Should we do this deal? #2

Acquisition case studies




shaking hands on a deal

What are Drucker's rules for mergers and acquisitions? Read Part One of this article here.

Quantifying Drucker's Rules

While working in China for over ten years and observing a number of failed acquisitions, I decided to try to quantify Ducker's Rules in an attempt to provide a tool to help answer the question, "Should we do this deal?"  Exhibit One below is an Assessment Matrix that allows one to answer each one of Drucker's Six Rules in terms of does the deal "Violate," "Somewhat Meet," or "Meets" Drucker's Rules and assigning a corresponding numerical value of "1," "3,"  or "5."

Exhibit One - Drucker's Rules Assessment Matrix

Drucker's Rules

Violates Rules

(1)

Somewhat Meets Rules

(3)

Meets Rules

(5)

1. Business Strategy

 

 

 

2. What Acquirer Contributes

 

 

 

3. Common Core

 

 

 

4. Respect

 

 

 

5. Provide Top Management

 

 

 

6. Promote Across Lines

 

 

 

Total Evaluation

 

 

 

 

Exhibit Two - Deal Scores, provides a guideline as to whether one should do the deal or not depending on the total Assessment Score. As an example, an Assessment Score of 24 to 30 suggests it is okay to do this deal while a score of 15 to 19 suggests you are taking a chance doing this deal. Scores below 14 obviously suggest the deal should not be done.

                 Exhibit Two - Deal Scores

Scores

Assessment

Guideline

24 - 30

Meets Drucker's Rules

OK to do deal

20 - 23

Barely Meets Rules

Might work

15 - 19

Somewhat Meets Rules

Taking a chance

11 - 14

Hardly Meets Rules

Look for a better deal

  6 - 10

Does Not Meet Rules

Join the 80% failure rate

 

Case Studies - Two Chinese Deals

In 2010 and In conjunction with my book signing  tour in China, I was invited to deliver a lecture on M&A for an MBA class at the Peeking University Graduate School. I decided as part of my lecture to try out my deal assessment model on the class as there were two M&A deals pending in China, both in the automotive segment. Using this tool, I asked the class to evaluate  these two Chinese M&A deals.

The Chinese Auto Industry

I first visited China in 1984 and commented that I seldom ever saw an auto during my over one week visit. That could be explained by the fact that China manufactured few autos. As an example, there were only 5,200 autos manufactured in all of China in 1985.  Eventually there were over 100 auto companies in China, some manufacturing less than 100 autos per year. Today there are still over 50 Chinese auto companies, most state owned. Unless they meet certain annual production goals, the government will shut them down, hence why the decrease from over 100 to 50 companies.

While living in Beijing in the early 2000s, the Chinese were adding one thousand autos a day to the streets of Beijing creating streets to parking lots, traffic jams and the worst air polluted city in the world. In 2016, 33.9% of all the autos in the world were built in China totaling  24 million autos. This is more than all the autos produced in the EU, US and Japan combined. At the time of this case there were four big state owned auto companies including SAIC Motor, Dongfeng, FAW and Chang An. Other Chinese companies included; Geely Auto, Beijing Automotive Group, Brilliance Auto, Guangzhou Auto Group, Great  Wall, BYD, Chery and Jianghauai. Many of these companies had joint ventures with companies like VW, GM and Chrysler (Jeep) and Japanese companies such as Nissan, Toyota and  Mitsubishi.  

 Deal One - Tengzhong Heavy Industrial Machinery Company (Chengdu, China)  and Hummer (General Motors).

Tengshong Heavy Industrial Machinery Company (Tengshong) was a builder of road equipment including highway construction and maintenance machinery. It had recently started building heavy duty trucks and tow vehicles however they had no previous automotive industry experience or international experience for that matter. They had recently made an offer to buy the Hummer from GM for $150 million (USD).     

GM acquired the Hummer brand in 1999 when gas prices were under $2 a gallon. As a product the Hummer’s image was that of a large, thirsty SUV that was a symbol of American excess at a time when more and more consumers were looking for ways to make the cars they drove less excessive and more efficient. Weighing in at 2.6 tons, a typical Hummer could only do between 10 and 15 miles on a gallon of fuel (roughly 15 liters per 100km), compared with 30 to 50 miles for a Volkswagen Golf. GM sold only 5,113 Hummers in the first five months of 2009 - a drop of 63.7% on 2008 – that after suffering a decrease of over 50 percent in sales in 2008. The Hummer's problems had delighted green campaigners who viewed the vehicle as the ultimate in motoring irresponsibility. David Hirsch, of Friends of the Earth in the US, described the Hummer as "the most anti-environmental vehicle in the history of the world".

Tengshong offered GM $150 million (USD) for the Hummer and its plant in the US which GM accepted.  Although Tengshong was a private company, they still required the Chinese government's approval for deals over $100 million done in the U.S. which was pending at the time of my lecture.

Case Two - Zhejiang Geely Holdings Group (Geely Auto) and Volvo (Ford Motors)

Geely Auto was the largest privately owned auto company in China that was founded in 1997. They initially built small economical autos and were a well recognized brand in China. Their total sales in 2010 were only 412, 286 autos.  They had entered into discussions with Ford who wanted to divest itself of its Swedish Volvo brand. The Volvo competed with other luxury autos such as Mercedes Benz and BMW and was known for its safety.  Ford had paid $6.45 billion for Volvo in 1999 and Geely had offered to buy Volvo for $1.8 billion, a 72% loss for Ford. This deal was also pending at the time of my lecture.

