Bringing sense to merger madness m

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'Shareholder value' is the mantra for deal-crazy managers - so it's a good thing the man who invented the idea is back on the bookshelves, writes Roger Trapp

Look at any annual report these days and, likely as not, the word "value" will be, if not boldly emblazoned on the cover, peppered throughout the text. Suddenly "creation of shareholder value" has become the name of the game.

And the credit - or fault, depending on your point of view - largely belongs to Alfred Rappaport, a distinguished academic at the Kellogg Business School at Northwestern University, near Chicago.

The consultancy Stern Stewart may have propagated the idea, particularly in the field of executive remuneration, through its trademarked concept of Economic Value Added. But, by common consent, the origins go back to Rappaport and his 1986 book "Creating Shareholder Value".

And, now just as the idea has gained common currency, the book is being republished in a revised and updated edition.

There are good reasons - other than the desire to cash in on the increasing acceptance of an idea you helped create - for making such a move. Not only is it helpful for managers to go back to the roots of a concept they are - in many cases - talking about without really analysing. It is also particularly pertinent at a time when all sectors of business are set upon a great mergers and acquisitions scramble. When it reaches the point where such unlikely bedfellows as Citicorp, headed by the corporate America archetype John Reed, and Travelers Group, run by maverick deal-maker Sandy Weill, decide to cement their futures together, any tool that offers insights into the pros and cons of deals is to be welcomed.

These days, it is customary - in fact, almost obligatory - for executives and analysts to talk of the value that will be created by whatever deal is being contemplated. Of course, this can be seen as a euphemism for the "pots of money" to be made in the short term for shareholders of a company acquired at a premium to its market value and for executives with generous options packages - and in the long term, if the deal genuinely creates the economies of scale and synergies so often predicted at the outset but so rarely seen in practice.

But Rappaport uses his professor's teaching skills to describe how the framework can be used by boards to pick and choose between deals. One of the most commonly quoted destroyers of shareholder value was the Quaker Oats purchase of Snapple Beverages. Though the operation had been bought in late 1994 for $1.7bn (pounds 1m), Quaker had by early 1997 decided to cut its losses by reaching an agreement to sell Snapple for just $300m. He also points out how the US telecommunications giant AT&T in 1991 paid $7.5bn for NCR - most famous for making cash machines - and five years later spun if off to shareholders for $3.5bn.

Such obvious failures are merely the tip of an iceberg of doomed deals. And there is a danger that the current frenzy of activity - though skewed more towards mergers in which there is no premium - could result in similar embarrassments. Even if the received wisdom is that consolidation in any given sector is inevitable, companies still need to do their sums to ensure that the particular move in question has the potential to create the value being claimed.

On the face of it, it is hardly surprising that executives should be encouraged to think this way. In fact, it is arguable that they should need to be told this. Deep down, boards have always known that their role is to produce better-than-average returns for investors. After all, if they do not do so, they feel the full weight of market forces - which usually takes the form of a take-over bid.

But the decade or so since Rappaport's book appeared has been characterised by great upheaval, so that boards have been encouraged to focus their attention on business fundamentals. At the same time, the corporate governance debate sparked by the spate of high-profile collapses at the end of the 1980s boom and set in motion by the Cadbury report has put shareholder interests at the front of executives' minds - even as wider concerns have been brought into focus through such developments as the stakeholder concept and the balanced scorecard.

Accordingly, just about every consultancy worth its salt has sought to get in on the act. KPMG even engaged in a bit of legal sparring with Stern Stewart over EVA.

Though some see shareholder value as the replacement of one financial measure - earnings per share - by another, proponents claim that is both wider and deeper and therefore less likely to lead to the problems associated with the likes of Maxwell Communications and Coloroll. Both collapsed despite high reported profits and revenues looking good, while Polly Peck reported profits of pounds 161m, a 70 per cent growth in earnings on the previous year, only days before falling to earth.

Another driver is the increasing globalisation of business - and the requirement to have something like a universal set of business measures. The International Accounting Standards Committee under Sir Bryan Carsberg is trying to come up with a set of harmonised accounting standards to help prevent repetitions of the now-legendary tale of what happened when Daimler-Benz applied for a listing on the New York Stock Exchange in 1993. What looked a highly profitable concern under German accounting rules appeared to turn into a heavy loss maker when US principles were applied.

As usual, the tidal wave of interest among corporates began in the United States, but such well focused UK groups as BP, Boots and Lloyds TSB have signed up to join such renowned value creators as Coca-Cola and General Electric.

Many organisations will no doubt be put off by the wealth of acronyms - such as WACC, or weighted average cost of capital, and CFROI, or cash flow return on investment, which provides a methodology for calculating residual values - spawned by the concept. In keeping with the best economic theory, it can get fiendishly complex and technical.

But Rappaport brings it all back to basics. In a straightforward acquisition, "if the buying company is going to create value for its shareholders the acquisition price must be no greater than the stand-alone value of the selling company plus the value created by acquisition synergies".

This then puts the pressure on the managers to go beyond conventional acquisition analysis and identify the real synergies. Because this can be difficult, it is common for management, says Rappaport, to justify substantial premiums by talking about "strategic fit", "market share opportunity" or "technological imperative". As he says: "Such unwillingness to face uncertainty squarely can be costly."

'Creating Shareholder Value' is published by Simon & Schuster at pounds 25.

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