Deals From Hell
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Deals From Hell is a detailed look at the worst M&A deals ever and the lessons learned from them.
Through these real-world examples, the author shows readers what went wrong and why, and converts these examples into cautionary tales for investors who need to know what to look for in a successful M&A deal.
By addressing the key factors of M&A failure and success, Deals From Hell illustrates the best ways to analyze, design, and implement M&A deals.
🧠 Key Takeaways
Businesses that are growing and innovating are always taking risks, trying new things, and pushing the envelope. As a result, failure becomes an inevitable part of the process to survive and grow.
The six outcomes of M&A failure: Destruction of market value, financial instability, impaired strategic position, organizational weakness, damaged reputation, violation of ethical norms and laws.
Extensive research suggests that, on average, while M&A is no get-rich-quick scheme and can be challenging, it is a respectable way to earn a reasonable return on investment—certainly no less so than other types of corporate investments.
In the best deals, buyers acquire targets in industrially related areas. In the worst deals, targets are in areas that are more distant.
The worst M&A deals often happen in hot, trendy markets, such as internet companies between 1998-2000 or the semiconductor/AI industry right now. In these markets, you're likely to pay a premium for companies because they're en vogue.
Every M&A deal involves unique companies with their own individual strengths, weaknesses, and cultures. Recognizing and tailoring the deal to these differences is essential for the success of the deal.
When a business seems to be doing well, it will naturally draw competitors. As more competitors enter the market, increased competition drives returns down from exceptional levels, where minimal or no competition existed, to more moderate levels as the market becomes saturated with players.
Investors tend to respond positively when a company decides to divest (sale or spin-off) parts of its business that aren't performing well. This generally creates value for the shareholders of the selling company, which typically results in a positive share price movement.
When a company announces it’s using stock to pay for an acquisition, investors might raise an eyebrow and consider that a red flag. They might take that as an indicator that management believes the share price is too high, which ultimately can cause the share price to dip. On the other hand, cash deals don’t send the same kind of signal. They don’t make investors think the stock is overpriced (because the stock is completely left out of the equation), so these deals usually have a more neutral or slightly positive effect on the stock’s share price.
The best deals typically involve targets with lower profit margins, less liquidity, and higher leverage. These characteristics present opportunities for the buyer to implement their strong processes and best practices, which can have a positive impact on the target company. On the flip side, the worst deals usually occur when the target is in a stronger position than the buyer. Here, the acquisition is usually an attempt to mask the buyer’s deficiencies, but it’s often a bandaid for a bullet wound since it fails to address the buyer's underlying issues.
It feels worse to lose money than it does to make money—something rooted in our survival instincts. In the context of M&A, loss aversion helps us understand two related bugs in our human software: the Endowment Effect and Status Quo Bias. The Endowment Effect occurs when sellers place a premium on an asset they own, valuing it more than its worth due to their emotional attachment. If you’re afraid to sell a stock simply because you’ve owned it for so long, you might be suffering from Status Quo Bias. This is the preference to maintain your current state of affairs due to a fear of change.
In an LBO, a significant portion of the purchase price is financed with debt, so ample and consistent cash flow is of the utmost importance to ensure that the company can meet its debt obligations.
✍️ Memorable Quotes
“Within healthy growing businesses, failure is a constant companion. Most patented inventions fail to become commercial successes. Most new products fizzle out not long after the launch pad. Paradoxically, the success and renewal of capitalism depends on this enormous rate of failure, what the economist Joseph Schumpeter called the ‘perennial gale of creative destruction.’”
Failure is a regular occurrence in any thriving business. This might seem counterintuitive at first—you’d think that successful businesses would actively try to avoid failure.
But in reality, businesses that are growing and innovating are always taking risks, trying new things, and pushing the envelope. As a result, failure becomes an inevitable part of the process to survive and grow.
Capitalism actually thrives because of this. The irony is that the constant churn of ideas—many of which don’t turn out to be good ideas—drives progress. Businesses learn from these failures, refine their ideas, and eventually stumble upon breakthroughs that propel growth and innovation.