EVALUATING THE DEALS

“An acquisition must make business sense, or it does not work even as a financial move. It leads to both business and financial failure.”

Rule One: Acquisitions Should be Based on Business, Not Financial, Strategy

Here, Drucker would ask, “How does the acquisition of the Hummer Brand relate to the business strategy of the Tengzhong Heavy Industrial Machinery Company?” At the time of this deal, if there was a strategy, it had not been made clear?  Class Score (1).

Geely's acquisition of Volvo on the other hand could be considered  as a product extension as a business strategy and another vehicle to compete with Mercedes and BMW in a rapidly growing Chinese auto market. Class Score (5).

 

Rule Two: What the Acquirer Should Contribute 

“Because we are not competent to manage our own business, we better go into another one of which we know even less."  

The above quote was specifically directed at making an acquisition to diversify, which according to Drucker would fail if the objective was to cure a weakness on the part of the acquiring company. He commented, “The successful acquisition is based on what the acquirer contributes to the acquisition, not the reverse. It has to be more than money, something that gives the acquired business a new potential of performance. So then, what does the Tengzhong Heavy Industrial Machinery Company contribute to this deal besides money? Unfortunately, that’s all it planned to contribute in violation of this rule. Quoting Hummer CEO, Jack Taylor, “All I need is cash. We were looking for companies with the resources to develop and keep the brand and dealers alive. I’ll bring all the experience and expertise to the table.” Commenting on the acquirer’s lack of automotive industry experience he added, “The Chinese firm was happy to simply pay the bills and leave the vehicle-end of operations to Hummer’s existing management, engineering, marketing and advertising teams.” How long will Tengzhong be happy just paying bills? Class Score (1).

With respect to the Geely-Volvo deal, Geely would provide Volvo with an established dealer network in China and experience in the Chinese market. Class Score (5).

Rule Three: Common Core of Unity

It was difficult to determine what the common core of unity was between Tengshong Heavy Industrial Machinery Company,  a builder of road equipment including highway construction and maintenance machinery and the Hummer gas hog?  Obviously, it did not appear to be a common core of unity here and a clear violation of Drucker’s third rule. Class Score (1)

Geely and Volvo, both being in the automotive industry obviously had a common core of unity. Class Score (5).

Rule Four: Respect the Business, Products, Customers, and Values

The acquiring company must respect the business of its acquired counterpart. No acquisition is likely to work unless people in the acquiring company believe in the business they take over. They must believe that it makes a contribution and, equally, have respect for its products, markets and its customers. The acquisition must be a “temperamental fit.”

Drucker would find it difficult to find the “temperamental fit” here when it comes to the products and the customers of both companies. Hummers were widely regarded as gas-guzzling, road-hogging, oversized machines rich people buy to flaunt their wealth. Hummer customers at the time included movie star-turned-Governor of California Arnold Schwarzenegger, who was reported to have once owned as many as seven before giving them up after his election. Soon after, GM began offering scaled-down models to boost its customer base, with these being bought  by celebrities such as socialite Paris Hilton, basketball star Shaquille O'Neal, Playboy magazine founder Hugh Hefner, England soccer star David Beckham and former world heavyweight boxing champion Mike Tyson. These were hardly the type of customers that Tengzhong would be comfortable with in its existing business - in fact, there were only ten Hummer owners in all of Chengdu at the time of this deal. Based on this image, it would be difficult to see how Tengzhong could show respect for this product.  Class Score (1).

Geely respected the Volvo product and its reputation for safety. Obviously this was one of the contributing factors for doing this deal. Class Score (5).

Rule Five: Provide Top Management

Drucker felt that an acquisition is unlikely to do well unless the acquiring company is able and prepared to provide the acquired Company with new top management within one year at most. It was obvious that Tengzhong did not have the ability to provide auto industry experienced top management, either now or if needed in the near future “– a violation of this rule. Furthermore, looking at the track record of the existing Hummer team CEO Taylor feels can create miracles given enough money – the question remains why have they not addressed the issue of the Hummer being the biggest gas hog in the world, excluding perhaps some of Tengzhong’s cement mixing trucks, long before now? Is it really a question of money or is the caliber of Hummer’s present management team also an issue?  Class Score (1).

Geely did have the capability of providing top management, perhaps initially not in production but in sales and marketing. Class Score (3).

Rule Six: Promote Across Lines

With respect to the Hummer deal, since there is no common core of unity between these two companies, it would be virtually impossible to comply with this rule. It is hard to imagine a Tengzhong manager being promoted into the Hummer organization or a Hummer manager being promoted to Chengdu.  Class Score (1).

It appeared that the chances of promoting individuals across lines stood a better chance in the Geely-Volvo deal although language could be a problem. Class Score (3).

Assessment Scores

Hummer Deal - Class Score 6  - "Join the 80 percent failure rate."

Volvo Deal - Class Score 26 - " Okay to do the deal."

Summary

The Chinese government did not approve the Hummer deal. I am not sure if anyone in my class had contact with the government to advise them not to approve the deal?

So far, the Volvo deal has proven to have been a good move for Geely as their total sales in 2018 were 1.5 million autos compared to 412, 286 at the time of the deal.

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