Breaking Up is Hard to Do

During my 20+ years in the financial services world, a tenure that started as an M&A banker, I've observed that, in general, mergers destroy value. Why? Here are a few common pitfalls:

1. Overpaying
2. Promised "synergies" don't come to pass
3. Disparate cultures
4. Poor integration planning
5. Poor integration execution
6. Added complexity outweighs strategic benefits
7. Hard decisions are avoided in favor of short-team peace, sowing the seeds of long-term failure
8. Distraction hurts both the buyer and the seller's businesses
9. Loss of focus
10. Customer confusion

The list is far longer but you get the picture. It seems as if the M&A profession exists to help build up and then break down. This is not to say that every M&A idea is bad; in fact, many of them are good. The best mergers aren't truly transformational (which often transform for the worse), but those that are "fill-in" acquisitions and extensions of existing businesses that either bring in brands and product lines that can be better marketed and distributed or top talent that has a related book of businesses that can be leveraged across the firm. But the egos and personalities atop many of the companies doing the buying is what pushes mega-transactions that seem good in theory but offer dubious and hard-to-realize benefits. AOL and Time Warner was one of those "big ideas" that highlighted the brilliance of Steve Case and the starry-eyed fantasies of Jerry Levin. Travelers and Citicorp was the brainchild of the empire-builder Sandy Weill with a willing accomplice in the less politically-savvy but well-intentioned John Reed. Yet another incarnation of the "financial supermarket" that has lived so many lives over the past 75 years, charming investors in every generation only to see them dismantled shortly thereafter. But for some reason we just can't stop falling for the same twisted logic again and again and again.

Today witnessed two stories in this vein, where former stewards of acquisition-happy, overly-complex, unwieldy enterprises said either "We made a big mistake," or "We've got to undo this." First, my former CEO John Reed, who now realizes that the promise of Citigroup was, in fact, illusory. From today's Financial Times:

The landmark merger that created Citigroup was a “mistake” that failed to benefit the financial services conglomerate’s investors, customers and employees, says John Reed, who masterminded the $166bn deal with Sandy Weill in 1998.

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At the time of its creation, Citigroup – which combined Citicorp, Mr Reed’s bank, with Mr Weill’s Travelers insurance and brokerage business – was hailed as ushering in a new era in finance by creating a one-stop shop for consumer and corporate customers.

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“The stockholders have not benefited, the employees certainly have not benefited and I don’t think the customers have benefited because our franchises are weaker than they have been.”

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Citi insiders say Mr Reed has advised Mr Pandit at least to consider spin-offs, such as Citi’s international consumer arm.

Yet even in the face of obvious failure, as noted by the poor relative and absolute stock price performance since the merger, together with the massive amount of capital that has been needed to bolster the equity base, consider these words from one of the firm's most senior executives:

Don Callahan, Citi’s chief administrative officer, defended the merger, saying it had “revolutionised” the financial sector.

“After 10 years there is still no other financial services firm that has the combination of businesses or the global reach that Citi has,” he said.

If this is what revolution yields, I think we need fewer revolutions. And who cares if "no other financial services firm...has the combination of businesses or global reach...?" Maybe that's because they shouldn't have them, unless they want to share the same fate as Citigroup's shareholders, employees and customers. It is this kind of denial that makes shareholders, strategic thinkers and those with brains completely pissed off. And as one who spent 12 years of my career there (11 great ones from 1987-1997 and one crappy one, 1998), I mourned the degradation of the culture and the loss of the institution I knew following the Travelers merger. The time has come for Pandit, et al to admit that management can't handle the massive, confusing, unmanageable behemoth it has become, spin off operations that would benefit by operating as focused, stand-alone businesses  (e.g., credit cards, consumer) and get on with fixing the core investment and corporate banking franchise. Enough is enough, don't you think?

Luqman Arnold seems to think so. He is now agitating for his former employer, UBS, to break itself up to protect its high-quality assets from the subprime problems that threaten to bring the entire firm down. From today's Wall Street Journal:

A former president of UBS AG is pushing for a breakup of the banking giant, launching an activist-shareholder campaign, after UBS booked $37.7 billion in write-downs.

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Among Mr. Arnold's proposals: UBS should legally separate its investment bank from its private-client bank and consider selling the investment bank; sell its asset-management business to raise money; and remove the chairman it named just Tuesday, according to a letter Mr. Arnold prepared for the UBS board.

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UBS, created by the 1997 merger of Swiss Bank Corp. and Union Bank of Switzerland, has been under pressure from other shareholders to split off its investment bank. They blame the division for moving the traditionally conservative bank into trading complex mortgage securities that led to the write-downs and wiped out profits in 2007 and in the first quarter this year.

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UBS officials have maintained that the bank can operate an integrated model, boosting business by moving clients from the investment bank to the private bank.

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Mr. Arnold, however, writes that the bank's business of catering to wealthy clients will be tarnished by its subprime problems. "We are not convinced that the 'one bank' integrated business model that has served UBS well in the past will survive the damage inflicted by the proprietary trading losses and write-downs," Mr. Arnold said.

As with Citigroup, even in the face of the facts and compelling logic there are still counter-arguments inside the company for maintaining the status quo. I'm not sure how much more proof the Board needs to conclude that managing a firm with the breadth of business, geographies and risks that UBS has is hazardous to shareholders' health. $37.7 billion down, how many more billions to go before the portfolio hits rock bottom? We still don't know. Nobody does.

Fact is, these mega-mergers never should have been done in the first place. Especially in people-driven, relationship-centric businesses, large-scale mergers are incredibly risky and generally fail. Consider the major securities firms. Which ones have done the best? Those that have done the least. Goldman and Lehman. All the others have done "transformational" deals, deals that have, arguably, made the combined entities less valuable than if the businesses had been run separately. In people businesses the answer always has to be focus, focus, focus. Because once distraction, confusion, stretched management resources and weak controls permeate the organization, it's like leaving a bunch of children alone with a pile of dry kindling and a box of matches: only bad things can happen.

 

Comments

[Anonymous]

Do the people who try and build business empires really add value to shareholders or simply think that they are adding a few more inches to....?? Or maybe they think its a form of virility. Such primitive thinking in people who manage so much money. We seem to be back to primitive ages where shareholder wealth a.k.a. increased member size translates into better mating partners and healthier future generations.

[gregory]

so why do they do it? ego?

[JN]

How would JPMorgan Chase fit into your "framework"? It is the result of (many) mega deals, but has arguably performed quite well in recent turmoil. Some people claim that a lot of trouble lies ahead of them. However, but I am not well enough informed to comment on this. Hence, I ask you - what do you think?

[Evan]

The Bolshevik's had a little revolution too. Most "revolutions" can be found on the dustheap of history. Citi's crumbling empire is in good company.

[Richard Beddard]

Quite agree - cases of diworsefication as Peter LYnch might say.