M&A – Turning the odds in your favor
Research indicates that only half of mergers and acquisitions succeed – implying that the odds are similar to a coin toss. Moreover, more than 80% of companies surveyed globally, who have gone through an M&A transaction report that they have failed to achieve the stated goals of merger. Based on these sobering statistics, one would expect that CEOs, investors, and boards of companies would shy away from M&A as a source of growth and focus instead on deploying capital and resources towards generating growth and profitability organically.
However, if anything, M&A activity has continued to see a significant uptrend over the last several years. In 2015, global M&A exceeded US $5 trillion – an all time high. Even in India, M&A remained robust. Per an E&Y report the deal tally in 2015 rose to 970 deals totaling a transaction value of US$26.3 billion. Domestic deals accounted for 41% of this value, with cross border deals making up 59%. Outbound deals grew from 8% in 2014 to 20% in value last year indicating a growing interest in Indian companies to expand their businesses overseas.
Within domestic M&A, the average deal size has come down to $21 million implying that there are more deals happening in the mid-market space.
There are quite clearly several compelling reasons for acquisitions – access to new markets and regions; access to new technology or capabilities which would be more expensive, difficult or time-consuming to develop in house; access to new products that could bolster an existing range and enhance profitability; access to new customer relationships which would otherwise take a significant amount of time, bandwidth and investment to develop; and perhaps even consolidation of existing position in a market by eliminating competition.
As mentioned earlier, there are inherent risks in mergers and acquisitions, which can be further compounded for mid-market companies. While a larger company with a failed or under performing acquisition can put finances and bandwidth to work to fix or absorb the problem, a mid sized company doesn’t have the same luxury.
An acquisition that doesn’t deliver, or worse fails, can take up a lot of valuable management time and resources and derail the growth process – sometimes permanently.
That doesn’t mean that mid-market companies should stay away from acquisitions. M&A can be every successful means for jump-starting growth or for achieving scale. But it has to be done for the right reasons and in the right way. Times when valuations are low can be a particularly opportune time to make acquisitions, but making one without a well-crafted strategy and execution plan is akin to going to a flea market without any self-discipline.
You come back with things that are incongruous fits and don’t align with the rest of the house -in effect taking away, rather than adding to the whole.
The best acquirers use M&A to drive growth when the evidence to do so is compelling. They use M&A as an extension of their growth strategy and plan long before any opportunity arises. They ensure that they focus appropriately on business diligence, cultural compatibility and post merger integration, because they understand that issues on any of them can undermine the eventual success of the transaction.
We have shared with promoters and management teams our lists of do’s and don’ts when looking at M&A as a growth tool.
Our list of do’s include:
- Do create a playbook for your acquisition strategy. What are the gaps in your offering that you are looking to fill? Is it new markets, new technology, new manufacturing capabilities, new customer base? What is the rubric against which any acquisition target would be evaluated? This rubric should include things such as valuation, fit with your business strategy, ease of integration, future growth potential etc. In 2010, as it evaluated international expansion, Godrej Consumer Products Limited (GCPL) chalked out a well considered 3×3 strategy which laid out the geographical regions and product segments that it would consider. Rubrics within the strategy laid out ideal characteristics of prospective targets (market shares, technology capabilities, management strength etc.). This strategy was the master plan on the basis of which the company made over a dozen successful acquisitions in the following years.
- Do cast your net wide, but employ the disciplined review and selection process mentioned above to filter out opportunities with unclear strategic fit or lower than expected synergies.Sutherland Global, a BPO services provider, extended its service offerings beyond the telecom and technology verticals by acquiring players such as Adventity and Apollo Health Street. As part of the acquisition efforts, it evaluated many companies but had the discipline to select the ones that were the best fits with its strategic direction of expanding into complimentary verticals in vital emerging markets.
- Do develop a thesis that clearly spells out how the deal will add value to both the target and the acquirer. Prime Focus Limited, a leader in the 2D-to-3D conversion services market transformed itself into one of the largest integrated service providers to the global media & entertainment industry through the acquisition of Double Negative, one of the top 3 global VFX services providers. The acquisition provided Prime Focus with Academy Award winning VFX credentials and deep relationships with Hollywood majors. On its part, Double Negative benefits from access to a large, low-cost, scalable execution capacity provided by Prime Focus.