Joseph Schumpeter, a famous economist, coined the term "creative destruction" to describe this process. Creative destruction refers to the continuous cycle of old businesses, products, and ideas being destroyed and replaced by new ones, and it’s always happening.
While it means a lot of failure—and a lot of “out with the old”—it also means constant renewal and progress. It's this cycle of “creative destruction” that keeps the economy and society going and growing.
In essence, failure is vital to capitalism.
“The six outcomes of M&A failure: Destruction of market value, financial instability, impaired strategic position, organizational weakness, damaged reputation, violation of ethical norms and laws.”
Poor M&A decisions can lead to several negative outcomes, including:
Losses in share price
Weakened financial standing
Loss of market share
Internal struggles
A tarnished reputation and brand image
“M&A failures amount to a small percentage of the total volume of M&A activity. Investments through acquisition appear to pay about as well as other forms of corporate investment. The mass of research suggests that on average, buyers earn a reasonable return relative to their risks. M&A is no money-pump. But neither is it a loser’s game. Conventional wisdom seems to think otherwise, even though the empirical basis for such a view is scant.”
The general consensus is that M&A is a poor and risky strategy for growth. Companies that frequently engage in M&A activities are seen as riskier because they are more likely to make poor acquisition decisions. As a result, M&A is generally frowned upon.
However, this view is misguided. Extensive research suggests that, on average, while M&A is no get-rich-quick scheme and can be challenging, it is a respectable way to earn a reasonable return on investment—certainly no less so than other types of corporate investments.
“In the best deals, buyers acquire targets in industrially related areas. In the worst deals, targets are in areas that are more distant. This may reflect the benefits of sticking to your knitting. Better knowledge of a related industry may yield fewer surprises and more opportunities to succeed.”
This echoes Warren Buffett’s advice to stay within your Circle of Competence.
“The worst deals show a propensity to occur in “hot” market conditions. The preeminent hot market in business history was the equity market bubble from 1998 to 2000 associated with the emergence of the Internet. Industries can also be hotbeds of activity caused by sudden deregulation, technological change, shifts in consumer demand, and so on.”
The worst M&A deals often happen in hot, trendy markets, such as internet companies between 1998-2000 or the semiconductor/AI industry right now. In these markets, you're likely to pay a premium for companies because they're en vogue.
Conversely, it's better to seek M&A deals in industries that are out of favor and industrially related to your own. This approach leverages your industry knowledge, reducing the likelihood of unpleasant surprises.
“Deal tailoring pays. One size does not fit all. Better deals are associated with payment by cash and earnout schemes and the use of specialized deal terms. The worst deals are associated with payment by stock.”
Every business is unique, so tailoring deals to account for the specific strengths and weaknesses of both the target and purchasing companies is crucial.
Regarding payments, cash is more straightforward than stock. The seller receives a definite amount of money, mitigating the risk associated with the future, uncertain performance of stock.
If the acquiring company’s stock drops in value, the seller receives less than anticipated. Additionally, issuing new stock dilutes the ownership of existing shareholders, leading to potential dissatisfaction and reduced share value.
“Six factors that help understand the cases of M&A failure.”
The businesses and/or the deal were complicated. This made it difficult for people on the scene to understand what was going on or to take quick and effective action.
Flexibility was at a minimum. Little slack or inadequate safety buffers meant that problems in one part of the business system would radiate to other parts. Trouble would travel.
Deliberately or inadvertently, management made some choices that elevated the risk exposure of the new firm.
The thinking of decision makers was biased by recent successes, sunk costs, pride, overoptimism, and so on.
Business was not as usual. Something in the business environment departed from expectation causing errors or problems.
The operational team broke down. Cultural differences between the buyer and target, unresolved political issues, and generally overwhelming stress prevented the team from responding appropriately to the unfolding crisis.
