By Dr Alan Waring
Dubai International again and three hours to kill. Time to ponder an old risk issue which, until relatively recently, had largely passed by Cyprus companies. I refer to the risks entailed in mergers and acquisitions (M&As). There now appears to be a growing M&A feeding frenzy in the Eastern Med but are all the players up to speed with the risk issues?
It’s always an exciting time when company A sets its sights on Company B. Overtures are made, prospectuses are drafted and MoUs exchanged. Whether gentlemanly courtship or hostile pursuit, rumours abound and the markets speculate. The lawyers and the accountants rub their hands at the fat fees involved. Traditionally, it has been their job to cast an eye over the contractual details and the finances, to try to ensure that there are no nasty risks attached to the venture. But, how comprehensive and realistic are such overviews?
Pre-Nuptial Due Diligence
In the period 2004-2006, a number of Cyprus companies were snapped up, especially by Greek companies who spotted that they were quite cheap. More recently, some of the tastier Cyprus companies have been targeted. Some of the larger Cyprus companies are strong enough to make counter-bids or to seek out foreign targets or partners of their own. The Bank of Cyprus’s failed acquisition offer to Emporiki Bank of Greece is an example. More recent has been the announcement of a potential merger between Cyprus’s Laiki Bank, Greece’s Egnatia Bank and the Greek investment group Marfin Financial.
These are big players who perforce of resources and experience ought to know a lot about the risks involved and how to avoid or control them. However, to many companies, the M&A and Joint Venture field is a relatively unknown territory. Home-grown experience of such things is sparse.
So, what sort of risks might be involved? How do buying parties or would-be partners protect themselves against getting a pig-in-a-poke or taking on hidden and unwelcome liabilities? Quite properly, accountants will examine the books, the assets and the financial liabilities. The lawyers will pore over the M&A contracts as well as other pre-existing contracts and legal liabilities. However, there are other significant risk exposures that all too often get overlooked or ignored.
Here are some examples that should undergo ‘due diligence’ examination at the pre-nuptial stage.
Mismatched Cultures and Systems
Arguably the most critical risk area to examine is the cultural fit between the two parties. Just like a couple getting married, there will almost certainly be differences in attitudes, beliefs, values, opinions, expectations and ways of doing things. Sometimes in addition the two parties have different national cultures and languages to contend with. The possibilities for significant differences are endless and these may result in misunderstandings, tension, hostility, conflict and turf wars – all leading to poor performance and possibly eventual breakdown.
Compatibility is never assured and considerable efforts may be required to achieve harmony. But this pre-supposes that someone in authority has taken the trouble to examine the two cultures before it is too late and the parties end up in a marriage made in hell.
I vividly recall the appalling aftermath when a well-known consulting firm I worked for many years ago was acquired by a much larger international engineering firm. The culture of the new owner was well suited to their principal line of business in manufacturing and heavy engineering but anathema to the management consultants. This is not to say that a marriage could never have worked, just that no one on behalf of the buyer had thought even to consider the possibility that their particular cultures were so different as to render the acquisition unworkable. Disaffected consultants left in droves, business performance suffered and the corporate reputation was damaged. The expected ‘honey pot’ had become instead a ‘hornets’ nest’.
Other high profile examples include the 1998 acquisition of First Chicago NBD by Bank One. By early 2000 the bad blood between the parties was so intense that performance had suffered and share values had declined dramatically. The ‘bitter culture clash’ became headline news, which amplified the decline in share values.
In Hong Kong, the potential merger between the main mass rapid transit company MTR and KCRC (Kowloon-Canton Railway Company) continues to raise eyebrows in the business community. Apart from both being rail companies, their organisational structures and systems are quite different as are their cultures. Earlier this year, some 4,000 of KCRC’s 6,000 employees backed 20 senior managers to support the Chief Executive in a near coup against the Chairman appointed to instil management discipline and efficiency. Such naked rebellion evident within KCRC would be anathema to MTR personnel. Unsurprisingly, a full merger between MTR and KCRC has been postponed for 20 years in favour of an interim asset-leasing deal and gradual inter-working.
Only a ‘due diligence’ cultural appraisal by specialists will expose the strengths and weaknesses to be weighed up in the decision-making as to whether to continue with the M&A or JV or call it a day. This is risk ‘brain surgery’ and clearly is too remote from the expertise of accountants, lawyers or the parties’ own personnel to undertake.
Environmental and Major Hazards
Companies whose operations entail major hazards, such as large scale chemical or flammable inventories or processes, may pose significant risks of explosion, fire or environmental contamination, let alone potential loss of life and property damage. A due diligence audit of major accident hazards control (including all the required management systems) is warranted for such settings.
However, even commercial companies can come a cropper if, for example, the acquired assets include premises containing asbestos, a common legacy from thermal insulation and fire protection applications in the past. Ordinary workaday light industrial operations can also create serious contamination of land or water, which would have to be cleaned up and which may also create long-term external legal liabilities and bad publicity. An environmental due diligence audit, possibly extended to a more detailed environmental impact assessment where necessary, is likely to be warranted. Again, as with cultural due diligence, such audits require technical expertise beyond that of accountants and lawyers.
Some Surprises
My experience from client work leads me to urge due caution in any prospective M&A, JV or award of capital contracts, not only in relation to cultural fit but also to related matters such as corporate ethics, staff integrity, management styles, reward systems and management systems in general. Corporate governance demands that all significant risks should be properly assessed before decisions are made and contracts signed.
Typically, national monetary authorities cite 8 key risks that banks, investment companies and other financial institutions should address: credit risk, interest rate risk, market risk, liquidity risk, operational risk, reputation risk, legal risk and strategic risk. What might be labelled as ‘people, organisation and system risks’ such as cultural fit, corporate ethics, human integrity, HR risks, organisational change etc impact all 8 to some extent but particularly the last four as highlighted. Yet, they are rarely if ever addressed as part of internal controls let alone in relation to other parties, M&As, JVs etc. This blind spot must be corrected if organisations truly wish to reduce their risk exposures.
Dr Alan Waring is an internationally recognised risk management consultant who advises companies, organisations and government departments on a wide range of risk issues. Contact [email protected].
©2006 A E Waring
