11 minute read
Acquisitions can propel companies towards competitive advantage at a faster pace than organic growth can achieve. When well-executed, acquisitions can grab headlines and secure ‘CEO saviour’ or ‘leader’ reputations – but, when badly executed, they can destroy value and create ‘CEO scoundrels’, such as we saw with Sir Fred Goodwin’s ABN AMRO purchase. The acquisition was badly delivered, over-priced and the timing was poor. Acquisitions can provide good investment yields and, with the right scale-up strategy can result in later exits at increased value with shareholder value increasing 2, 3 or more times the original investment. This is the private equity arena – but how do both trade or private equity ensure they ‘buy right’?
What is the Strategy?
The best acquisitions start with the fundamental questions – what is the strategy? What is your plan and vision and why does the acquisition fit or, not? While it seems obvious that no one would spend millions or sometimes billions of pounds without a clear vision of a potential acquisition’s strategic benefits, motivation, and potential outcome, you would be surprised. Acquisitions can create short-term boosts, headlines, and immediate returns, but a longer-term organic growth strategy may be an alternative, but less obvious. Many leaders are simply not clear on what the vision or mission within their segment is and with abundant capital and not enough opportunity they can rush to acquisitions as the growth solution with little focus on execution.
When setting out an acquisition strategy CEO’s must have a clear understanding of:
- The mission and vision for the business against market dynamics and the likely future line of probability in those dynamics.
- What business the organisation is in and why and what they are not in.
- Resources and yield to generate a return on capital.
- What are the alternative organic growth strategies?
- The culture, ethos, and standards of the business today and tomorrow.
- What customers want today and tomorrow.
Strategy is deeper than a plan, as it anticipates scenarios – we liken it to the game of chess where a player is constantly thinking more moves ahead. The winners in strategy are those who have a better vision and understanding of where market dynamics are taking them. Yes, we need scale, we need shareholder value, we want a return on capital employed, we want synergy, and we want economies of scale – but most of all we want to create organisations that customers champion and can aspire to and here is where it becomes clearer who to buy. The CEO or investment team must focus on the market rather than following it. They should consider what business they are in and why, and in that context, are they ahead or behind the market? The right strategic acquisitions can help create competitive advantage, increasing business breadth or depth through market share, new territories, products and/or skills capabilities. We view the four foundation corners of strategic M&A to be economies of scale, synergy, share value and positive disruption.
The Four Corners of M&A
- Economies of Scale – These are long-term, usually scale-led cost savings. This may include optimising production in manufacturing or access to more efficient equipment, using technical infrastructure for data mining, reducing distribution costs through larger containers or bulk carriers or enhancing buying power.
- Shareholder Value – Growth in both the buyer and the seller and increasing value through the combination of the two. This may include a multiple arbitrage strategy buying 2 or 3 companies at multiples of 5-6 and then selling out with more scale and higher quality earnings at multiples of 8 or more. This also reflects how often, the bigger the earnings in the emerging mid-market sector, the bigger the price-earnings ‘multiple’ used to value these companies.
- Synergy – A synergistic acquisition is where the cooperation of or merger of the organisations produce a combined market effect that is greater than the sum of their capabilities. Our view is that synergistic mergers and acquisitions are hallmarked by growth aspects, such as better combined know-how or cross-selling to enhance revenues. Economies of scale can be seen as cost and efficiency whereas synergy is a trigger or catalyst for growth, and can encompass access to new customers, expertise, ideas, territories, channels, or products.
- Positive Disruption – This is achieved by buying valuable skills and capabilities to reduced barriers to entry for new markets. This might include buying intellectual property or team know-how. When we do this deep analysis, we get a clear view on who we should buy and how to realise the best return on capital – whilst simultaneously understanding who we should not buy, which is why we see positive disruption as the keystone to a successful acquisition. In positive disruption; the alternatives to acquisitions may also be joint ventures or partial equity stakes.
The primary role of the CEO or investment leaders is to set out the acquisition strategy and manage both the financial and capital resources to create sustainable growth. Acquisitions may sit alongside or even be central to securing such growth in slow-growth economies, where organic growth becomes less of a choice. This leaves the leaders running a careful balancing act of optimising the return from the core business yet investing in uncertain futures.
Ultimately, the right decision to acquire is ideally based on the overall objective to create value in the acquired venture and if it is a trade buyer, in the overall organisation, not on their current profits or earnings. This value creation should be through both competitive advantages and return on capital – when, where and how will performance gains be secured versus the acquisition price?
If an acquirer is uncertain whether an acquisition will generate the required synergies and value, then an earn-out can create a hedge, although this will usually slow any proposed integration. Experienced and successful acquirers will carefully evaluate the risk that anticipated synergies may not be realised. Additionally, they understand the challenges that face effective merger integration, including assessing the true costs of distraction and lost opportunity in the core business that can occur. A pre-Covid survey by PWC in 2019 showed that only 53% of acquired businesses underperformed their peers, on average, over the 24 months following completion, with only 34% of acquirers saying that value creation was an immediate priority.
Why do acquisitions fail?
Distraction from core business – Finding and securing the right deal can be incredibly time-consuming – potentially a full-time job over six months or more for senior executives, which is costly. The potential upside of a well-executed acquisition is compelling, so many private companies get caught up in the excitement of the “hunt”. Outsourcing to professional advisors wherever possible does reduce this risk, as does awareness of the problem.
- Deal fever – This happens when you have so much time, energy and emotion tied up in a deal that your focus shifts from doing the right deal, to simply getting a deal done. Even seasoned private equity professionals get deal fever – it is hard not to ignore potential deal downsides. Sometimes the best investment decisions are to not invest.
- Paying too much – It is only with hindsight we can truly assess this. If a deal is agreed upon, it is assumed that all the parties have correctly assessed a value at that point in time that they are happy with. However, sometimes competitive bids can drive value to the top of the charts, added to which taking on significant debt to complete a deal followed by a downturn either due to the acquisition or just recession timing can create significant problems. We suggest getting second and third opinions on the value and allowing for the downside.
- People – Management is not elastic. Firstly, M&A activity usually creates a long list of things to do and change. Secondly, this list will often combine with a cultural change, which then adds a layer of stress on management already running in fast-changing, competitive and dynamic markets. These three aspects combine to create an overwhelming and sometimes deadly cocktail that results in management failure.
Summary
Acquisitions can sit at the heart of effective business growth and shareholder value strategy, but they are technical and require a robust, expert approach and good advisors to ensure success. Done well, they offer new territories, products, expertise, and scale that can accelerate both profits and value. Acquirers can also gain strong brands, innovation, and Intellectual property. In the current slow-growth economic climate (western economies) acquisitions offer a viable alternative to organic growth because they provide fast growth, whereas continuing to compete in existing markets may not be an option where the seller has effectively built a brand and secured market loyalty that creates a barrier to market share.
Contact Avondale Corporate
Avondale is a leading business advisor that helps ambitious owners buy or sell companies, secure investment, grow their business and enhance shareholder value. If you’re thinking about Employee Ownership, why don’t you give us a call for an exploratory discussion without obligation on +44 (0)20 7788 8250, view our Contact Us page or email us at av@avondale.co.uk for further information?
Alternatively, you are invited to join our next discussion by registering here for our next webinar “How to improve the saleability of your business” on 17th March 2022.