“Tip O’Neill, the Boston pol who rose to be Speaker of the U.S. House of Representatives, explained that in trying to understand the workings of Congress, it made no sense to focus on lofty national issues or policy debates within the Washington Beltway. Instead, he said, “All politics is local.” The mindset of the successful politician begins with his or her constituency and the hopes and fears in town halls, school boards, and police precincts. It is the same in M&A: The best foundation for pursuing success and avoiding failure in M&A lies in seeing the important ways in which individual deals differ from one another. In other words, all M&A is local.”
Just as politicians need to focus on local issues to be effective, companies engaging in M&A need to consider the specific, unique aspects of each deal rather than relying on a standardized, one-size-fits-all approach.
Every M&A deal involves unique companies with their own individual strengths, weaknesses, and cultures. Recognizing and tailoring the deal to these differences is essential for the success of the deal.
“One of the basic conclusions of economics is that where markets are reasonably competitive, players will earn a “fair” rate of return; that is, you just get paid for the risk you take, but no more. The intuition for this is simple: Where information is free-flowing and entry is easy, a firm earning very high returns will draw competitors as surely as honey draws flies. The entry of these other firms will drive returns down to the point where the marginal investor gets just a fair rate of return.”
When a business seems to be doing well, it will naturally draw competitors. As more competitors enter the market, increased competition drives returns down from exceptional levels, where minimal or no competition existed, to more moderate levels as the market becomes saturated with players.
“Reinforcing the point about industry attractiveness is the mass of research showing that the sale or redeployment of underperforming businesses is greeted positively by investors. Studies of the announcement returns from divestitures find that they uniformly create value for shareholders of sellers, on the order of 1 percent to 3 percent significant abnormal returns (although the results for buyers are mixed). Generally, the studies of restructurings suggest that the redeployment of assets seems to be what matters, not merely the sale. In particular, there is evidence that the market rewards divestitures that focus the business activity of the firm.”
Essentially, investors tend to respond positively when a company decides to divest (sale or spin-off) parts of its business that aren't performing well. This generally creates value for the shareholders of the selling company, which typically results in a positive share price movement.
With that said, it’s not necessarily the act of selling itself that creates this response. What really drives it is how the assets are redeployed back into the business and how the business focuses its activities post-divestiture.
In other words, the market tends to reward companies that use divestitures to streamline and concentrate on their core business operations. A notable example of this is AT&T’s decision to sell WarnerMedia in 2022 (which merged with Discovery to become Warner Bros. Discovery). This move was well-received for several reasons.
First, AT&T had accumulated significant debt from its acquisition spree, including the purchases of Time Warner and DirecTV. By divesting WarnerMedia, AT&T was able to substantially reduce its debt burden—from nearly $200 billion in 2021 to about $155 billion by the end of 2022. This reduction in debt was a positive signal to investors who are concerned about the company’s solvency (and there are a lot of them).
Along with this, divesting WarnerMedia allowed AT&T to refocus on its primary business of telecommunications. This clearer focus can lead to better operational efficiencies and a stronger, more coherent strategic direction.
Overall, the divestiture allowed both AT&T and WarnerMedia to unlock value. WarnerMedia, now merged with Discovery, has the potential to be better managed and more agile as an independent streaming and media-focused entity. Meanwhile, AT&T can enhance its value proposition as a pure-play telecom company.
“Several studies report that stock-based deals are associated with negative returns to the buyer’s shareholders at deal announcements, whereas cash deals are zero or slightly positive. This finding is consistent with the idea that managers time the issuance of shares of stock to occur at the high point in the cycle of the company’s fortunes, or in the stock market cycle. Thus, the announcement of the payment with shares, like the announcement of an offering of seasoned stock, could be taken as a sign that managers believe the firm’s shares are overpriced.”
The negative reaction to stock-based deals makes sense when you consider that managers might decide to issue new shares if they believe the company’s stock is overpriced. They do this because issuing shares at a high price maximizes the value received from those shares, and you have to issue less shares to create the same value.
With that said, when a company announces it’s using stock to pay for an acquisition, investors might raise an eyebrow and consider that a red flag. They might take that as an indicator that management believes the share price is too high, which ultimately can cause the share price to dip.
