SEPTEMBER 22, 2008

MERGERS & ACQUISITIONS

The Secrets of Successful Acquisitions

By KOEN H. HEIMERIKS, STEPHEN GATES and MAURIZIO ZOLLO

Managers who have been involved in mergers and acquisitions know the odds of a painless integration are low. Rarely, it seems, does combining two organizations go smoothly, at least in the short term.

All of which leads to an inevitable question: What do the successful acquirers do right?

Based on our study of the M&A activities of 101 companies world-wide, we concluded that the key factor for successful companies was something simple yet uncommon: They made systematic efforts to learn from their past acquisitions.

Many of the successful companies were "serial acquirers" -- those that made continual acquisitions an integral part of their growth strategy. But it wasn't the amount of prior M&A experience that made the difference. It was the fact that these companies had devoted a lot of time and money and thought to what they had done, and had changed their practices as a result. Companies with lots of M&A experience that didn't invest in a learning process actually fared worse, on average, than companies with less experience.

In other words, "learning by doing" isn't enough. Companies must also "learn by thinking."

For instance, at one company we studied, an international chemical firm, a risk-management team was closely involved in every stage of the company's M&A activities -- from helping to prepare bids to performing post-integration reviews. The team would play key investigative and advisory roles on a host of issues, such as personnel, legal, financial and regulatory problems. Once acquisitions were approved, the team coordinated efforts by both companies to address these issues. And when deals were finalized, the team played a similar role in overseeing integration, ensuring that key parties from both companies were involved.

Pass It On

Such involvement uniquely qualified the team to perform post-integration reviews -- and to preserve and pass on any knowledge gained about the process.

The M&A team at another global chemical maker conducted post-integration reviews in which open-ended surveys were sent to key players and one-on-one interviews were conducted to hear unvarnished analyses of what had worked well and what hadn't.

The team and the business manager responsible for the integration would also codify anything new learned in each acquisition for use in coaching sessions. Lesson subjects could involve assessing the worth of a potential acquisition; environmental, health or safety issues that weren't foreseen; or organizational challenges, such as how to absorb the acquisition's sales force with minimum disturbance to customers. Lessons produced in this manner, including more than 100 scenarios, covered integration issues ranging from customer service and purchasing to engineering.

'Deal Room'

One company, the finance unit of a global industrial conglomerate, used a wiki-style online "deal room" which served as both a forum where integration teams could discuss initiatives in progress, and as a generator of lessons for the future. Details in deal-room discussions were documented and referenced for access on the company's intranet to ensure that employees could easily find the latest insights.

Maintaining a body of M&A knowledge, organizing it into lessons and making it easily accessible are key to developing and leveraging a company's M&A capability. Without such a framework, companies can slip into applying general types of strategies developed in prior acquisitions that are inappropriate to the one at hand. Managers might also become overconfident by thinking that the mere accumulation of experience brings with it a stronger capability.

Codifying and studying lessons from prior acquisition experience makes it easier to foresee, identify and act on specific integration problems. It also can help at the negotiating table, making it easier to walk away from deals that appear overpriced in relation to the expected integration issues. In addition, when managers reflect on acquired firms' contributions to the acquirer, they often find unexpected wisdom that emerges from adopting the target's new perspectives and different ways of doing things.

—Dr. Heimeriks is assistant professor of strategy at the Rotterdam School of Management, Erasmus University, Rotterdam, the Netherlands. Dr. Gates is professor, department of strategy, at Audencia Nantes School of Management, Nantes, France. Dr. Zollo is dean's chaired professor of strategy and director of the Center for Research on Management at Bocconi University, Milan, Italy. They can be reached at reports@wsj.com.

What Other Financial Crises Tell Us

The lesson of history is grim: Expect a prolonged slump.

By CARMEN M. REINHART and KENNETH S. ROGOFF

Perhaps the Obama administration will be able to bring a surprisingly early end to the ongoing U.S. financial crisis. We hope so, but it is not going to be easy. Until now, the U.S. economy has been driving straight down the tracks of past severe financial crises, at least according to a variety of standard macroeconomic indicators we evaluated in a study for the National Bureau of Economic Research (NBER) last December.

In particular, when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning.

Let's start with the good news. Financial crises, even very deep ones, do not last forever. Really. In fact, negative growth episodes typically subside in just under two years. If one accepts the NBER's judgment that the recession began in December 2007, then the U.S. economy should stop contracting toward the end of 2009. Of course, if one dates the start of the real recession from September 2008, as many on Wall Street do, the case for an end in 2009 is less compelling.

On other fronts the news is similarly grim, although perhaps not out of bounds of market expectations. In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels.

Equity prices tend to bottom out somewhat more quickly, taking only three and a half years from peak to trough -- dropping an average of 55% in real terms, a mark the S&P has already touched. However, given that most stock indices peaked only around mid-2007, equity prices could still take a couple more years for a sustained rebound, at least by historical benchmarks.

