The importance of human capital in an M&A transaction
Rob Thissen, energy sector leader for the Middle East at Mercer, says companies in the middle of a merger or acquisition must prioritise people
While oil and gas prices rise and fall, a resurgent regional and global energy market, driven by increased demand, should set the stage for sustained merger and acquisition (M&A) activity over the long term.
M&A activity in the Middle East region rose by 50% in 2018, bringing to light HR-related challenges that investors are becoming increasingly concerned about. This includes how workforces are being managed through the screening, diligence and post-merger integration phases of the transaction. According to Mercer’s in-depth research in mitigating culture risks to drive deal value, people risks in M&A transactions are manifested by the inability of employees to manage uncertainty and embrace change – which in return, results in declining business performance and the potential loss of transaction value. Poorly executed integrations, failure to consider differences in company culture, and lack of transparency in employee communications are prime examples of people risks that can severely undermine deals and destroy value. Clearly, the stakes are high, and the Energy sector, as a capital-intensive industry, doesn’t appear to be on the forefront of dealing with these challenges.
People related risks have profound implications for organisations: If they are not effectively addressed, they can lead to low morale and engagement, reduces productivity, diminished performance, inconsistent customer service, and – ultimately – revenue and profit loss.
The magnitude of these risks stress that companies must consider people issues at the outset if they hope to protect the value of the transaction. Research reveals organisations that demonstrate the same discipline and rigor to addressing human capital investment and people issues as they do in managing balance sheet risks and other key operational aspects of a deal realise the most value from the transaction.
Our extensive research highlights the following people-related risks that successful multinationals prioritise during M&A transactions to maintain sustainable returns for investors:
Employee Retention. Managing employee retention, or diminishing “flight risk”, used to solely focus on retaining key leadership in the acquired company and their pay packages. However, we are observing a clear shift to broaden the spectrum to other critical employees as well, with 35% of companies globally extending retention pay to critical, lower level staff. It is worth noting that this practice is much more common in the West than in most emerging markets, including the Middle East.
Retention-related pay typically comes in the form of a bonus, usually based on time spent with the company pre- or post-transaction rather than performance. While retention bonuses are common practice in other industries, slightly surprisingly, we found that it is prevalent in less than half of M&A transactions in the Energy industry. One of the reasons may be the downturn in the industry seen in the last few years, which has led to lower incentives needed to prevent flight risk, but it’s a tool the industry could rely upon more than it does now.
While historically categorised as a non-financial risk, cultural fit is key to a successful transaction, with “30% of transactions failing or underperforming because of a cultural issue". Corporate culture is a main determinant for employee retention and performance. It is important to point out that company culture is often referred to as “the working environment”, however culture encompasses much more. Employees in the Energy sector have indicated that the way leaders behave, the decision-making processes in place as well as communication styles are strong indicators for a successful merger or acquisition.
Cultural fit is probably the most underestimated or least understood angle to M&A, but it is crucial to obtain data in this area to assess any cultural risks. Running culture surveys to understand how both organisations compare is a good place to start.
The quality of the leadership team within the new structure tends to appear on the radar of acquiring organisations post-deal, however, it is crucial to start this process early as part of due diligence. We find that organisations around the globe, as well as in the region, put a lot of emphasis on assessing technical and behavioral competencies as part of integration exercises, however, acquirers dedicate limited time and resources to studying the leadership / management history at the target company. Mercer urges acquiring companies to at least employ informal strategies, such as observation of leadership behavior during presentations and meetings, or even reviews of CVs archived in the data room.
Compensation & Benefits (rewards)
Last but not least, it is remarkable that compensation & benefits have been listed only as the 4th HR priority in M&A transactions. Western companies, for instance, are well aware that pensions can become a post-merger headache if not managed properly and around 80% of companies have a dedicated work stream for retirement plans and liabilities. Although pensions are not so much a topic in the Middle East, in general, reward packages here are more complex than in most other parts of the world. The diverse scope of allowances and benefits employees receive in our region requires proper scrutiny and costing during the integration, and we often see overseas multinationals enlisting consulting services as part of this process. What’s more, especially in the Energy industry, acquiring assets from a multinational in the Middle East often comes with a large number of staff on various international assignment and rotation packages, which adds another layer of complexity.
Clearly, all of the points discussed above need to be carefully considered by acquiring companies in the oil and gas sector, particularly given the unique employee populations in the region. Flight risk of senior management can arguably be considered an even higher risk in the region due to the number of expats in these positions. While nationalisation agendas require companies to set up mechanisms to meet targets, companies must simultaneously ensure a seamless cultural and leadership transition. With an increased rate of M&A activity in the Middle East region, it is time to seriously consider the human factor, pre- rather than post transaction.