In “The Mathematics of Love”, a Ted Talk available here, Dr. Hannah Fry explains how mathematics can help achieve success in love affairs. In a perilous exercise, this note will seek to draw an analogy with M&A. But first let us look at the three “love tips” shared by Dr. Fry:
1. Dating: Thanks to an analysis of online dating statistics, it can be demonstrated that the candidates who receive the most approaches from potential partners are not necessarily those who are deemed to be the most attractive. Indeed, many potential contenders disqualify themselves as they do not want to risk the humiliation from being rejected by these most attractive candidates. Instead, perhaps counter-intuitively, the most differentiated candidates (those with a large spread in their attractiveness scores) are those who attract the most attention as contenders wrongly assume that they have a better chance of winning the prize
2. The optimal partner: According to the optimal stopping theory, any person should systematically reject marriage candidates during the first 37% of his or her dating window, and marry the next person s/he meets which is above the average of the persons already met in order to maximize the probability of meeting the optimal partner
3. Avoiding a break-up: It can be there again mathematically demonstrated that couples with a low negativity threshold have the highest chance of success. In a low negativity threshold environment, couples do not let anything go unnoticed and allow each other some room to complain, which allow them to be in a constant relationship “repairing” mode
The takeaways from an M&A perspective:
1. In “hot” sell-side processes, a number of potential buyers typically disqualify themselves, as in dating. Advisors often argue that this enhances the exclusive nature of the process—and perhaps it does. But the reduced competitive tension may have a negative impact on the outcome.
The dating stats suggest that playing up to whatever makes an asset different, even if some potential buyers might find it unattractive, would instead maximize competitive tension, and thus optimize the M&A process outcome.
In any event, overstating the attractiveness of an average quality asset creates a dual execution risk. Not only does this generally lead to the self-disqualification of bona fide buyers, but intrepid bidders could also end up being disappointed with the target during the due diligence process. Bankers who advise their clients to seek to “anchor” a process at a high valuation level should think more than twice before proceeding. Such approach can be the kiss of death. If you ask me, this happens far too often;
2. The optimal stopping theory is relevant under the scenario where a company would randomly screen a large, but overall limited number of targets in a specific segment and would not be allowed to get back to ideas rejected in the first place (say, because it would have been bought by a competitor on the back of an auction process). In that case, a company would have to screen the first 37% of the anticipated target universe, and pick the following target which would score above the average quality of the 37% companies already screened and rejected. That way, the probability to acquire the optimal target is maximized.
In an alternative version which may be closer to reality in its application, a company may decide to make an acquisition in a specific segment and gives itself three years to do so. In that context, the company would screen companies during the first 37% of the search window, here about a year, and then seek to acquire the first company which rates above the average of the companies screened over the first year.
The key here is that once an acquirer has seen 37% of the potential targets (it expects to see within a certain timeframe), a coherent picture of the ideal target is created and the next company who meets the criteria should be acquired.
Whilst the immediate applicability of some of the assumptions can be disputed, the following notion much be correct: Rejecting a large number of targets with the ambition to find the perfect one later on is not necessarily a winning strategy. The optimal stopping theory offers at a minimum a conceptual framework providing both time to evaluate targets and a decision making framework to minimise regrets down the road;
3. Love Tip 3 is relevant during the post-merger integration phase. During that delicate period, employees who tend to complain should perhaps be given greater credit as they might just be allowing for the emergence of a climate of constant integration repair mode.
So yes, M&A can be both an art and a science.
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