AOL dumps $850M Bebo acquisition - Why big M&A rarely works

AOL acquired Bebo for $850M two years ago. Today AOL said they will sell it or shut it down. What went wrong? Like many M&A deals, the Bebo deal factored in synergies and strategic leverage that never materialized. The AOL / Time Warner merger was the biggest bust in history destroying more than $140B in investor value. It is not so much that the acquisition was wrong, but that the valuation was so wrong that nothing made financial sense post acquisition.

The public stock markets tend to value companies dispassionately, on a stand alone basis, valued at some multiple of earnings or cash flow. M&A buyers ignore the financial fundamentals and look at strategic synergies. The difference in value is enormous...and devastating. Take a look at these "Worst Billion Dollar Acquisitions in History" Lots of different companies...all made the same mistake.

Spread The Risk - My philosophy has always been that I would rather acquire 20 companies for $50M each, than acquire one company for $1B. Either way you spend a billion, but by acquiring many smaller companies you;

1. Spread the risk over 20 companies. One winner can pay for all the mistakes.
2. Integrating a $50M company is much easier than a $1B company
3. Smaller acquisition mistakes can be redeployed on other projects and still retain some value
4. Acquiring smaller companies earlier enables more upside potential than later stage deals
5. Smaller companies don't have ingrained management and cultures making the transition easier.

Don't pay product valuations for feature companies - It is a good strategy to acquire small companies to gain super star employees, cool new features, and access to new market segments. But, the acquiring company needs the discipline to only pay a valuation commensurate with a "feature" not a "product". Don't add lots of valuation for synergies that probably won't happen, or for revenue streams that may not materialize.

Pay more later for reduced risk - Some big acquirers are willing to pay more for a company later after the market has been proven, and the company delivers product and revenue. I have seen big companies pass on acquisitions early when they could have been bought for $20M, and later pay $200M or more. They justify it by looking at all the startups that fail and the emerging markets that turn out to be fads that go out of style in a year or two. Hard to argue with that...many times they are right.

Integrate or Isolate? - When acquiring a company the question is, should the new company be deeply integrated, and perhaps disappear, within the acquiring company? Or, should the acquisition be allowed the autonomy to be independent and grow at its own pace? I think it depends on the size of the acquisition, stage of the company, and strategy for the acquisition.

If the strategy is to leverage synergies than tight integration makes sense. If the acquisition is a fast growing startup in a new market it is probably better to leave them alone. Provide the capital they need, and let them leverage the big company brand. Many times the big company culture and brand smothers the startup to the point that they disappear. The big company can still get a lot of value from an acquisition that has "disappeared" into the fabric of the company...as long as they didn't overpay.

It all comes down to price -  The Bebo acquisition, like all acquisitions, made sense at some price. The problem comes when the price gets way out of line. Once the financial guys start looking at it...nothing will ever make sense. Oddly, rather than look at it as a sunk cost, and try to turn it around, they will just dump it for peanuts or shut it down, and move on.

The best billion dollar acquisitions? - There are lots of small acquisitions that have turned out really well for the acquiring company. Microsoft and Google have been very successful in acquiring small companies that went on to form the basis of huge new products or businesses. However, there are very few examples of billion dollar acquisitions that have paid off. 

Can you name any billion dollar acquisitions that were very successful?

UPDATE: Great comments here and on Twitter, Facebook, and LinkedIn. I will do a future post on great $Billion+ acquisitions. So far readers have suggested the following successes;

• IBM acquisition of Lotus, Rational, PWC
• EMC acquisitions of RSA and VMware
• HP acquisitions of Compaq and EDS
• Oracle acquisition of Peoplesoft
• Ebay acquisition of PayPal
• Google acquisition of YouTube
• Microsoft acquisition of Great Plains and Navision
• Others?

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