Turning to unemployment, where the new administration is concentrating its focus, pain seems likely to worsen for a minimum of two more years. Over past crises, the duration of the period of rising unemployment averaged nearly five years, with a mean increase in the unemployment rate of seven percentage points, which would bring the U.S. to double digits.

Interestingly, unemployment is a category where rich countries, with their high levels of wage insurance and stronger worker protections, tend to experience larger problems after financial crises than do emerging markets. Emerging market economies do have deeper output falls after their banking crises, but the parallels in other areas such as housing prices are quite strong.

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession. Aggressive countercyclical fiscal policies also play a role, as we are about to witness in spades here in the U.S. with the passage of a more than $800 billion stimulus bill.

Needless to say, a near doubling of the U.S. national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates and a collapse in today's bond-market bubble. The legacy of high government debt is yet another reason why the current crisis could mean stunted U.S. growth for at least five to seven more years.

Yes, there are important differences between the current U.S. crisis and past deep financial crises, but they are not all to the good. True, for the moment the U.S. government is in the very fortunate position of being able to borrow at lower interest rates than before the crisis, and the dollar has actually strengthened. Still, deep financial crises in the past have mostly been country-specific or regional, allowing countries to export their way out.

The current crisis is decidedly global. The collapse in foreign equity and bond markets has inflicted massive losses on the U.S. external asset holdings. At the same time, weak global demand limits how much the U.S. can rely on exports to cushion the ongoing collapse in domestic consumption and investment.

Can the U.S. avoid continuing down the deep rut of past financial crises and recessions? At this point, effective policy prescriptions -- such as coming up with realistic costs of the size of the hole in bank balance sheets -- require a sober assessment of where the economy is going.

For far too long, official estimates of the likely trajectory of U.S. growth have been absurdly rosy and always behind the curve, leading to a distinctly underpowered response, particularly in terms of forcing the necessary restructuring of the financial system. Instead, authorities should be prepared to allow financial institutions to be restructured through accelerated bankruptcy, if necessary placing them under temporary receivership, and only then recapitalizing and reprivatizing them. This is not the time for the U.S. to avoid painful but necessary restructuring by telling ourselves we are different from everyone else.

Ms. Reinhart is professor of economics at the University of Maryland. Mr. Rogoff is professor of economics at Harvard and former chief economist at the International Monetary Fund.

Now Hiring: Lehman

As Bankrupt Firm Winds Down, Gigs There Are Hot Commodity
By PETER LATTMAN

It's bankrupt. Its reputation is in tatters. And it has been forced from its plush headquarters building. Yet working for Lehman Brothers Holdings Inc. -- what remains of it -- has become one of the hottest jobs on Wall Street.

That's because Lehman, though a shadow of its former self after selling many of its businesses to Barclays PLC and Nomura Holdings Inc., retains a broad patchwork of assets. It has some $7 billion in cash and more than 1,400 private investments valued at $12.3 billion. Then there's a thicket of about 500,000 derivative contracts with 4,000 trading partners worth some $24 billion.

So for now, Lehman is seen as a relatively secure home for throngs of finance professionals thrown out of work in recent months. It's even become a place for former Lehman CEO Richard Fuld to informally hang his hat.

"We're getting swamped with resumes," says Bryan Marsal, a turnaround expert who is now Lehman's chief executive officer. The inquiries, he says, are from people affiliated with marquee names such as Bank of America, Citigroup Inc., and Morgan Stanley.

"It's just a tough, tough time, and there are a lot of good people out there looking for work."

The wages are not great by past standards. But there are hidden benefits. It could take two years or more to wind down the firm. Such a timeline promises the kind of job security that's a rarity on Wall Street today.

Charged with untangling the mess is Alvarez & Marsal, the New York-based restructuring firm where Mr. Marsal is a co-founder. With 150 full-time employees working on the case, its chief task is to sell off Lehman's remaining assets and maximize recovery for creditors, which are owed more than $150 billion.

Mr. Marsal says the goal is to dissolve the firm in 18 to 24 months from now, though several restructuring experts say that's an aggressive timetable.

Alvarez & Marsal got the gig in September after Lehman's board appointed it to administer the bankrupt company's estate. To carry out the mission, Alvarez & Marsal kept 130 Lehman employees on the firm's payroll. It has also recruited back more than 200 former Lehman employees, and is still hiring staff to handle targeted areas such derivatives and real-estate holdings.

Behind the scenes is Mr. Fuld, the firm's former chairman and chief executive, who was widely vilified when Lehman collapsed in mid-September. Though Mr. Fuld was removed from the payroll on Jan. 1 and relieved of his company-provided black Mercedes, Lehman has agreed to let him keep an office at the firm. He's just around the corner from Mr. Marsal, who says he picks Mr. Fuld's brain about Lehman's business several times a week.

"We asked him to stay if he has nowhere better to go," says Mr. Marsal. "He's been very good about making himself available for questions about Lehman assets."

Through a spokeswoman, Mr. Fuld declined to comment.

