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Come Together: Creating M&A Success Stories
The increased pace of merger and acquisition activity late in 2010 and early in 2011, including some huge deals, suggests this will be an active year. Low interest rates, significant cash on many firms’ balance sheets, and stock prices that are low enough to attract buyers but high enough to move sellers off the sidelines all reinforce that possibility.
Decisions on acquisitions are always a challenge. There is extensive literature that documents the too-high percentage of failed combinations, ones that failed to reward shareholders with a positive return on their investment.
Yet most consulting firms are motivated to consider acquisitions as an element of their growth strategy, citing the potential contributions from acquired firms, including ones targeted to fill gaps in a firm’s portfolio and ones seen as having the potential to help create a game-changing position. And often it is the case that an acquisition can bring assets and competencies that are otherwise either unavailable or that would take years to develop.
The hardest acquisitions to evaluate are those that involve a decision to enter a new line of business and new markets. “Bolt-on acquisitions” are far simpler, involving familiar business environments with known characteristics and risks. Often, the acquisition target in such situations is quite familiar to the acquiring firm as one of the well-known players operating in the same market. But when the acquisition option involves a new and unfamiliar situation, the need to ask the right questions
Most corporations have established solid processes of due diligence to evaluate acquisition candidates, spanning a wide spectrum of economic, legal, and other factors. In the implementation of these processes, there is an intense focus on the firm targeted to ensure that its market position is solid, its assets secure, and its financial structure sound. Such assessments are critical to decisions likely to yield success in the end.
Stay Market Focused
In analyzing acquisitions that succeeded and ones that failed, one insight that has emerged is that this strategic due diligence process should also focus on the overall market in which the acquisition candidate operates and link insights that emerge to the capabilities of the acquiring firm itself. Quite a few of the problems of failed acquisitions had nothing to do with the firm that was acquired. Rather, they could be traced to changes taking place in the broader business environment that the acquiring firm was ill-prepared to address.
The criticality of a strategic due diligence process that includes both traditional elements and ones that look at the potential evolution of the business environment cannot be understated. Despite the long roster of ways in which acquisitions can create value, studies of acquisitions find numerous examples in which eventual problems were rooted in shortcomings in the business case that justified the acquisition.
Harding and Rovit, for example, reviewed more than 1,700 mergers and acquisitions and interviewed 250 CEOs. They found that “less than one in three CEOs interviewed had a clear strategic rationale for the M&A decision, or understood the contribution the deal would make to their company’s long-term financial future.” Furthermore, “over half of those companies with a clear rationale underpinning their M&A activity came to a post-M&A conclusion that their rationale had been wrong.”
Ask the Right Questions
The starting point for an expanded assessment that considers the potential for disruption in the business environment is a set of questions that are already part of the due diligence process for most firms. Is this a good business to be in? Do the firms in this business make money, and does the forecast point to a positive future outlook? Does the business create legitimate value for its customers, and is this value recognized? Are the firms in this industry that create value for their customers rewarded for their contributions, or is the business characterized by aggressive price-buying?
Adverse answers to such questions trigger the caution flags, and appropriately so. But even when the answers are positive and the future outlook appears rosy, it makes sense to develop scenarios that are disruptive. A starting point is to ask the acquisition team and available experts the question “If five years from now, this industry looked totally different, can you give me a scenario as to how that might have happened?”
In quite a few cases, that question has triggered ideas about opportunities that exist for a “game changing” strategy that will generate value and rewards for the firm that implements it. In a few instances, the firm considering the acquisition identified a strategy through which it could gain far more from being the change agent than had been anticipated prior to then.
Sometimes the disruptive scenario involves changes that are taking place in the business environment (e.g., technology innovations, new regulations, changes in demand patterns, distress situations involving current players in the market). Other times, the scenario involves some participant from within or outside the industry implementing a strategy that creates value in a new way (through rolling up smaller firms and creating economies of scale, through some technology foundation that provides an advantage).
Sometimes the scenario involves changes that undermine the current foundations for industry profitability (e.g., new competitors that overcome barriers to entry). And sometimes the scenario involves growth through the industry’s expansion into new global markets or adjacency businesses. In all of these cases, when it is possible to identify a disruptive strategy that creates a “leadership position” that can be sustained, it has to be taken as a serious possibility.
Whether the disruptive scenario is one involving a great upside or a significant downside risk, it has to be included in the acquisition evaluation and plan. That evaluation and plan must start with self-examination on the part of the acquiring firm. The acquiring firm must ask if it is the “right firm” to implement such a strategy. It must ask whether there are reasons why it is better positioned for success than are others (for example, expertise in the market, synergy through existing operations, core competencies that are transferrable, assets that can be leveraged).
It must ask if the business model changes that will be required are practical in terms of its demands on resources (financial resources, human resources, etc.). It must assume that competitors will react, and decide if their reactions can be thwarted in order to ensure that the pro forma forecasts associated with the strategy are realized. Far too often, the acquisition decisions and business case assume a “steady-on-course” future for the acquired company, when the reality in fact involves significant change, disruption, and requirements for investment of time, money, and expertise.
Identifying a disruptive scenario need not derail the decision to go forward with an acquisition. After all, in many instances, such scenarios are correctly characterized as low probability events, and the attractiveness of the acquisition under more likely forecasts should be the primary driver of decisions. But there are several ways in which the acquisition implementation plan should be modified so as to reflect such scenarios.
For example, in any implementation plan, it is critical to identify the “killer variables” that will determine whether the plan succeeds or fails. The integration team should develop a monitoring plan that allows them to forecast whether the base case forecast is unfolding or whether one of the disruptive scenarios is beginning to develop.
The business environment of 2011 and beyond is one in which this guidance is likely to be of even greater importance than normal. There are significant changes taking place in many markets, as they recover from the recession, as the forces of globalization introduce new competitors and sources of innovation, and as slow-moving trends in the economy motivate decisions to implement new business models.
Evaluating the potential for disruption and determining if your own firm is in a solid position to gain during such times can allow decisions on acquisitions to result in success stories that strengthen your prospects for sustained profitable growth.
Author: George F. Brown, Jr.