As with all good investments, it is expected that they will result in an increase in the value of the firm, which may be achieved in several ways. Higher levels of performance may be attained through improved management if the management of the acquiring firm is superior to that of the target firm. Benefits may also be achieved if a more efficient firm is created through the elimination of redundant facilities and personnel or through offering a more profitable mix of products and services. Also, increased market power may raise performance.

Usually, M&As can be divided into three stages: the premerger process, the actual deal, and the postmerger integration process. Premerger and postmerger processes have traditionally been viewed as separate issues: merger performance has been regarded as the result of the success of premerger decision making plus the success of postmerger implementation (Pablo 1994). Often different groups and even managers are involved in the predeal and postdeal stages. This may result in a disconnection between the expected benefits of the M&A with the achievement of those benefits during the integration process.

Recently, both academics and practitioners have focused on a holistic approach to M&A (e.g., Chanmugam et al. 2005). This approach treats the M&A transaction as a single process that begins with the predeal strategy, progresses through deal execution, and continues with postmerger integration. The expected benefits of the merger will be realized only if the postmerger integration activities are prioritized based on their potential for value creation as estimated during the premerger stage (Chanmugam et al. 2005). It is impossible to execute a thorough due diligence process and develop a fair price during the first two stages without taking the integration stage into account. Given that the first two stages of the M&A process are successful, it is more likely that that the final implementation stage will also be successful if managers plan to proactively manage the integration process of the relevant areas. Yet many companies frequently do not plan the integration process until after the deal is announced or even closed (Carr et al. 2004). That is too late. Mangers need to identify early on the areas where integration is important, the degree of integration, and incorporate this into the initial plan of action.

The degree of integration depends on the deal. Active investments, such as the acquisition of a hotel property, may require minimal integration. Deals meant to increase scale by adding similar products or customers may require extensive integration at the corporate level. But scope deals, those that extend a company's reach into new products, customer segments, or markets, may call for integration only in specific areas. An acquisition that expands a company's product scope, for example, may require extensive integration in distribution and overhead functions. In the next issue, I examine the matter of degree of relatedness as it relates to the success of a merger.

References

Carr, R., G. Elton, S. Rovit, and T. Vestring. 2004. Beating the odds: A blueprint for successful merger integration. European Business Journal, 16 (4) pp. 161-66.

Chanmugam, R., W. Shill, D. Mann, K. Ficery, and B. Pursche. 2005. The intelligent clean room: Ensuring value capture in mergers and acquisitions. Journal of Business Strategy 26 (3): 43-49.

The Economist. 1999. How to make mergers work. 350 (8101): 15-16.

Fee, C. E., and S. Thomas. 2004. The sources of gains in horizontal mergers: Evidence from customer, supplier, and rival firms. Journal of Financial Economics 74:423-60.

Gregg, A., J. A. Brickley, and J. Netter. 1988. The market for corporate control: The empirical evidence since 1980. Journal of Economic Perspectives 2:49-68.

Haspeslagh, P. C., and D. B. Jemison. 1991. Managing acquisitions: Creating value through corporate renewal. New York: Simon & Schuster.

Jensen, M. C., and R. S. Ruback. 1983. The market for corporate control: The scientific evidence. Journal of. Financial Economics 11:5-50.

Marks, M. L., and P. H. Mirvis. 2001. Making mergers and acquisitions work: Strategic and psychological preparation. Academy of Management Executive 15:80-92.

Pablo, A. L. 1994. Determinants of acquisition integration level: A decision-making perspective. Academy of Management Journal 37 (4): 803-36.

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