Harvard Business Review

Discipline and the Dilutive Deal

Kellogg’s acquisition of Keebler demonstrates how discipline can counteract dilution.

By David Harding and Phyllis Yale

First published on julio 01, 2002
min read


This article originally appeared on HBR.org (subscription may be required). When cereal giant Kellogg acquired Keebler Foods last year, many analysts were skeptical of the merger’s prospects. Because Keebler had a higher price-earnings ratio than Kellogg, the deal was dilutive, instantly slashing Kellogg’s estimated earnings per share by 20% (including goodwill charges). But a year after the merger announcement, Kellogg rewarded its shareholders with a 25% return. This remarkable performance flies in the face of conventional wisdom. Analysts expect dilutive deals to depress shareholder value, and accretive ones—those that instantly boost EPS—to enhance returns. Was Kellogg’s experience an anomaly? Not at all. When we examined nearly 100 U.S. acquisitions announced between 1996 and 2000 with price tags over $1 billion, we found that the companies making dilutive deals actually outperformed those making accretive deals. In the year following the merger announcement, nearly half of companies completing dilutive deals surpassed their industry’s average stock-price returns by more than 10%. Only a third of companies that had done accretive deals achieved similar results. What could account for this? In a word: discipline. The market’s suspicion of dilutive deals places enormous pressure on executives to be rigorous in both analyzing and executing mergers. Meanwhile, the market’s embrace of accretive acquisitions eases the pressure on executives, raising the likelihood of sloppiness in analysis and tardiness in execution. Four Tough Tests In previous Bain research, interviews with deal makers in a sample of 1,700 mergers showed that executives who led high-performing mergers consistently applied four disciplines, which they credit for their success: Strategic Fit: They developed rational, well-articulated merger strategies that nested each transaction in existing strategy. Due Diligence: They ascertained exactly how the target business operated and how it really made its money. Business Synergies: They tightly quantified the value that managers planned to extract from combining operations and developed detailed plans for reaping the synergies. Management Capabilities: They carefully examined their management strengths and limitations and designed the merger to exploit both companies’ capabilities. When we examined the mergers in our current study, looking for attention to these disciplines, we found that the highest shareholder returns correlated with an aggressive focus on at least three of the four. Bain Book Mastering the Merger Learn more about the core decision strategies that help companies win in M&A. The Good and the Bad Kellogg’s acquisition of Keebler demonstrates how discipline can counteract dilution. Kellogg applied all four disciplines. First, the company filled a big strategic hole in direct distribution. Kellogg was developing a line of new snack foods, including Nutri-Grain bars and Rice Krispies Treats, but it had no distribution system to get those snacks into convenience stores, gas stations, and other points of impulse buying. Keebler had strong, direct distribution but needed more volume. Second, Kellogg had a precise understanding of the business it was targeting because it had worked closely with Keebler for years before the deal. Third, the company meticulously quantified expected synergies, telling analysts to expect “$170 million in annual cost savings by 2003 through procurement savings, capacity rationalization, improved logistics and warehousing, and the reduction of duplicate expenses.” Finally, Kellogg’s executives understood and tapped Keebler’s management strengths, insisting that the Keebler team that was overseeing distribution stay on and run the new business. Indeed, Kellogg moved its snack food business under the entrepreneurial Keebler team for its next phase of innovation. *Read the full article in the Harvard Business Review.* David Harding is an advisory partner in Bain & Company’s Boston office and the former leader of the Global Mergers & Acquisitions practice. He is a coauthor of Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, 2004). Phyllis Yale is an advisory partner in Bain’s Boston office.

This article originally appeared on HBR.org (subscription may be required).

When cereal giant Kellogg acquired Keebler Foods last year, many analysts were skeptical of the merger’s prospects. Because Keebler had a higher price-earnings ratio than Kellogg, the deal was dilutive, instantly slashing Kellogg’s estimated earnings per share by 20% (including goodwill charges). But a year after the merger announcement, Kellogg rewarded its shareholders with a 25% return. This remarkable performance flies in the face of conventional wisdom. Analysts expect dilutive deals to depress shareholder value, and accretive ones—those that instantly boost EPS—to enhance returns.

Was Kellogg’s experience an anomaly? Not at all. When we examined nearly 100 U.S. acquisitions announced between 1996 and 2000 with price tags over $1 billion, we found that the companies making dilutive deals actually outperformed those making accretive deals. In the year following the merger announcement, nearly half of companies completing dilutive deals surpassed their industry’s average stock-price returns by more than 10%. Only a third of companies that had done accretive deals achieved similar results.

What could account for this? In a word: discipline. The market’s suspicion of dilutive deals places enormous pressure on executives to be rigorous in both analyzing and executing mergers. Meanwhile, the market’s embrace of accretive acquisitions eases the pressure on executives, raising the likelihood of sloppiness in analysis and tardiness in execution.

Four Tough Tests

In previous Bain research, interviews with deal makers in a sample of 1,700 mergers showed that executives who led high-performing mergers consistently applied four disciplines, which they credit for their success:

Strategic Fit: They developed rational, well-articulated merger strategies that nested each transaction in existing strategy.
Due Diligence: They ascertained exactly how the target business operated and how it really made its money.
Business Synergies: They tightly quantified the value that managers planned to extract from combining operations and developed detailed plans for reaping the synergies.
Management Capabilities: They carefully examined their management strengths and limitations and designed the merger to exploit both companies’ capabilities.

When we examined the mergers in our current study, looking for attention to these disciplines, we found that the highest shareholder returns correlated with an aggressive focus on at least three of the four.

Bain Book

Mastering the Merger

Learn more about the core decision strategies that help companies win in M&A.

The Good and the Bad

Kellogg’s acquisition of Keebler demonstrates how discipline can counteract dilution. Kellogg applied all four disciplines. First, the company filled a big strategic hole in direct distribution. Kellogg was developing a line of new snack foods, including Nutri-Grain bars and Rice Krispies Treats, but it had no distribution system to get those snacks into convenience stores, gas stations, and other points of impulse buying. Keebler had strong, direct distribution but needed more volume. Second, Kellogg had a precise understanding of the business it was targeting because it had worked closely with Keebler for years before the deal. Third, the company meticulously quantified expected synergies, telling analysts to expect “$170 million in annual cost savings by 2003 through procurement savings, capacity rationalization, improved logistics and warehousing, and the reduction of duplicate expenses.” Finally, Kellogg’s executives understood and tapped Keebler’s management strengths, insisting that the Keebler team that was overseeing distribution stay on and run the new business. Indeed, Kellogg moved its snack food business under the entrepreneurial Keebler team for its next phase of innovation.

Read the full article in the Harvard Business Review.

David Harding is an advisory partner in Bain & Company’s Boston office and the former leader of the Global Mergers & Acquisitions practice. He is a coauthor of Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, 2004). Phyllis Yale is an advisory partner in Bain’s Boston office.