- Do conduct thorough, hard-nosed due diligence to test the deal thesis, including an objective look at the purchase consideration. There is no substitute for unbiased due diligence. Ensuring that you are getting what you are paying for in advance of finalizing the transaction is crucial, and the only way to do that is by looking under the hood of the target company. Evaluate how the purchase price compares with other transactions in the industry.
- Do develop a detailed post merger integration plan, including determining what must be integrated and what can be kept separate, based on where value is expected to be created. This is where the rubber meets the road and having a detailed post integration plan and flawless execution separates the winners from the rest of the pack. TVS Logistics – a global integrated 3PL player – grew EBITDA by more than 10x over a six-year period by successfully completing seven value accretive bolt-on acquisitions while retaining management.
- Do communicate with all stakeholders, including employees and shareholders, to explain the rationale for the transaction.Acquisitive phases can become times of uncertainty for stakeholders of a company. In several examples we have seen the CEO and senior management holding town hall meetings with employees to explain the reasons for the transaction –the clarity expressed from the top goes a long way in ensuring alignment at all levels.
On the flip side, there are also several don’ts, which we recommend paying close attention to:
- Don’t stray from your core business and strategy. If you have ever narrowed your eyes at the news of an acquisition and wondered about the rationale behind it, you know what we mean here. A diversion from the core business strategy for a mid sized company can be a very costly detour. Acquisitions should be in areas that will clearly enhance the company’s growth and capabilities. Not in ones that leave you scratching your head
- Don’t ignore the cultural fit and human capital alignment. As per research, over 30% of mergers fail because of culture incompatibility. Some famous (or rather, infamous) examples include Daimler-Chrysler, AOL-Time Warner, HP-Compaq. In each one of them cultural misalignment was cited as the main reason for the failure. What happens when a company that has thrived in an entrepreneurial setting is acquired by one that functions more bureaucratically? What happens if incentive structures or talent development and advancement are different at the two companies? In some companies decision-making is done by consensus, while in another it is based on rapid determination. How does that impact the merged entity? Ignoring these issues as “softer” issues, has cost many companies dearly. Cultural incompatibility can create resentment, bitterness and even unwanted attrition.
- Don’t underestimate the management bandwidth it will take to successfully integrate an acquisition. Integrating the new business will take significant time and effort. Making the acquisition is the start of the journey. If your team is already stretched, perhaps this is not the best time to undertake an acquisition. It is just as important to ensure that your management team is committed to the effective integration of the acquisition.
- Don’t let ego get in the way. Ego and M&A are a toxic combination. Ego causes inflated valuations, poor quality corporate governance, sub-optimal diligence,and ignorance of issues that could go on to derail the transaction. Make sure you remain objective. Ask yourself the key questions. Is the deal priced fairly enough so that it can be value accretive to your business? Is the acquisition, along with its costs and risks, the best option for the shareholders of the company? Is there a game plan to address known and unknown issues as they arise during integration?.
Research suggests that M&A creates the most value when it is frequent and material over time. Companies that have a repeatable model and institutional discipline to find, diligence and integrate companies over and over again are the companies that outperform in the marketplace. And there in, lay the two words that form the crux of the successful M&A – “having discipline”. Danaher Corporation, for example, invests millions of dollars every year to train its employees and managers on the philosophy and tools of the Danaher Business System an integrated and tested set of processes, designed to deliver high impact in an efficient manner –and it becomes the engine behind successful post merger integration time and time again.
In short, M&A is an essential part of successful strategies for profitable growth. If your company has a successful strategy, you can use the balance sheet to strengthen and extend that strategy. M&A can help you enter new markets and product lines, find new customers and develop new capabilities. They can help you boost your earnings and turbo charge your growth. The trick is, as always, to do M&A right. Else, you’re better off not tossing that coin.