On the other hand, cash deals don’t send the same kind of signal. They don’t make investors think the stock is overpriced (because the stock is completely left out of the equation), so these deals usually have a more neutral or slightly positive effect on the stock’s share price.
“The comparison reveals that targets in the best deals have relatively lower profit margins, liquidity, and leverage, and higher activity and growth, consistent with the notion that they represent opportunities to restructure and reinvigorate the target. The worst deals show the opposite. It is logical to infer that the best deals arise when the buyer brings something in the way of best processes and practices to the target, making it a transformation of the target; in the worst deals it seems that the target is the superior performer possibly acquired to help transform the buyer.”
The best deals typically involve targets with lower profit margins, less liquidity, and higher leverage. These characteristics present opportunities for the buyer to implement their strong processes and best practices, which can have a positive impact on the target company.
The reason for this is that companies with lower profit margins, less liquidity, and higher leverage often have untapped potential. These companies may be struggling due to inefficient processes, poor management, or a myriad of other things.
When a buyer with superior qualities acquires such a target, they can implement improvements that drive profitability, streamline operations, and reduce debt. These improvements can lead to value creation that benefs both the buyer and the target.
On the flip side, the worst deals usually occur when the target is in a stronger position than the buyer. Here, the acquisition is usually an attempt to mask the buyer’s deficiencies, but it’s often a bandaid for a bullet wound since it fails to address the buyer's underlying issues.
The reason this happens is because the target companies are already performing well and have fewer areas needing improvement. When such a target is acquired, there is less room for the buyer to add value. This can result in a mismatch where the buyer struggles to integrate and leverage the target's strengths, leading to a less successful merger.
“The five real disasters each featured little margin for error. The Hyatt bridge system had no backup paths of support. Safety systems at Chernobyl and Bhopal were shut down or inoperable. The manual override on the Ocean Ranger’s short-circuited ballast management system was extremely difficult to use. The Everest expeditions had limited time and oxygen for the final ascent. In all of these situations, the absence of a backup or buffer meant that the disaster, once triggered, would be very difficult to stop. This is ‘tight coupling.’”
"Tight coupling" refers to a situation where components are highly dependent on each other and leave little room for error. This chapter in the book details several infamous disasters that serve as important reminders of the dangers of tight coupling.
In these scenarios, the lack of backups or buffers meant that once a failure occurred, it quickly cascaded into a full-blown catastrophe.
Hyatt Bridge Collapse: The bridge's support system had no backup paths. When one part failed, the entire structure collapsed because there was nothing to distribute the load.
Chernobyl Nuclear Disaster: Essential safety systems were either shut down or inoperable. Without these critical backups, the reactor went out of control, leading to one of the worst nuclear disasters in history.
Bhopal Gas Tragedy: Similar to Chernobyl, safety mechanisms were compromised. Once the gas leak started, the lack of operational safety systems made it impossible to stop the disaster.
Ocean Ranger Oil Rig: The manual override for the ballast management system was extremely difficult to use. When the system failed, the inability to quickly manage the ballast led to the sinking of the rig.
Everest Expeditions: Limited time and oxygen for climbers created a situation with very little room for error. When problems arose, there were no additional resources to recover, leading to tragic outcomes.
In each of these cases, the tight coupling meant that once a failure began, it quickly escalated into a disaster because the systems couldn't correct the error.
In a business context, we can compare two auto manufacturers with different operating strategies:
Manufacturer A: Utilizes a just-in-time (JIT) inventory system where parts arrive just in time for assembly. This system minimizes inventory costs but makes the operation highly vulnerable to supply chain disruptions. A delay or failure in the delivery of any part can halt the entire production process, creating a tightly coupled system.
Manufacturer B: Creates a buffer by maintaining ample inventory of parts. Although this strategy comes with higher costs due to increased inventory, it provides a cushion against supply chain disruptions. If the delivery of a part is delayed, production can continue using the stockpiled inventory. This represents a loosely coupled system, where there is more room for error and disruptions are less likely to halt operations.