Lehman's dismantling is an expensive process. Associated costs run about $30 million a month, excluding fees to lawyers and advisers on the case. Employees are paid a salary -- with modest retention bonus added as "a kiss" says Mr. Marsal -- to entice workers to stay at a place with a limited lifespan.

The assignment is a lucrative one for Alvarez & Marsal, which is charging Lehman hourly fees of $550 to $850 for its top executives working on the case, with rich incentive fees for the firm depending on its recovery for creditors.

Despite Lehman's assured dissolution, executive recruiters say it isn't surprising that the collapsed investment bank has become a desirable place to work.

"This is a well-paying job in one of the worst employment markets in history," says Skiddy von Stade, founder of New York-based executive placement firm F.S. von Stade & Associates. "Through the disposition of Lehman's assets, the employees will have a chance to demonstrate their strengths and skills for opportunities down the road -- possibly with the very buyers of these securities and investments."

Mr. Marsal says compensation is in line with similar jobs on Wall Street, yet far below what it was at Lehman. He and his team are "very, very careful" about the expenses of the firm, which he says are generally lean. "The excess of Lehman was the size of the salaries and the expectations of people with the bonus plan," he says.

Gone are the pay and perks that came with being a top executive at pre-bankruptcy Lehman. Mr. Fuld and his management team sat on the 31st floor of Lehman's former headquarters, a state-of-the-art steel-and-granite building in Times Square. Barclays bought that site and took it over, so now Lehman's command center is a run-of-the-mill office on the 45th floor of the Time-Life building, which long served as Lehman overflow space.

Mr. Marsal and his team are making due without weekly deliveries of fresh flowers and warm chocolate-chip muffins on Fridays -- perks enjoyed by the firm's former brass. Gone too is the executive dining suite where a private chef prepared lunch for Lehman's top executives. Instead, Mr. Marsal and his crew grab a bite in the cafeteria at Time Inc., which has granted access to the Lehman employees.

Henry Klein is part of Lehman's new topsy-turvy reality. A nine-year Lehman veteran, he oversaw a portfolio of investments in India from the firm's New York office. When Lehman failed, Mr. Klein was transferred to Barclays, but says he had little to do there. "I was at Barclays, but my assets were at Lehman."

Mr. Klein left Barclays in mid-November, and then approached Alvarez & Marsal. Today, he's back overseeing the very assets he says he managed at Lehman.

The 46-year-old Mr. Klein is currently focused on a small $36 million real-estate investment in Hyderabad, a large city in south central India. Lehman may continue to back the deal, but also may have to pull its funding. "It's a difficult decision," says Mr. Klein. "We don't have tons of time."

Luc Faucheux, 39, heads up the desk at the bankrupt entity that trades interest-rate swaps and other fixed-income derivatives. "I always wanted this job," laughs the former Lehman staffer who says he had a related, but less senior role. "Be careful what you wish for, because you might just get it."

"Let's face it," he adds. "Given the state of the world we're in, the things I'm learning working on the largest bankruptcy in history are a set of skills that could be marketable for the foreseeable future."

Rather than immediately sell assets into a depressed market, Alvarez & Marsal has opted to retain and manage a chunk of Lehman's holdings.

Last month, Alvarez & Marsal decided to keep a 49% interest in Lehman's money-management business, Neuberger Investment Management, selling the balance to Neuberger's management. It made a similar move with Lehman Brothers Merchant Banking, the firm's flagship private-equity business. The estate also has held on to more than 100 direct stakes in private companies. These include direct investments made alongside Lehman's private-equity clients in large boom-era buyouts such as First Data Corp. and Texas utility TXU Corp.

So far, Lehman has more than doubled its cash reserves to $7 billion from $3.3 billion, in part through the sale of its headquarters to Barclays. It is also raising money by selling off the firm's sizable art collection, whose value Lehman has pegged at roughly $30 million. Some of the photographs and paintings still grace the halls of Barclays and Lehman's Neuberger unit.

Finally, there is a cavalry of corporate jets valued at $164 million. Lehman has already sold six jets, as well as interests in fractional shares service NetJets Inc. for $53 million. Still on the block: Six more planes, including a Boeing 767, and a Sikorsky chopper.

Some of those jets Lehman owned as investments and only four were used for corporate purposes at any one time, according to a Lehman spokeswoman.

"The fleet's been grounded," Mr. Marsal reassured the bankruptcy judge overseeing the case at a hearing last month. "Nobody is flying around these planes and no one is using the helicopter."

Write to Peter Lattman at peter.lattman@wsj.com
Printed in The Wall Street Journal, page A1

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

Staff members stand in a meeting room at the Lehman Brothers offices in the financial district of Canary Wharf in London Sept. 11, 2008.

Then & Now

Associated Press

Then:

CEO: Richard Fuld (above)

Employees: 25,158

Cash on balance sheet: $3.3 billion

Alvarez & Marsal

Now:

CEO: Bryan Marsal, (above)

Employees: 500

Cash on balance sheet: $7 billion