Similar But Different: Exploring the Value of Non-Horizontal Mergers

In 2001, America Online merged with Time Warner in a deal worth $350 billion. It was a corporate marriage celebrated throughout the business world, as the titan of one media joined forces with another. Less than 10 years later, however, the two parted ways in a breakup so bad it’s often named as one of the worst corporate merger failures of all time.

That situation, however, is far from unique. Every year, according to Harvard Business Review, companies spend more than $2 trillion on acquisitions, yet 70-90 percent of them fail. So what’s the secret to creating mergers that truly yield value?

For years, popular wisdom held that the more closely companies were related, the better they could capitalize on their combined strengths. But new research by Gies associate professor Arkadiy Sakhartov shows that this may not be the case. In considering the question, one of the key areas Sakhartov examined was resource redeployment. As the former CFO of a diversified group of companies, it’s a topic that has always fascinated him, because it requires a delicate dance.

“Practically all resources are what we call ‘non-scale-free,’ so you can’t leverage them indefinitely,” said Sakhartov (right).

To add assets to one business, you must take them from another. This makes effective resource redeployment a critical part of mergers and acquisitions. But Sakhartov found that the two topics were often disconnected in existing studies.

“There was research on resource redeployment, where resources were redeployed between industries, and there was research on corporate acquisitions, which sometimes mentioned resource redeployment,” said Sakhartov, “But only in the context of horizontal acquisitions, where the acquirer and the target come from the exact same industry.”

There’s only one problem with that, says Sakhartov. “It doesn’t correspond to reality.”

That’s easily seen in the practice of acqui-hiring, where large tech companies like Google and Apple acquire companies from wildly different businesses, simply to obtain their engineering talent. It’s a phenomenon that’s so prevalent that there are websites like killedbygoogle.com dedicated to tracking all the small companies that disappear in the process.

“Google acquires a firm in one industry where resources are presumably applicable to its business, redeploys the resources, and then just cancels the business of the acquired firm,” said Sakhartov.

This practice offers anecdotal evidence that non-horizontal acquisitions provide value, but they’re hard to study using typical research methods because details from these transactions are rarely revealed. So Sakhartov created a formal model to develop a theory of resource redeployment that embraced and contrasted both types of acquisitions. The resulting study, “Resource Redeployment in Corporate Acquisitions: Going Beyond Horizontal Acquisitions,” which Sakhartov completed with Jeffrey Reuer from the University of Colorado-Boulder’s Leeds School of Business showed that the process work better when the parties involved aren’t too closely related.

“The most attractive type of deal will be when the target is somehow different from the acquirer,” says Sakhartov, who calls this situation “moderate relatedness.” “When businesses are different — not drastically, but moderately different — this is the context that is the most interesting for the acquirer. And this argument — with an intermediate level of relatedness being optimal — works for both the valuation challenges and the integration challenges, which are two notorious challenges faced by acquirers in making merger acquisition deals.”

On the valuation side, the enhanced return comes from recognizing opportunities that companies competing in the same industry may not see. With a little due diligence, an outsider can buy the target company from the market at a price that’s less than others believe it’s worth, generating a good return.

Similarly, on the integration side of the equation, the acquiring company may see that some integration efforts will help them more easily redeploy the target’s resources to their business than competing suitors from the same industry. In this case, they win the target and realize more value from the deal than alternative buyers would be able to achieve.

Sakhartov’s model, which demonstrates an inverse relationship in relatedness and net return, also explores the importance of performance, which has additional ramifications for merging companies. “When we look at the valuation challenge, it is better for the acquirer if the target company is performing at the same level,” says Sakhartov. “When we consider the integration challenge, it’s better that the target substantially outperforms the acquirer.”

All of these findings could have important implications for future business leaders as they contemplate multi-billion-dollar acquisitions that could shape the future of their companies for many years to come.