Overall, while tightly coupled systems can be highly efficient, they are also more vulnerable to disruptions. In any operation—business or otherwise—allowing yourself some wiggle room can prevent minor issues from escalating into major disasters.
“All of the disaster stories offer evidence that the thinking of decision-makers was biased against evidence or actions not consistent with a prevailing mindset. In all of the cases, overconfidence figured prominently in the mindset. Chernobyl (recent operating award) and Ocean Ranger (survival of previous storms) show that optimism can derive from successful past experience. Bhopal and the Hyatt walkways suggest that optimism can derive from ignorance or a general faith that someone else knows what is going on and has matters under control. The leaders of the Everest expeditions displayed optimism to the point of bravado, based in part on their own recent successes. Knowing what we know now, such optimism was unwarranted.”
Decision-makers, like all humans, have biases that cause them to dismiss evidence or actions that don't align with their existing beliefs. A key factor in this bias is overconfidence, which can stem from various sources, including past successes or misplaced trust in others.
Regarding the disasters referenced in the book:
Chernobyl: Ironically, safety was overlooked because the plant had recently won an operating award for its safety protocols.
Ocean Ranger: The crew had seen the rig survive many storms. They became complacent, thinking it was indestructible, which led them to neglect necessary safety measures.
Bhopal and Hyatt Walkways: The decision-makers assumed that safety was someone else’s responsibility. They trusted that others had ensured everything was fine, leading to catastrophic oversights.
Everest Expeditions: The leaders were so buoyed by their recent successes that they underestimated the mountain's dangers.
Similar to the decision-makers in all of these situations, investors can also become biased and ignore evidence that contradicts their investment thesis. For example, they might disregard or downplay detrimental news about a company.
It’s also easy for investors to become overconfident. If they’ve made profitable trades or investments in the past, they might believe they are impervious to losses or wrong decisions, leading them to take on more risk than they should.
A real-life example of these principles can be seen in the dot-com bubble of the late 1990s. Investors were overconfident in the potential of internet-based companies, which caused them to ignore clearly unrealistic valuations. This overconfidence was based on the initial success of a few internet companies, which led many to believe that all tech startups would eventually be profitable.
Obviously, this didn’t end up being the case, and a lot of money was lost investing in tech-stocks during this bubble. For those of us who have the benefit of hindsight, it serves as an important reminder to stay humble and never rest on one’s laurels.
“People will pay more to avoid a loss than to acquire a gain of equal size. This loss aversion led to a better understanding of two related phenomena of great importance in M&A: endowment effect in which people tend to ask more in selling an asset than they would offer to buy it; and status quo bias in which people tend to stick with their current situation because the disadvantages of changing seem larger than the advantages.”
Loss aversion is a common theme in investing. It feels worse to lose money than it does to make money—something rooted in our survival instincts. In the context of M&A, loss aversion helps us understand two related bugs in our human software: the Endowment Effect and Status Quo Bias.
The Endowment Effect occurs when sellers place a premium on an asset they own, valuing it more than its worth due to their emotional attachment.
This bias is extremely common in real estate, where homeowners often overprice their homes. Because a home is such a personal and sentimental thing, it’s difficult for the seller to not see it as more valuable than it might objectively be, leading to inflated asking prices.
The same thing happens with stocks. You might unknowingly overvalue a stock, believing it has more potential or worth than what others see, simply because you possess it.
Sometimes, this mindset is necessary because investing inherently involves a degree of arrogance. The act of buying a stock essentially means you’re saying, “I am right and the person selling it to me is wrong.” You are betting that the market has undervalued the stock and that your estimation of its true value will eventually be proven right.
On the flip side of that, you might also be hesitant to sell an underperforming stock. You may hold onto it longer than you should because you feel a sense of ownership and attachment, convincing yourself that the stock will rebound despite evidence that might indicate otherwise.
This attachment can cause you to miss out on better investment opportunities. You might refuse to sell a stock that has sentimental value or has been in your portfolio for a long time, even if other stocks offer better return prospects.
