When Big Deals Go Bad—and Why

Amid a flurry of bad news for big deals, it bears remembering that successful mergers heed the basic rules of business

by Steve Rosenbush

AOL Chairman and CEO Steve Case (left) and Time Warner Chairman and CEO Gerald Levin at the New York news conference announcing the AOL Time Warner deal on Jan. 10, 2000. Rick Maiman/Bloomberg News

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The greatest business successes are often engineered by bold visionaries who altered industries: Think Microsoft (MSFT), Berkshire Hathaway (BRKB), and Southwest Airlines (LUV). Unfortunately, when that type of grand thinking is applied to the mergers-and-acquisitions arena, disaster often ensues. Multibillion-dollar deals are based on personal relationships and egos, grandiose plans for so-called transformational changes to an industry, and a sense that the new sum will be far greater than all the previous parts. And, of course, the path for much of the wheeling and dealing is well lubricated by fee-hunting bankers and lawyers.

The wreckage of deals gone bad litters the business landscape these days. On Oct. 4, shareholders of German automaker DaimlerChrysler (DAI) are expected to approve renaming the company Daimler, jettisoning the last vestiges of the disastrous 1998 acquisition of Chrysler, for which it paid some $40 billion. While retaining a 19.9% stake in the Michigan company, Daimler's shareholders will be more than happy to forget the whole episode, which saw litigation over the deal, a dearth of hit models, cultural and operational snags between U.S. and German managers, and heavy financial losses. In May, Daimler agreed to sell the bulk of the company (BusinessWeek.com, 5/14/07) to private equity firm Cerberus Capital Management for a mere $6 billion.

On Oct. 1, online auction house eBay (EBAY) conceded that it had overpaid in its $2.6 billion acquisition of Internet telephone service Skype Technologies in 2005. EBay took a writedown of $1.4 billion, and Skype founders Niklas Zennström and Janus Friis departed (BusinessWeek.com, 10/1/07) from their former suitor.

And years after the catastrophic merger of Time Warner and AOL, Time Warner (TWX) is still trying to make the deal work. Time Warner's latest move: Focus AOL on the advertising market and move AOL headquarters from Virginia to Manhattan. "AOL is for keeps," Time Warner Chief Executive Richard Parsons has said, arguing that it wouldn't make sense to part with the Internet property just as advertising dollars are shifting online.

"Game-Changing" ROI and Disasters

How is it that such deals come together in the first place? In each case, managers were clearly swinging for the fences, pouring huge sums into the bet like a Vegas gambler desperate to score a big win as he sees his chips dwindle. And bad deals often are born of fear or desperation. A rival—or potential rival—is forging a new market or making inroads into the existing one and the incumbents must respond. Sometimes there's a surfeit of confidence about what the future will hold and management's ability to stitch the various pieces together nicely. In other cases, the deal may make strategic sense but at a price that is wildly off the mark.

No doubt, some large deals yield rich rewards. One of the richest was the 1965 deal that merged Pepsi-Cola and Frito-Lay to form PepsiCo. (PEP). In the decades since, the Purchase (N.Y.) company has become a global juggernaut, with more than 15 brands that each tout annual sales of over $100 million. And in July, 2005, many people questioned the wisdom when Rupert Murdoch's News Corp. (NWS) paid $580 million for the social networking site MySpace. Analysts now figure the popular property could be worth $10 billion, just as rival site Facebook is reportedly mulling selling a 5% stake (BusinessWeek.com, 9/25/07) that would also value it at around $10 billion. Two years on, Murdoch appears to have gotten an extraordinary bargain.

In many cases, the deals that end in disaster often come with descriptions like "game-changing" and "transformational," and hype attains currency. In every major disaster, the acquirer was a major player run by professional management and overseen by a board of directors. The target companies were scrutinized by analysts, vetted by advisers, and ultimately approved by shareholders, including sophisticated institutional investors. Yet those safeguards weren't adequate to prevent disaster at Time Warner, eBay, or Daimler. So why do they still happen so regularly?