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Defence a key to explaining many financial services M&As Back  
A recent report by Arthur Andersen on the rationale behind financial services M&As reveals that these deals are still mostly a defensive maneuver, which ignores the human and technology implications for making the deal work.
Arthur Andersen recently undertook a global mergers and acquisitions research study in the financial services industry, which proves insight into how financial services organisations consider the value drivers when they enter into combinations. The report is based on a survey of 310 senior executives at financial institutions. The survey, conducted by the company’s global financial services industry team, finds that the primary reason an institution seeks to enter a corporate combination is to enhance its customer reach or product offerings. However, when selecting a combination partner, institutions often overlook the internal value-creating areas of the business that would support growth in customers or products - areas such as people technology and organisational assets.

The objective of the survey was to determine how financial services organisations assess their own organisation’s strength and weaknesses, identify drivers for entering into corporate combinations and discuss the attributes of potential partners in a combination.

From a global perspective, the research reveals an industry faced with many choices. Consolidation, competition and deregulation have contributed to a period of accelerated growth and a constant search for value. In this environment, often the decision is to ‘eat or be eaten’. Financial institutions must ensure that entering into a combination adds real value in their business. While value is measured in terms of share price performance, one must also look at the internal supports within the business that drive this share price.

The responses show that organisation often enter into combinations to address the customer and product related areas of their business. They do this without also addressing those internal areas such as employees, technology and organisational aspects that will enable them to go to market with a new product or customer segments they gain from the deal. When proper attention is given to all the facets of the business, and is embedded in the organisation, real value is created and sustained.

In 1999, the value of financial mergers and acquisitions in the G10 area exceeded $350 billion. Last year, the value of mergers globally exceeded $3490 billion and the financial service industry lead the way with some of the largest deals. Mergers and acquisitions activity in financial services is likely to continue at a rapid pace for the foreseeable future. Apart from actual mergers, there has been an upsurge in other types of corporate combinations, notably strategic alliances, which enable companies in the financial services industry to broaden their product offering or extend their geographic reach. At the heart of this process is the ongoing search for value to meet the expectations of all stakeholders and the marketplace more generally.

The Arthur Andersen survey results showed that far from favouring corporate combinations as a value adding activity, they seem as a defensive rather than a proactive strategy to meet the challenge of business growth.

‘What is clear from our respondents is that they see combinations as a way of addressing the external drivers of their business, rather than as a way of bolstering their internal supports needed to sustain and develop external growth. While showing a good appreciation of the importance of customer base and product range, respondents are less willing to see that the successful exploitation of such factors depends on filling the human and technology gaps which may many acknowledge exist within their companies.

‘We would argue that achieving value in corporate combinations - be they mergers, acquisitions, strategic alliances or other partnerships - depends on addressing a broader range of internal and external factors in a structured and robust way in order to protect and bolster the company’s rating in the equity markets.’

‘Our research also sought to learn how companies assess value within their own business as the basis for understanding the drivers for, and potential partners within, corporate combinations. We asked respondents about their measures of success as well as their views on how corporate combinations would evolve in the future. What emerged was a mixed picture. Respondents gave candid assessments of the strength and weaknesses of their current position. More cautious sentiments on how these could be strengthened or complemented through combination process and deeply conservative views on how success of this process would be measured.’

Financial services institutions still see corporate combinations as defensive rather than an offensive strategy, a reaction to external market and - in some regions - regulatory pressures rather than an activity internally motivated or directed. The ‘me-too’-ism that characterises a lot of financial services activities has its parallel in the urge to merge based on competitor or market activity. Defensive combinations can have a negative impact on price, timing and value creation. A poorly thought out and or executed deal; in the end, defends against nothing.

Growth from the outside in
Corporate combinations are seen as a solution for acquiring products and customers, as well as geographical spread, rather than solving internal issues such as skill or technology shortages, although the survey participants agreed that these were essential to the growth of the external area of the business.

Friendship vs. marriage
Respondents clearly see organic growth as the best way to provide shareholder value. But of the alternatives, strategic alliances are favoured over mergers and acquisitions. Alliances satisfy the objective of customer and product development while being less disruptive than a full-scale merger. They also sidestep the competition for leadership between senior management in mergers of equals, which has stopped some potential deals dead in their tracks. However, alliances are not a good substitute unless they are exclusive.

Neither cross-industry nor cross-sector mergers are seen as the way ahead within financial services. Looking to the future respondents still favour consolidation above all other types of combinations. This probably reflects that nearly every economy is over-banked, over-insured and over-provided with financial services. In this environment M&A is well established as a way of eliminating competitors to build up market share and at the same time, significantly reduce the combined entity’s cost/income ratio. Nonetheless, the conservatism of respondents is surprising, given that convergence is supported by these same respondents as a shorter-term trend, as well as being well established in a number of areas in the financial services marketplace. As financial services become more and more of a technology play, we expect to see the blurring of lines and barriers, enabling cross-sector deals to become more prevalent.

Performance and value
According to the survey there is a disconnect between what people say is important to them and how they measure the success of corporate combinations. The value attached by respondents to growth in customers is not maintained in the means by which they evaluate the success of a deal. Respondents cited cost reductions, financial returns and share price trends as their criteria for measuring success. However, as the market gives increased emphasis to long-term share price trends, alongside short-term trends that have been the traditional benchmarks, management attention must be given to broader value measures that support longer-term share growth. While short-term share price performance will always be an important measurement of value, it should not be the only measurement used by management.

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