If you’re afraid to sell a stock simply because you’ve owned it for so long, you might be suffering from Status Quo Bias. This is the preference to maintain your current state of affairs due to a fear of change.
For example, consider an employee who has been with the same company for many years despite better job opportunities elsewhere. The employee may fear that switching jobs could lead to an undesirable outcome, such as a less favorable work environment—which, to be fair, does happen. Here, the fear of the potential downsides outweighs the possible upsides from a new opportunity.
With investing, Status Quo Bias might cause you to stick with the stocks (and industries) you are familiar with, even when potentially better opportunities present themselves. While it's undoubtedly important to invest within your Circle of Competence, you should also actively work to expand it over time. After all, the wider your circle, the more potential investment opportunities you have.
At the end of the day, both the Endowment Effect and Status Quo Bias tie back to loss aversion. Whether it's overvaluing what we own or fearing the risks of change, our decisions are often driven by a desire to avoid losses rather than achieve gains.
This fundamental feature of human behavior plays a key role in how we manage our investments and make decisions in our portfolio. While we can’t always overcome these biases, we can at least be aware of them to hopefully make more rational and objective investment choices.
“After an event, people have a tendency to believe that they ‘knew it would happen.’ They overestimate the likelihood that what happened would happen; this is hindsight bias. Displaying confirmation bias, decision makers observe more, give more weight to, and solicit evidence that confirms their beliefs.”
The saying "hindsight is 20/20" reminds us how easy it is to look back and believe that the events that happened were predictable. In reality, predicting the future, especially in the stock market, is impossible. No one truly knows what’s going to happen next.
People will often say they "knew it would happen" just to boost their ego. It’s no different than saying, “I told you so.”
This is a classic example of hindsight bias, where past events seem more predictable than they actually were. In investing, this bias can distort our understanding of certain outcomes, and can cause us to be overconfident in our ability to predict the future.
In addition to hindsight bias, investors often suffer from confirmation bias. This occurs when individuals favor information and opinions that confirm their pre-existing beliefs and ignore those that contradict them.
For example, they might only read articles or analyses that align with their opinion about a stock, which reinforces their viewpoints while preventing them from considering opposing evidence.
This is dangerous for obvious reasons, and both hindsight and confirmation biases can lead to poor investment decisions. They create a false sense of confidence and understanding, which is why it’s so crucial for investors to remain objective and open-minded.
“A typical LBO candidate would have most of the following features: Strong cash flow, low level of capital expenditures, strong market position, stable industry, low rate of technological change (and low R&D expense), proven management with no anticipated changes, no major change in strategy.”
In an LBO, a significant portion of the purchase price is financed with debt, so ample and consistent cash flow is of the utmost importance to ensure that the company can meet its debt obligations. All of the qualities mentioned in this quote help support the generation of consistent cash flow.
Companies with low capital expenditures require less ongoing investment in fixed assets, which means more cash can be used to service debt and generate returns.
A strong market position means the company is well-established in its industry, which supports ongoing cash flow and profitability.
A stable industry has more consistent demand and less volatility, which helps ensure steady cash flow and minimizes the volatility that comes with with economic fluctuations.
Industries with low technological change and R&D needs are less capital intensive, which allows more cash to be directed towards debt servicing if need be.
Experienced management ensures that the company operates smoothly and effectively, which is essential for executing the LBO strategy without disruption.
A sound strategy indicates that the company has a clear direction and operational model that doesn’t require major adjustments. This too supports consistent performance and cash flow.
“Deal designers must preserve some financial slack in the structuring of their transactions. Bad things can happen to good companies. It is through the maintenance of slack that buyers can withstand the vicissitudes of business life. Intuitively, one knows that slack can be valuable. Slack is like an insurance policy, to be drawn upon in times of adversity.”
"Slack" is what Warren Buffett and Ben Graham would call a "margin of safety."
Essentially, it’s about giving yourself enough buffer in a deal to cover potential errors in your analysis or unexpected events. As the quote suggests, bad things can happen to even good companies, and having that "slack" helps reduce your risk if something goes wrong.