Opinion | Of gluttonous pythons and hostile corporate takeovers

Company acquisitions done solely to gain size and scale are often like predators swallowing a prey too big to ingest

When I was a teenager, my family subscribed to a magazine called Sanctuary. This was a monthly publication and dealt solely with Indian wildlife. The magazine had access to some of the finest experts in Indian wildlife who both wrote articles as well as took breathtaking photographs.

This was many decades ago and photographic equipment was nowhere near as sophisticated as it is today. Digital cameras were unheard of, and in a pre-liberalization India, even rudimentary equipment of the day like photographic film and decent cameras were very hard to come by. Capturing good images was extraordinarily difficult for Sanctuary’s photographers, who nonetheless rose to the challenge, and some of their images are still clearly etched in my memory. One of these was a set of images of an Indian python which had just finished a meal. For the millennials reading this column, just to be clear, the python is actually a snake, not a computer programming language.

The Indian python normally eats creatures that are the size of small rabbits and takes many days to digest its meal. In this series of the Sanctuary, however, the python had taken on rather a lot more than it could manage. It had ingested a barking deer, which is the size of many hares put together, and which probably weighed every bit as much as the python. After several hours of excruciating discomfort, exquisitely captured by the photographer, the python finally disgorged its meal and slunk away after having been badly injured in the process. I doubt it lived much longer after its misadventure.

And therein lies a lesson for corporate acquisitions. I have been on both the receiving end as well as the eating end of such acquisitions more than once during my career, and for a long spell of time, was responsible for the strategy behind such acquisitions. Corporate acquirers often seek to round out their capabilities by acquiring firms that do not entirely match their own; they seek out “white space". Such “white space" is usually either a new geography where the acquirer has little coverage, or a new product or service line that it would be proud of. These tend to be more digestible than acquisitions that are made in the same service or product areas that the acquirer is already active in. Acquisitions made solely for scale and size are akin to the hapless python in Sanctuary—they result in injury, or death, of both the acquired firm and its prey.

Some weeks ago, I wrote in this column that information technology (IT) services firms might soon see a move coming at them from an orthogonal direction. In all these cases, however, I would expect that super-large firms, such as Microsoft Corp. and Oracle Corp., would ingest something much smaller, something that is easy for them to assimilate and also lets them fill the “white space" in their professional services that would have taken them years to achieve on their own.

Indian IT services firms have also been on the prowl. Organic growth becomes progressively harder to maintain and their forays into software product or “software as a service" offerings have been spotty at best. Some of these acquisitions are also being driven by private equity investors who will look to consolidate their holdings for future exits. However, when acquisition overtures become more hostile in nature, especially between firms of a relatively similar scale, despite all the attendant talk about a “merger of equals", a number of insidious side effects may start to present themselves.

First, customers, employees and partners are uncertain of the strategic direction of the future organization, causing a “wait and see" attitude which can paralyse decisions and negatively impact operational performance. Much of this is because each of the above must answer the question: “What does this mean for me?" This is particularly pronounced among employees of the new “merged" entity who must face these personal insecurities.

Secondly, confrontational deals take much longer to close, further exacerbating the “wait and see" effects and delaying the realization of the expected value to be derived from the combination of the companies. When a merger takes place solely for scale, and not for “white space" expansion, the only acceptable result for the shareholders of the two firms is an increase in the profitability of the new merged enterprise. This is often termed an “accretive" benefit and passed off as part of the “synergies" envisioned. Such synergies,more often than not, are only achieved by severe cost cutting. In the services milieu, where employee payroll costs are huge, this is often achieved through laying off employees.

The fear of such reductions in the workforce only tend to worsen the “wait and see" problem. Meanwhile, other employees, usually ones with highly marketable talent, take this as a cue to exit the combined enterprise, resulting in a brain drain. Finally, such turbulence causes the top management to focus disproportionately on the internal impact of the acquisition and take their “eyes off the ball" on current sales and revenue additions.

So, much like the python, companies must carefully gauge their ability to absorb their prey. It has been my experience that there must be a compelling “white space" opportunity to penetrate new product lines or untapped markets to make these acquisitions successful . Simple scale plays rarely achieve the promised “synergies" and do not result in substantial shareholder upside.

And this is even before we begin to speak of the difficulty of merging corporate cultures.

Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep science and tech in India.